One of the simplest yet most often improperly utilized chart patterns is the double top, a common indicator of trend reversal. An analysis of the pattern will show why all too often, traders enter the market too early.

There are seven steps within the double top pattern:

1.    A trend of significant length and strength.

2.    The first peak. At this point in the pattern, no one would recognise this as the first peak or set of peaks in a double top, but would assume it to be a continuation of the trend. It does, however, set a resistance level for future testing.

3.    The trough. Most chart readers would assume this to be the consolidation and minor reversal caused by profit-taking. The dip of the trough should be 10–20% the length of the trend line and on long-term charts may require several months to complete, setting a new support level at its lowest point. Volume and volatility will decrease as the trend’s momentum wanes.

4.    The second peak. This should be very near to the same price set by the first peak. Volume should remain low as the price hits the resistance level, where it may stutter a bit before falling away.

5.    The second decline. At this point, many traders become wary that the trend’s momentum has broken, and begin to close out their open positions in the forex trading market. This renews the currency pair’s volume and accelerates the trend reversal. Candlestick traders speak of bears winning the battle against the bulls.

6.    Break of the support level. Only at this point is the pattern confirmed and complete; prior to this, the potential double top remains just that: a potentiality. However, when the price falls in a convincing manner and with mounting volume through the support level set earlier by the trough, the double top is confirmed.

7.    The support level created by the deepest level of the trough becomes the new resistance level, and occasionally a reaction rally will test its strength. It’s been known for the rally to break back above that level to a second line of resistance, often a level paused at during the second decline. When that happens, some of the bear traders, concerned with their losses, will close their short positions, creating the very rally they desired.

After the support/resistance level set by the trough is decisively broken, the target price for the bears is an equal distance below that point.

Keeping this pattern in mind, examine this one-hour chart of GBP/JPY from late January of this year:

This is almost a textbook example of a double top: the long climb up, the first peak, trough, second peak, sudden drop, test of the “neckline,” then the continued drop.

Now examine this four-hour chart of EUR/USD from mid-October 2007:

At first glance, this seems a double top in the making: the climb up, the two peaks, the second descent. However, until the support line is decisively broken, the pattern is not complete and not reliable.

Here’s the chart from several days later:

The currency pair respected the support line and resumed its rally.

With double tops or any other chart pattern, the golden rule is: always wait for confirmation.