Most trading strategies you come across often give you the gist of the setup. While most traders are happy with this information, it can be difficult to consistently make a profit when you follow this method.
A day trading strategy is only as successful as how well you understand and use it properly. Using a top down approach to trading can be a little bit time consuming. But when it comes to trading with your money, you can never be too careful. Spending time to understand the trading system and how it works can be beneficial for you as a trader.
One of the advantages of this being that it can remove some emotions from the market when you trade. Trading, as you may know is a psychology game. You can gain a psychological edge only if you are able to understand the reasoning behind the trading system.
In this top down approach to trading, which is based on a free double top and double bottom indicator, you can be sure of having a reliable trading system that will consistently give you an edge. This strategy combines logic of a few concepts in trading and puts you in control of your trading.
As you may know, there are many methods of technical analysis. Among these, price action-based patterns are quite reliable. These patterns form because of the investor psychology that drives prices.
Most traders often trade such price action-based patterns without giving it much thought. It is important to understand the meaning behind such patterns.
Among the many patterns available, one of the most consistent patterns is the double top and the double bottom pattern.
What is the double top and double bottom pattern?
As the name suggests, a double top pattern is where price fails to break a previously established price level. This indicates area of resistance where sellers overwhelm the market. As a result, the buyers eventually give up leading to a double top pattern.
A double bottom pattern is the exact opposite of a double top pattern. Here, price initially forms a low and then bounce back. Following this bounce, price once again tests the same level but fails to break any lower.
The double bottom pattern indicates an area of support or demand where buyers overwhelm the sellers, leading to price forming this pattern.
A subsequent validation of these patterns eventually signals a reversal in the price’s direction.
The double top and double bottom patterns are formed at the top or at the bottom of a trend. When these patterns form, it tells you that the market momentum in the direction is stalling.
When price fails to make any fresh lows or highs but closes at or near the previously established high or low, a double top or a double bottom pattern is formed.
The next chart below shows the double top and the double bottom pattern on a real chart.
In figure 1, you can notice that after the double top pattern is formed, price tends to eventually move lower. A few sessions later, you will see the double bottom pattern that emerges. A successful formation of this double top or double bottom pattern results in a change of trend.
By now you should get a fair idea of where we are heading. We know that the double top and double bottom patterns are useful to identify when price changes direction.
Another way to view the double top or the double bottom pattern is illustrated below.
In figure 2, you can see how the double top and double bottom patterns are formed. The reference point 2 marks the second retest of the top or the bottom. It should be noted that not all double top or double bottom patterns are perfect.
It is very rare to find price forming a double top or a double bottom pattern at exactly the same price level.
Another point to note is the swing point in the pattern. This is the interim high in case of a double bottom pattern or an interim low in case of a double top pattern. When this reference point is breached (marked by the horizontal line in figure 2), you can expect the pattern to be validated.
Figure 2: Double top/bottom pattern for easy identification
Once the pattern is formed, price now changes direction. Knowing these patterns can be important as it helps you to trade the price movements. When you combine these patterns with the concept of trends, you can see that your trading confidence also improves greatly.
To put it simply, if you see an uptrend on a daily chart but a double top on the one-hour chart, it can mean two things. Price is either reversing direction and therefore posting a correction, or price is indeed starting to change the trend.
Regardless, keeping an eye out on the major and the minor trends can help you to gain confidence when trading with these setups.
Now that we have an understanding of the double top and the double bottom patterns, let’s see how we can apply this to different aspects of trading.
Double bottom/top at trend line
A double bottom (DB) or a double top (DT) when formed within a trend can signal a continuation. For example, figure 3 shows the DB on a rising trend line.
In this method, you will first look to a main longer-term chart and plot your trend line there. This tells you that the main trend is to the upside.
Figure 3: Double Bottom on a rising trend line on a smaller time frame
Now, when you look to a smaller time frame, you will be able to identify potential setups such as the double bottom pattern that can occur close to the trend line. When this pattern emerges, you can be confident in trading in the direction of the trend.
In figure 4, you can see the double top pattern formed on the H4 chart. The trend line is plotted on the daily chart. The emergence of the double top pattern signals a potential continuation to the downtrend. As you can see on the chart, price tends to post a fresh low.
Let’s look at another example of a long setup. In this instance, as you might have guessed, we look to a rising trend line and wait for price to post a double bottom pattern near the trend line.
This is illustrated in figure 5 below.
In the above chart, we see that after the trend line is plotted, price posts a double bottom pattern. This pattern forms right near the trend line, increasing the validity of the double bottom pattern.
Since we already know that price is in an uptrend, the validation of the double bottom pattern off the trend line increases the odds of this setup being successful when compared to trading it in isolation.
You do not necessarily need to wait for the DT or the DB patterns to form right near the trend line. These patterns can appear at any point in the uptrend. The key thing to remember is that the trend line still remains intact and that price has not deviated too far away from the trend line.
This is because when price deviates too far away from the trend line, it can revert to the mean, or snap back to the trend line. This can reduce the odds of the double top or the double bottom pattern being a successful trade setup.
Automatically spot double top and double bottom patterns
It can be a bit tedious if you are manually searching for the double top and double bottom patterns. To make this trading life easier for yourself, you can download the Free Double Top/Bottom indicator. This free indicator can be dragged and dropped onto your charts and it will spot the chart area there is a double top or a double bottom pattern formed.
What’s unique about this free technical indicator is that you do not have to be stuck to your screen. Once the indicator is up and running, you do not have to keep staring at the charts. When you get an alert, you can quickly head to the currency pair that was alerted and you can then trade if you are convinced that the setup is valid after some analysis.
Below are some examples of the free double top and double bottom indicator at work.
Figure 7: Another example of the double top/bottom indicator
As you can see, this indicator is versatile. You can simply move to a lower time frame chart and add this indicator which will then continuously scanning the price action and alert you when there is a valid pattern that is formed.
Other ways to increase the probability of this top down approach
Before we get into other means on how to improve the probability and the profitability of this top down approach, it is important to note that having too many elements to analyze is also not recommended.
This leads to what is known as analysis paralysis, which will lead to confusion and your being unable to make a good trading decision. Since the trend line and the double top and double bottom pattern is already strong, you can only slightly improve its performance.
One way to do this is to use the Heikin Ashi charts. The Heikin Ashi charts are a type of Japanese Candlestick patterns which can visually depict the trends. With the Heikin Ashi charts you do not have to use any more indicators.
An example of this is shown below.
In the above example you can see that the Heikin Ashi chart depicts an uptrend after the double bottom pattern is formed. Following the breakout from the interim high of the double bottom pattern, price action continues to rally higher eventually reaching the target.
When trading the double bottom or the double top pattern, the stops can be placed at the second bottom or the second top. From there on, you can set your positions to a 1:1 and 1:2 risk reward setup. This can be relatively easy once you use the Free Double Top/Bottom indicator.
As the indicator eases time, you can focus more on the setups and make a more informed decision.
Benefits of using a top down approach to trading
Using this top down approach has many benefits. For one, it will prevent you from over trading. Overtrading in forex is one of the main reasons why traders lose so much money. Most often, trades are taken based on impulse rather than logic.
This can lead to putting your trading capital at risk. Another benefit of the top down approach is that it makes it easy for you to trade with a set of rules. This is better as it helps to keep emotions in check. If a setup that you thought to be valid fails, in most likelihood, price was changing trend.
Losing out on a trade with a set risk is much better than trading with emotions and losing a lot more money. This will not only tell you stay away from the markets but also give you time to analyze your setup more thoroughly.
Going through your past trade setups to see what worked and what did not work is a great way to improve yourself as a trader. This is something that can be done when you use this top down approach to trading.
Your charts are also a lot more professional and cleaner looking. Most traders, as you might have seen, tend to clutter their charts by using redundant indicators. It gets to a point when price, which is the most important reference in the chart, goes into the background.
You can avoid all of this by using the top down approach and utilizing the double top and the double bottom pattern. The multi time frame analysis will ensure that while you are still trading in the direction of the trend, it will enable you pick the turning points in the trend, right after a correction is completed.
Because of its effectivity, similar top down approaches are also used for trading with the V-Power trading system (an intraday reversal trading system) and the MagicEntry system (a momentum-based trading system).