Reversal Trading Setups

These patterns are formed after the stock trading market has had an extended move up or down and the stock price reaches a strong resistance or support respectively.

When price reaches such a point it starts to form a pattern. Since these formations are frequently formed it is easy to spot them once you learn how and start using them. There are four types:

• Double Top
• Double Bottom
• Head & shoulders
• Reverse Head & shoulders

This learn indices trading tutorial will only cover double tops and bottoms, for the other 2, read this other tutorial: head & shoulders and reverse head & shoulders

Double Tops

This is a reversal pattern which forms after an extended up-ward trend. As its name implies, this pattern is made up of 2 consecutive peaks that are roughly equal, with a moderate trough between.

This formation is considered complete once stock price makes the second peak & then penetrates the lowest point between the highs, called the neckline. The sell stock signal from this formation occurs when the stock market breaks-out below the neckline.

In Indices, this formation is used as a early warning signal that a bullish trend is about to reverse. However, it's only confirmed once the neck line is broken and the stock trading market moves below the neck line. Neckline is just another term for last support level formed on chart.

Summary:

• Forms after an extended move upwards
• This formation indicates that there will be a reversal in trading market
• We sell when price breaks out below the neckline: see below for the explanation.

The double top look like an M Shape, the best reversal stock signal is where the second top is lower than the first one as pictured below, this means that the reversal can be confirmed by drawing a downward trendline as shown below. If a trader opens a sell stock signal the stop loss will be placed just above this down-wards trendline.

M-Shaped

Double Bottom

This is a reversal pattern which forms after an extended downwards trend. It is made up of two consecutive troughs that are roughly equal, with a moderate peak between.

This formation is considered complete once stock price makes the second low & then penetrates the highest point between the lows, called the neckline. The buy indication from this bottoming out signal occurs when trading market breaks-out the neckline to the upside.

In Indices, this formation is an early warning signal that the bearish trend is about to reverse. It's only considered complete/completed once the neckline is broken. In this formation the neck line is the resistance area for the price. Once this resistance is broken the stock trading market will move up.

Summary:

• Forms after an extended move downward
• This formation indicates that there will be a reversal in trading market
• We buy when trading price breaks out above neckline: see below for an explanation.

The double bottom pattern look like a W-Shape, the best reversal stock signal is where the second bottom is higher than the first one as pictured below, this means that the reversal can be confirmed by drawing an upward trendline as shown below. If a trader opens a buy stock signal the stop loss will be placed just below this up-wards trendline.

W-Shaped