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 and shoulders
• Reverse Head & shoulders

This learn 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 in between.

This setup is regarded complete once stock price makes the second peak & then penetrates the lowest point between the highs, called the neck-line. 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 is only confirmed once the neck-line is broken and the stock trading market moves below the neck-line. Neck-line is just another term for last support level formed on the chart.

Summary:

• Forms after an extended move upwards
• This formation indicates that there will be a reversal in market
• We sell when the price breaks out below the neck-line: 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 signal can be confirmed by drawing a downwards trend line as shown below. If a trader opens a sell stock signal the stop loss will be placed just above this down-wards trend line.

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 in between.

This setup is regarded complete once stock price makes the second low & then penetrates the highest point between the lows, called the neck-line. 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 neck-line is broken. In this formation the neckline is the resistance area for the price. Once this resistance is breached the stock trading market will move upward.

Summary:

• Forms after an extended move downward
• This formation indicates that there will be a reversal in market
• We buy when the price breaks out above neck-line: 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 signal can be confirmed by drawing an upwards trend line as shown below. If a trader opens a buy stock signal the stop loss will be placed just below this up-wards trend line.

W-Shaped