Top reversal patterns can be extremely useful to understand when a downtrend is about to start. What’s more, they work with more than one strategy.
Charts help technical analysts understand market movements, and some patterns are more reliable than others in helping them make decisions.
Some patterns are so popular that (almost) any trader makes the same moves when they appear in charts. Traders’ behavior is what drives the price, and being able to recognize patterns as experienced traders do is extremely useful to make reliable predictions and make the right decision.
Of course, no pattern works 100% of the time, but they offer guidelines that can increase the chances of success.
This article does not constitute financial advice: we will show you the most common top reversal patterns, those that usually signal that a downtrend is about to start. As always, be responsible and always do your own research before investing your money.
What Are Top Reversal Patterns?
Most of the technical analysis we use draws its origins to Japanese charting techniques. Japanese analysts, mainly for historical reasons, gave patterns names related to war actions. Sometimes western analysts modified the names of these patterns, but always using terms that somehow reflect what is visually evident on charts.
So you may find the patterns we are about to show you with different names, but we will use the most common denominations: Head and Shoulders, Diamond Top, Double Top and Triple Top. They are all top reversal patterns, but what does this mean?
These patterns – usually medium or long-term patterns – are particular formations usually found at the end of an extended uptrend. They usually signal that a new and extended downtrend is about to start. We will provide you with images that make it easier to understand how these patterns develop, but you will discover that it is not always so easy to spot them correctly.
Head and Shoulders
We will start with one of the most common chart formations, the Head and Shoulders.
This name derives from the fact that this formation looks like a half-length body, showing only a head and the shoulders, as you can see in the image below:
The Head and Shoulders develops during an uptrend. As we know, no trend is just a straight line, it develops and various small retests take place. In this case the retest forms a sort of peak. The second peak is the highest one. The third peak is similar to the first one.
The support line is called the neckline, the line at which the price retests and rises again, forming those peaks we can observe in the image above.
This chart formation usually signals that the price reached its top, and it’s time for a downtrend – so that is a reversal pattern.
Among the patterns we are listing, the Diamond Top is maybe the hardest to correctly spot.
This is because the chart looks quite chaotic and complex, but in reality it is only an impression.
Pro tip: When observing charts it is very important not to force patterns to fit your schemes or expectations.
Traders know that they have to step back from details and look at the whole picture, as well as they know that technical analysis and trading in general require discipline. Try to be as objective as possible, without letting your expectations or desires influence your analysis.
Being another top reversal pattern, the diamond top usually develops during an uptrend. It is a long-term formation. You can observe it by connecting the highs and lows: if the price movement broadens and then narrows, forming a sort of rhombus, you get a diamond top. This pattern usually occurs before a downtrend – so yet another reversal pattern.
The Double Top is far easier to spot if we compare it to other top reversal patterns, as you can see in the image below:
This pattern forms a sort of “M”. It develops during an uptrend: the price reaches a resistance level and retests until reaching a support level. At this point, it goes upwards again and reaches the same resistance zone of the previous peak. The top of this second peak should represent the highest point reached by the price before a downtrend.
The Triple Top is very similar to the Double Top, but it differs from the latter because it is formed by three peaks instead of two, as shown below:
Being another top pattern, it develops during an uptrend and requires more time than the double top – we can consider the Triple Top a long-term pattern.
This formation is made up of three similar peaks: the highs of these peaks form a strong resistance line, while the lows form the support. The high of the third and last peak should be the highest point reached by the price before an extended downtrend.
Pro tip: In this article we often make reference to support and resistance lines and zones. They are useful tools that help traders understand the behavior of price even before the development of chart patterns. More details can be found in this article on support and resistance levels.
What to Do With Top Reversal Patterns and Final Thoughts
The patterns we have shown you are commonly seen and can be extremely useful as long as you take into account some considerations:
- Never force chart patterns;
- Try to stay as objective as possible; and
- Consider support and resistance levels to decide the next move and start spotting longer-term chart formations.
Usually traders feel more comfortable with long positions. We decided to list these patterns for that reason: if you opened a long position, these formations can help you choose the right time to close it and make a profit.
But they also work for short positions; actually these patterns indicate the top and the right time to sell.
You may also consider combining two strategies and decide to flip your positions, from long to short.
Of course, more positions and strategies require more time to manage them, so you should consider the time you have available and the level of risk you want to take – what makes you feel comfortable with your trading activity.
As always, doing your own research before investing is essential. These chart formations are reliable because they are widely used by traders and investors, but they cannot replace your own analysis.
A good and prolonged observation of price charts will show that there are often more chart formations that arise – the patterns illustrated here all started during an uptrend and often occur with retests. Furthermore, taking into account other elements, like volume, can make your analysis and predictions even more reliable.
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