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Making Money with Double Top Formation in Stock Market

Posted By On 4/27/2009 08:15:00 PM Under
1. One must understand a double bottom formation as a trade executed with its help is generally very profitable. Double bottom implies that stock is about to show a reversal pattern (classic double bottom usually marks an intermediate or long-term change in trend) and for that an extended downward trend should be in place probably for months together. It has two consecutive troughs which are almost equal and has a moderate peak in-between. One has to observe that a key resistance has been broken which confirms that reversal is in offing.

2. One must keep a sharp eye on first trough (fairly normal in appearance and the downtrend remains firmly in place) which normally marks the lowest point of the current trend.

3. The first trough is followed by a peak and an advance up to 10 to 20% is seen and volume on advance from the first trough is usually inconsequential, but an increase could signal early accumulation. The high of the peak is sometimes rounded or drawn out a bit from the hesitation to go back down. This hesitation indicates that demand is increasing, but still not strong enough for a breakout.

4. Now due to high achieved one sees selling pressure and thus again stock price goes down but on low volumes and gets supported at previous low. One should not jump to conclusion thereafter and must see possibility of a double bottom existing and same needs to be confirmed. One has to keep in mind that time period between troughs can vary from a few weeks to many months, with the norm being 1-3 months (preferable to have at least 4 weeks between lows). While exact troughs are preferable, there is some room to maneuver and usually a trough within 3% of the previous is considered valid.

5. Now comes again an advance after second trough(second trough should form a low within 3% of the previous low) where one must focus on volume aspect and be sure that buying pressure is increasing with volume. Keep an eye onan accelerated ascent, perhaps marked with a gap or two, also indicates a potential change in sentiment.

6. Now once the key resistance (i.e. breaking resistance from the highest point between the troughs) on the upper side is broken with volumes or accelerated ascent completes the double bottom. Volume indicators like Chaikin Money Flow, OBV and Accumulation/Distribution can be used to look for signs of buying pressure.

7. Now the resistance which has been broken becomes its support and there is sometimes a test of this newfound support level with the first correction. Such a test can offer a second chance to close a short position or initiate a long.

8. One can technically calculate the price target : The distance from the resistance breakout to trough lows can be added on top of the resistance break to estimate a target. This would imply that the bigger the formation is, the larger the potential advance.

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