How to trade chart patterns, today: Double Top in the SP500 CFD

May 29, 2019 11:30

There are plenty of chart formations in the world of trading: double tops and -bottoms, head-shoulder, ascending/falling wedges, triangles, Harmonic pattern, etc., to name a few.

Today, we want to focus on a chart formation currently developing in the SP500 CFD: a potential double top on the daily time frame, and construct a strategy on how to trade it.

The Double Top

Double tops (but also double bottoms) are a basic, but nevertheless crucial concept when it comes to chart patterns.

Tops are peaks which are formed when the asset hits a certain price level that can't be broken to the upside (top) – the moment, a top is forming.

If this appears to happen two times, a double top is forming.

As you can see in the charts below, we can project a potential target of the chart pattern based on a so-called "neckline". A neckline is a horizontal line which highlights, to some extent, the last swing high/low which, if it's penetrated, confirms the double bottom/top.

After we identify the neckline, we drop a perpendicular on the horizontal line and go as low/as high as the double low/high, calculate the difference and then project that difference from the neckline in the direction of the reversal. That way we have a first potential target:

In the following, let's use this theoretical knowledge and adapt it to the current technical picture we can see in the SP500 CFD on a daily time frame:

Application of the double-top formation in SP500 CFD

When looking at the daily chart below, one can clearly spot a potential double-top: after the SP500 CFD marked a new all-time high on October 3, and seeing some heavy volatility in the weeks and months to come, the SP500 CFD stabilised into the first quarter of 2019 and, thanks to the Fed and intervention from the White House, pushed to these all-time highs around 2,940 points again.

Source: Admiral Markets MT5 with MT5-SE Add-on SP500 Daily chart (between February 15, 2018, to May 21, 2019). Accessed: May 21, 2019, at 12:30 GMT - Please note: Past performance is not a reliable indicator of future results, or future performance.

In 2014, the value of the SP500 CFD increased by 11.39%, in 2015, it fell by -0.73%, in 2016, it increased by 9.54%, in 2017, it increased by 19.42%, in 2018, it fell by -6.24%, meaning that after five years, it was up by 36.8%.

A sustainable break higher wasn't seen, most likely due to an escalating trade conflict between the US and China, and the SP500 CFD saw a pullback.

When looking at the chart below, it seems as if it was no coincidence that the pullback found an initial support around 2,815 points when looking at the chart below and the red circles.

For us, the resulting line is our neckline:

Source: Admiral Markets MT5 with MT5-SE Add-on SP500 Daily chart (between February 15, 2018, to May 21, 2019). Accessed: May 21, 2019, at 12:30 GMT - Please note: Past performance is not a reliable indicator of future results, or future performance.

What could a potential trading setup for the SP500 CFD look like?

First, we have to calculate the distance from the highs of the formation to the neckline: 2,940 points – 2,815 points = 115 points (vertical green line).

Then, we duplicate this distance of 115 points from the neckline and get our projected target at 2,815 points – 115 points = 2,700 points.

For the setup, we then have to place a sell stop order at 2,815 points with a stop at 2,940 points and a take profit at 2,700 points. We also want to take out half of the position if the sell stop is triggered, but the SP500 CFD does not take on bearish momentum, instead turns around and breaks again above 2,892 points.

This helps us to get a risk-reward of bigger 1:

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