I keep seeing talk about a double and triple top forming in the S&P 500. These market prognosticators are foretelling doom for the stock market because it is approaching a double top. They often cite all the problems in Europe, a slowing economy, and even the US debt problems as to why the market is going to fail right here. Although I agree that all of the fore mentioned items are problems, I don’t agree that reaching a previous price point will bring those problems to a crisis point.
Double tops (and double bottoms) are simply places of short term support or resistance. I’m always amazed to hear technicians pointing to a double top as a great place to get short over the intermediate term. If you’re not eating cat then a cursory glance at a medium to long term chart will tell you that double tops and bottoms should only be used for a trade with the trend or for a very short term trade against the trend.
Take a look at this five year chart and you’ll see that the market has a tendency to pause and correct at double tops. However, almost all of them are short term in nature and fairly small percentage point drops. What is more telling is that all but one of the double tops failed to generate an acceptable intermediate term trade.
If you think for yourself it doesn’t take much thought to realize that it is inevitable that the vast majority of double tops and double bottoms will fail. If the market is trending (which it does most of the time) each correction will eventually meet a prior price point and then most likely continue the primary trend and break out from the previous high or low. This means a double top during a long term up trend will most likely fail. Double bottoms during a long term down trend will also have a high failure rate.
If you want to trade double tops or double bottoms make sure you’re going with the trend. Short double tops in primary down trends and buy double bottoms in primary up trends. It’s a dangerous game to trade against the trend.