Let us have look at how we use the M and W patterns (also referred to as Double Top & Double Bottom Patterns) in trading. Here are some Trading Strategies.

1. Double Top (M Pattern) Strategy

Description:

The Double Top, or M pattern, is a bearish reversal pattern that forms after an uptrend. It consists of two peaks at roughly the same level, with a trough in between. This pattern indicates that the asset’s price has hit a resistance level twice and failed to break above it, suggesting a potential downtrend.

Steps to Apply:

  1. Identify the Pattern: Look for two distinct peaks with a trough in between. Ensure the peaks are at similar levels.
  2. Volume Confirmation: Volume often decreases on the second peak, indicating weakening buying pressure.
  3. Neckline Break: Draw a horizontal line at the trough level (neckline). Wait for the price to break below this neckline to confirm the pattern.
  4. Enter Trade: Place a sell order just below the neckline after a confirmed breakout.
  5. Stop-Loss Placement: Set a stop-loss above the second peak to manage risk.
  6. Profit Target: Measure the height from the peaks to the neckline and project this distance downward from the breakout point to set your profit target.

Example in a Volatile Market:

In a volatile market, the M pattern can provide early warning signals of a potential reversal. Suppose a stock shows a rapid increase followed by two peaks forming around $100, with a trough at $95. Volume decreases on the second peak, confirming the pattern. Once the price breaks below $95 (the neckline), enter a sell position, set a stop-loss at $102, and aim for a profit target around $90.

2. Double Bottom (W Pattern) Strategy

Description:

The Double Bottom, or W pattern, is a bullish reversal pattern that forms after a downtrend. It consists of two lows at roughly the same level, with a peak in between. This pattern suggests that the asset’s price has hit a support level twice and failed to break below it, indicating a potential uptrend.

Steps to Apply:

  1. Identify the Pattern: Look for two distinct lows with a peak in between. Ensure the lows are at similar levels.
  2. Volume Confirmation: Volume often increases on the second low, indicating strengthening buying pressure.
  3. Neckline Break: Draw a horizontal line at the peak level (neckline). Wait for the price to break above this neckline to confirm the pattern.
  4. Enter Trade: Place a buy order just above the neckline after a confirmed breakout.
  5. Stop-Loss Placement: Set a stop-loss below the second low to manage risk.
  6. Profit Target: Measure the height from the lows to the neckline and project this distance upward from the breakout point to set your profit target.

Example in a Volatile Market:

In a volatile market, the W pattern can signal a strong reversal opportunity. Suppose a cryptocurrency’s price drops to $50, rebounds to $55, and then drops again to $50 before rising. Volume increases on the second dip. Once the price breaks above $55 (the neckline), enter a buy position, set a stop-loss at $48, and aim for a profit target around $60.

3. Complex M and W Patterns with Divergence Strategy

Description:

Complex M and W patterns incorporate additional technical indicators, such as the Relative Strength Index (RSI) or Moving Average Convergence Divergence (MACD), to increase the accuracy of the patterns.

Steps to Apply:

  1. Identify the Pattern: Look for M or W patterns forming on the price chart.
  2. Check for Divergence: Use RSI or MACD to identify divergence. For an M pattern, look for bearish divergence (price forms higher highs, but the indicator forms lower highs). For a W pattern, look for bullish divergence (price forms lower lows, but the indicator forms higher lows).
  3. Volume Confirmation: Ensure volume supports the pattern and divergence.
  4. Neckline Break and Entry: Wait for the price to break the neckline and confirm the divergence before entering a trade.
  5. Stop-Loss Placement: Place a stop-loss above the second peak (M pattern) or below the second trough (W pattern).
  6. Profit Target: Use the pattern height for profit projection, considering the strength indicated by the divergence.

Example in a Volatile Market:

Suppose a stock forms a double top around $120 with peaks at $120 and a trough at $115. The RSI shows bearish divergence with the second peak having a lower RSI value. Volume decreases on the second peak. Once the price breaks below $115, enter a sell position, set a stop-loss at $122, and target a profit around $110.

Similarly, for a W pattern, if a currency pair forms a double bottom at $1.2000 with lows at $1.2000 and a peak at $1.2200, and the MACD shows bullish divergence, enter a buy position after the price breaks above $1.2200. Set a stop-loss at $1.1950 and aim for a profit around $1.2400.

Conclusion

Using M and W patterns effectively requires careful identification, confirmation with volume and other technical indicators, and strategic entry and exit points. In volatile markets, these patterns can offer reliable reversal signals, helping traders manage risk and capitalize on potential profit opportunities.