Can you discuss how to distinguish between a double top and a consolidation? There are many stocks these days that look like they could be interpreted as either one of these formations.
A double top is a bearish pattern characterized by a stock’s or index’ move to a high then a move back down, followed by a second attempt at a high that fails, the second try usually occurring on lower volume. That is unhealthy price/volume action which typically can’t boost the stock over the previous high. If the stock cannot strike a new high and then sells back down, usually on stronger volume, that may mean a sell-off is coming. This pattern can occur at any time on a run, but often arises after a stock has made a move out of a faulty base or has rallied long and hard and is in need of a rest.
As stated above, a double top is usually characterized by weaker volume on the second move up. This might also occur in a consolidation, but in that situation, price/volume action may be healthy; that is, the stock price might rise to the high on rising volume, then pullback to support on decreasing volume. It may not have the strength yet to break through the highs it is hitting, but if price/volume looks good, the pattern may then evolve into a trading range, which can occur when a stock is trying to consolidate. Stocks can break out of these patterns, which often form during consolidations. The key usually lies in the price/volume action: a second and rather quick attempt to reach a new high (it may even break to that high) that occurs on substantially lower volume is a caution flag. If it occurs after the stock has posted a strong run (50%, 75%, 100%), all the more reason to be cautious. If it then turns over and sells on rising volume, beware. If it snaps near support on volume it could spell a much deeper test.
Another important consideration has to be what the overall market is doing. 75% of stocks will follow the market, so in this time of consolidation, most stocks that are performing decently will likely do the same. Where are support levels–is the stock trading well above its 50 day moving average, or is it still above the 18 day moving average? Is it still riding above a long-term up trendline? All of these are pieces to the puzzle that can help answer the question on the difference between the two patterns. Even though most stocks follow the market, do not ignore the signals form the individual stock you are looking at.
In the current market, for a double top, be sure to check price/volume action and support levels. You want to make sure you get a good enough move down to support levels to make a downside play worthwhile. Typically you want to see a breakdown from any trading range that has developed or a fall through other key support on stronger volume than the prior moves.
