Chart patterns are important for every technical trader. There are various types of chart patterns. There are bullish and bearish, reversal and continuation patterns. M formation is one of the most popular chart patterns. Let’s find out what it is and how to trade the pattern in detail.
M formation definition
M formation, also known as double top, is an M-shaped chart pattern. M pattern is a bearish reversal pattern. When the pattern appears in an uptrend, it indicates that the price will reverse and start moving downwards. M pattern consists of two tops and a neckline. When the neckline is breached and the candle closes below the line, traders can start shorting an asset and place a Stop Loss order above the neckline.
Why is understanding the M formation important for traders?
- M formations are easy to identify on a chart thanks to their M-shaped appearance
- M formation or Double Top, is a frequently followed chart pattern in technical analysis
- Double tops and double bottoms are useful patterns for managing long and short positions
- M formations are reliable patterns that appear frequently and offer good risk to reward ratios
M formation explained in more detail
The M formation, or Double Top, is a bearish reversal chart pattern that shows two breakout attempts in the price of a pair which ultimately ends in a downward trend.
M formations can be identified when price action meets a resistance point, goes down to a favorable price for bullish traders who push the price up again and ultimately, the resistance point forces the price lower than the previous low. This price movement from the middle low to the resistance point is also called a neckline. Neckline is an important level as it serves as a significant level. It’s important to note that you should always wait for a breakout and candle closure to avoid trading false breakouts and unfinished patterns. After the breakout, the neckline serves as a helper for placing Stop Loss. Stops are usually placed right above the neckline.
Example of M formation in forex
Now, let’s take a look at the M formation example in a GBP/JPY pair. As you can see, the pattern appeared in an uptrend and gave us entry at neckline breakout. The pattern may not look as perfect as in charting books. However, in real life, traders should not look for perfection when it comes to finding trading setups. You will come across slightly deformed patterns. One head might look a little bit smaller than the other, one shoulder might be a bit wider than the other, etc. It’s the trader’s job to make sense of the data and find trading opportunities.
In this case, the entry point was given as soon as the breakout candle closed below the neckline. We could have entered the position short and placed a Stop Loss order right above the neckline. The profit target depends on the strength of a new trend. In this case we could take at least as large profit as the there was the risk, and we could also wait and claim larger profits.
FAQs on M formation
Is M formation bearish?
M formation signals the start of a bearish trend after a bullish run meets significant resistance after two attempts of a breakout. When the neckline is broker, traders can enter short positions to profit from the downside.
Should I trade M formations?
M formations are some of the most widely followed chart patterns on the market. Identifying an M formation can give traders with long positions some time to exit the trade and others can go short and make a profit.