The double bottom pattern is a bullish reversal pattern that appears towards the bottom of a downtrend and indicates that the market's sellers are losing power. Because of the two-touched low and the shift in trend direction from downtrend to uptrend, the pattern resembles the letter "W."
This blog article aims to show you how to spot a double bottom chart pattern and, more significantly, how to benefit from trading it by providing a basic trading approach.
In technical analysis, a double bottom chart pattern represents a stock or index decreasing in price, recovering, then lowering to a roughly equal level and rebounding.
As a result, the double bottom chart pattern looks like the letter "W."
A " W " pattern emerges when prices on a chart record two separate lows; a "W" pattern emerges.
However, an absolute double bottom is only defined when prices climb beyond the highest point of the whole formation, leaving the entire pattern behind.
In other words, a double bottom chart is a "reversal pattern" in a downward trending stock price.
Before surging back up and again falling to the support level, the price sinks to a "support level" floor before eventually initiating a fresh uptrend.
Two well-defined lows at nearly the same price level identify a double bottom. Although the timing of double bottoms varies greatly amongst stock charts, they are one of the most consistent chart patterns.
Double bottom patterns, for example, maybe seen in intra-day, daily, weekly, monthly, annual, and longer-term charts. There should be a difference between the two lows.
According to technical analysts or "chartists," it tends to be rounded. In contrast, the first bottom is distinct and sharp simply because the first bottom is formed at the peak of panic selling. In contrast, the second bottom is formed—generally—by a slower process that occurs after traders who bought the first bottom get out (taking profits) and allow the stock to drift back to its previous low before longer-term investors slowly step in.
When prices climb above the formation's highest peak, the pattern is complete. The confirmation point is the highest high.
The left bottom of a double bottom usually has a higher trade volume than the right bottom.
When the pattern makes its initial low, volume normally rises, then drops somewhat when the pattern makes its second low. (Warning: if the volume is not lower on the second low, the stock may go to much lower lows!) As the pattern completes, volume rises again, with buyers rushing in to push the stock beyond the confirmation mark.
The Structure of the Double Bottom Pattern
A downtrend concludes with a double bottom. As the price action swings down, printing lower highs and lower lows, the price bounces back higher before retesting the prior low.
The majority of technical experts say that the initial bottom should decline by 10% to 20%. The second bottom should form within 3 to 4% of the previous low, and volume on the succeeding rise should increase.
Like many other chart patterns, a double bottom pattern is best suited for examining a market's intermediate- to longer-term outlook. In general, the longer the time between the pattern's two lows, the more likely the chart pattern will be effective. The lows of the double bottom pattern should last at least three months to give the pattern a better chance of success.
When evaluating markets for this pattern, it is generally preferable to utilize daily or weekly data price charts. Although the pattern may show on intraday price charts, determine the authenticity of the double bottom pattern when using intraday data price charts.
A significant or small downtrend in a securities is always followed by a double bottom pattern, which predicts a reversal and the start of a prospective upswing. As a result, market fundamentals for the security and the sector to which the security belongs, and the market as a whole should support the pattern. The fundamentals should indicate the characteristics of a market situation reversal that is about to occur. During the creation of the pattern, the volume should also be constantly checked.
There is usually a rise in volume during the pattern's two upward price moves. These volume spikes suggest considerable upward price pressure and confirm the double bottom pattern's effectiveness.
Once the closing price is in the second rebound and is nearing the high of the first rebound of the pattern, and a substantial increase in volume is now paired with fundamentals that signal market circumstances favourable to a reversal, a long position should be established at the price level of the first rebound's high, with a stop loss at the second low in the pattern. Set a profit target that is two times the stop loss amount above the entry price.
WHY IS IT IMPORTANT TO HAVE A DOUBLE BOTTOM CHART PATTERN?
The double bottom may signify a great entry opportunity for investors if it is correctly detected, as it signals that the stock has struck a critical support level and is having difficulties continuing lower.
This indicates that the stock has created a low and is now poised to climb upward. It's important to be able to identify that upward surge in a company – and in the market as a whole – amid today's incredibly volatile, coronavirus-fueled market atmosphere.
WHERE CAN I GET THE DOUBLE BOTTOM?
Traders that are good at managing short-term risk might attempt to purchase as soon as a possible double bottom is seen. If they are correct, they will benefit quickly, and if they are incorrect, they will lose money when the stock goes below the fake double bottom.
However, investors who attempt to purchase bottoms (or sell tops) often realize that they underestimated the trend's strength and come to regret their haste. And if they don't know how to manage short-term risk, their losses might swiftly pile up if the double bottom collapses.
However, savvy investors will be more patient when it comes to using the double bottom pattern.
Instead of trying to purchase at the bottom, the intelligent investor waits for the stock to reach the confirmation point, so he can be assured (as definite as anything on Wall Street) that the double bottom has passed and that the uptrend has begun.
How Do You Trade During a Double Bottom?
A double bottom reversal is a positive trend in stock prices, and it has two lows in it. The initial low is reached after a negative movement in stock prices is followed by a bullish movement to reach the neckline, as shown in figure 1.
After that, there is a bullish trend that follows the second low. It's worth noting that the second bullish movement should be stronger than the first in order to achieve a double bottom.
Traders that are anticipating a bullish run frequently go long on the second low of a double bottom.
During a Double Bottom, Trading Strategies
1. A brash approach
Traders will utilize an aggressive approach at point A in diagram 1 by betting on a double bottom.
They will anticipate a negative movement to complete the pattern at the second high, therefore increasing the value of their portfolio.
2. A less aggressive tactic
The double bottom pattern has already occurred at position B in figure 1. As a result, compared to point A, the investor will have a lower possibility of generating a more significant return at this point and beyond.
Investors will perceive a significant advantage in making a profit at this point since it will be impossible to predict which way the prices will move beyond this point.
Weaknesses and Strengths
One of the most powerful reversal patterns is the double bottom pattern. It's not a very popular design since it has two bottoms. Once found, the pattern is quite good at anticipating trend direction changes.
The fact that there are clearly defined levels to compete against is its biggest strength. Once the pattern is triggered, the neckline denotes the risk and aids in determining the take profit. As a result, drawing the double bottom correctly is crucial.
The double bottom pattern's main flaw is a contrarian tactic. Remember that the general trend is bearish, and we're taking a "long" position. As a result, there is always the danger that the market will continue on the same path. As a result, it is important to review supporting elements in conjunction with other technical indications before joining the market.
The Double Bottom Pattern: How to Recognize It
As previously said, recognizing and sketching the double bottom pattern is crucial. Below is an hourly chart of the USD/CAD, which shows the pair moving down before struggling to break below the horizontal support and prolong the negative situation.
Instead, the bulls were able to hold off and eventually break over the neckline, wiping out all prior losses and setting new highs. Around the $1.30 mark, we find two lows that are almost identical in price. On the other hand, throughout the course of a comeback, the price action established two almost similar highs. Therefore we took use of this chance to draw the resistance line (the neckline) linking these two highs.
It's also worth mentioning that many traders make the fundamental error of initiating the "buy" transaction before the pattern is triggered, which is a critical blunder. A double bottom pattern is only active until the buyers break the neckline and secure a close above it, no matter how flawless it seems.
The Double Bottom Pattern in Trading
The same example will be used to demonstrate how to trade the double bottom pattern. This example also reveals a lot about how unsuccessful breakouts function. The price action rocketed higher as soon as it established a second bottom, breaking above the levels where two previous highs were recorded, as seen in the chart below.
The price promptly retreated below the neckline, indicating that this was an unsuccessful breakthrough. This exemplifies the importance of the virtue of patience in trading. Furthermore, this demonstrates the significance of waiting for a close above the neckline before entering the market.
A severe drop frequently follows failed breakouts to penalize purchasers for failing to complete the first upward rise, and this is precisely what occurred. However, at lower prices, the buyers regrouped and launched a second strong push higher, finally breaking above the neckline at $1.31.
As a result, our entry point is $1.3110, which is the first time the USD/CAD has closed above the neckline. Like a failed breakout when price movement swiftly penetrates through support/resistance without a follow-up, the stop-loss should be positioned below the neckline, providing room for the move.
Stop-loss levels vary depending on risk tolerance. However, they might be anywhere from 15 to 30 pips below the neckline. The triggered double bottom design is nullified by any movement or proximity below the neckline.
The take profit is determined in the same way as the head and shoulders pattern: the distance between the supportive trend line (double bottoms) and the neckline is measured. The same trend line is then copied and pasted from the breakout point, with the trend line's endpoint serving as our take profit. The trend line in our instance stops at $1.3180.
After a few days, our take profit order is filled, netting us roughly 70 pips. We got 70 pips while risking 15/30 pips, which offers a terrific risk-reward ratio depending on your risk tolerance and stop loss position.
The Distinction There's a difference between a double bottom and a double top.
Contrary to popular belief, double top patterns are the polar opposite of double top patterns. A double top design is created by stacking two rounded tops on top of each other. The initial rounding top is shaped like an upside-down U. Because they often occur after a lengthy bullish run, rounding tops might be a sign of a bearish reversal.
Inferences from double tops will be similar. When a double top happens, the second rounded top is normally significantly lower than the first, signifying resistance and tiredness. Double tops are uncommon, but it usually means that investors are looking for the highest profits from a firm trend when developing. Double tops often signal a negative reversal, allowing traders to benefit by selling the stock while it is in a slump.
Double Bottoms' Limitations
When correctly detected, double bottom formations are pretty compelling. When they are misinterpreted, however, they may be highly harmful. As a result, before leaping to conclusions, one must exercise utmost caution and patience.
A double bottom is a pricing pattern that causes a W-shaped movement in asset prices, and it signifies that there will be a significant price surge following two lows.
When opposed to a double bottom, a double top has the opposite price movement. The double top pattern suggests that the asset's price will drop dramatically following the two highs.
Investors who wish to trade at the second bottom of a double base should do so. The only risk is if they continue to believe it will be a double bottom.
Conclusion
The Double Bottom indicates that the downtrend may have reached its bottom and that the price may now begin to rise.
In a substantial decline, avoid buying a Double Bottom (when the price is below 20MA)
You may benefit from "stuck" traders by using the False Break strategy.
Wait for a buildup around the neckline to occur before trading the Double Bottom Breakout for a solid risk/reward ratio.
You may increase the accuracy of your reversal trades by using various timeframes.
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