The double bottom pattern is a type of candlestick pattern that is characterised by a W-shaped price chart. However, it can also be found in bar charts and line charts. The double bottom is formed when the price of a security drops and increases twice in succession. The lows are the two ‘bottoms’ of the pattern. The double bottom generally appears at the end of a downtrend in the price of an asset.
A trend reversal is said to begin whenever a double bottom appears as it generally indicates that a potential uptrend is around the corner. The double bottom chart pattern is helpful in trying to predict the intermediate to long-term price movement of a security.
A double bottom pattern is commonly studied in candlestick charts but it can also be spotted in bars and line charts. Candlestick patterns are important tools of technical analysis – the school of investing that believes that a trader can make gains in the share market by studying the price movement of a security as history repeats itself – meaning the patterns are recurring.
Candlesticks can be of two types – red or dark, denoting a higher opening price of a security than its closing price, and green or light, implying that the closing price is higher than the opening. Another important characteristic of candlestick patterns is the wick. Also called the shadow, these lines at the upper or lower threshold of a candlestick bar signify the highs and lows reached by the security during a trading session.
Formation of the double bottom pattern
Firstly, the two distinct troughs or double bottoms should be identified while looking for the pattern. Moreover, the first bottom should be the lowest point of the current trend. One must also check the distance between the two bottoms – it shouldn’t be too short. It is generally preferred that the first trough should be a price drop in the range of 10-20%. The next bottom shouldn’t be in the range of 3-4% of the preceding one.
When the price of the security moves up after the first bottom, it may hang around the high for some time – indicating a hesitation to go downwards again. This generally means that the demand for the asset is on an uptick but isn’t strong enough yet for a breakout.
The time duration between one trough and next could range anywhere between one to three months. Volume is a key parameter of the double bottom chart pattern as it indicates that there’s a shift in the momentum in the buy-side. It’s important to remember that there should be a prior trend to reverse for any pattern such as this. For the double bottom chart pattern, there should be a big enough downward momentum of several months preceding the formation of the pattern.
Difference Between a Double Bottom and a Double Top
Double top patterns, though similar in some respects to the double bottom, are the exact opposites. While the former is M-shaped, the latter is W-shaped. A double top is a bearish reversal pattern that forms when a security’s price hits highs two times in succession. The second rounded top is generally slightly below the first one, signaling resistance and a loss of momentum in the asset’s upward trajectory.
How to trade the double bottom chart pattern
- When the price of the security is upward bound a second time and approaches the neckline, a trader must look for a significant expansion in volumes to know if a reversal is on the cards. Moreover, other market fundamentals should also support this signal.
- One can go long at the price of the high after the first trough. The stop loss can be fixed at the second trough in the double bottom pattern
- While setting a price target for gains, aim for double the stop loss target over the entry price
- Sometimes, when the price of the security breaks the neckline (or resistance), it might find a new support level and offer a trader another chance to start a long position or go short.
Limitation of The Double Bottom Pattern
A double bottom is often perceived as a trend reversal pattern forming at the end of a downtrend. It signals that the sellers, who were in control of the market, are losing strength, and the downtrend is gradually losing momentum. Although the double bottom chart pattern is a valuable technical tool that indicates a strong trend reversal, it has a few limitations.
- False signals: Like other patterns, a double bottom can form false reversal signals, leading to losses if traders solely rely on them. Conditions such as a shift in the market, news events, etc., can reduce the effectiveness of the pattern.
- Subjectivity in pattern identification: The interpretation of a double bottom pattern can be subjective, depending on where the traders think the two troughs should be. It increases the risk of false signalling and results in conflicting trading decisions.
- Timeframe sensitivity: The analysis of the double bottom pattern is timeframe sensitive. It works better in longer time frames compared to shorter intraday time frames.
- Volume confirmation: Volume analysis is critical for analysing double bottom pattern stocks. Traders should incorporate volume analysis and ensure that increasing volume supports the pattern’s formation and potential reversal.
- Contrarian strategy pattern: A primary limitation of a double bottom is that it is a contrarian strategy formed at the end of a downtrend. Traders trading in the pattern enter a long position when the overall market is bearish. Hence, the risk of loss is always there with a double bottom.
Conclusion
The double bottom chart pattern can be a very helpful tool to ascertain a shift in market sentiment with regards to a security. However, if it’s not analysed correctly, an investor or a trader might lose gains. One should always look at the wider market and sectoral indicators to judge the veracity of the double bottom pattern before trading it. While it might appear on intraday charts, it’s preferable to use the pattern for longer time frames.
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FAQs
What is a double bottom pattern?
A double bottom is a pattern formed in the technical chart when the asset price creates two distinct lows of similar depth, separated by a temporary upward trend. It signifies a trend reversal.
Is a double bottom pattern reliable?
The double bottom pattern signifies a trend reversal. It is a strong formation, and when the pattern is verified, trading in it can bring good profits.
What does the double bottom pattern indicate?
A double bottom pattern signifies a trend reversal on the technical chart from bearish to bullish. It denotes a change in market sentiment when sellers lose momentum and buying interest increases.
How can traders use the double bottom pattern for trading?
It is a bullish trend reversal pattern, and traders use the double bottom to identify potential entry points. Buyers enter the market where the price line breaks above the neckline and use the pattern’s height to set a price target.
Are there risks and limitations to the double bottom pattern?
Like any other chart pattern, a double bottom is not foolproof and can result in false signals. Hence, traders shouldn’t rely on the chart pattern alone and must consider factors such as volume, trend confirmation, and overall market conditions to plan trades. Moreover, successfully trading during a double bottom also depends on identifying and interpreting the pattern correctly, which can be subjective.
