What Is a Double Bottom?
A double bottom pattern is a technical analysis charting pattern that describes a change in trend and a momentum reversal from prior leading price action. It describes the drop of a stock or index, a rebound, another drop to the same or similar level as the original drop, and finally another rebound. The double bottom looks like the letter "W". The twice-touched low is considered a support level.
- The double bottom looks like the letter "W". The twice-touched low is considered a support level.
- The advance of the first bottom should be a drop of 10% to 20%, then the second bottom should form within 3% to 4% of the previous low, and volume on the ensuing advance should increase.
- The double bottom pattern always follows a major or minor downtrend in a particular security, and signals the reversal and the beginning of a potential uptrend.
What Does a Double Bottom Tell You?
Most technical analysts believe that the advance of the first bottom should be a drop of 10 to 20%. The second bottom should form within 3 to 4% points of the previous low, and volume on the ensuing advance should increase.
As with many chart patterns, a double bottom pattern is best suited for analyzing the intermediate- to longer-term view of a market. Generally speaking, the longer the duration between the two lows in the pattern, the greater the probability that the chart pattern will be successful. At least a three-month duration is considered appropriate for the lows of the double bottom pattern, in order for the pattern to yield a greater probability of success. It is, therefore, better to use daily or weekly data price charts when analyzing markets for this particular pattern. Although the pattern may appear on intraday price charts, it is very difficult to ascertain the validity of the double bottom pattern when intraday data price charts are used.
The double bottom pattern always follows a major or minor down trend in a particular security, and signals the reversal and the beginning of a potential uptrend. Consequently, the pattern should be validated by market fundamentals for the security itself, as well as the sector that the security belongs to, and the market in general. The fundamentals should reflect the characteristics of an upcoming reversal in market conditions. Also, volume should be closely monitored during the formation of the pattern. A spike in volume typically occurs during the two upward price movements in the pattern. These spikes in volume are a strong indication of upward price pressure and serve as further confirmation of a successful double bottom pattern.
Once the closing price is in the second rebound and is approaching the high of the first rebound of the pattern, and a noticeable expansion in volume is presently coupled with fundamentals that indicate market conditions that are conducive to a reversal, a long position should be taken at the price level of the high of the first rebound, with a stop loss at the second low in the pattern. A profit target should be taken at two times the stop loss amount above the entry price.
Example of a Double Bottom
Let's look at a historical example of a double bottom from November 2018. Vodafone Group (VOD) shares rose more than 9% after the company reported better-than-expected financial results. More importantly, incoming CEO indicated that Vodafone's dividend was safe, despite efforts to rein in debt following its $22 billion takeover of Liberty Global's (LBTYA) German and Eastern European businesses.
From a technical standpoint, Vodafone stock formed a double bottom with a short-term upside price target of $21.50. Other indicators confirmed this pattern: The relative strength index (RSI) remained neutral with a reading of $55.00, but the moving average convergence divergence (MACD) remains in a bullish crossover dating back to early in the month.
The Difference Between a Double Bottom and a Double Top
Double top patterns are the opposite of double bottom patterns. A double top pattern is formed from two consecutive rounding tops. The first rounding top forms an upside-down U pattern. Rounding tops can often be an indicator for a bearish reversal as they often occur after an extended bullish rally. Double tops will have similar inferences. If a double top occurs, the second rounded top will usually be slightly below the first rounded tops peak indicating resistance and exhaustion. Double tops can be rare occurrences with their formation often indicating that investors are seeking to obtain final profits from a bullish trend. Double tops often lead to a bearish reversal in which traders can profit from selling the stock on a downtrend.
Limitations of Double Bottoms
Double bottom formations are highly effective when identified correctly. However, they can be extremely detrimental when they are interpreted incorrectly. Therefore, one must be extremely careful and patient before jumping to conclusions.