Double Bottom
Double bottoms look like the letter "W". A double
bottom is formed when a new low is created (a bottom) and is followed by
a rally upward; this middle part of the "W" is called the middle peak.
Middle Peak Relationship to Bottoms
Kirkpatrick & Dahlquist (2010) suggest that the middle peak
be about 10% above the bottom of the lowest low (p. 309). After the
retracement upward, prices move lower once again to the level of the
previous bottom and from there, prices bounce off an area of support and
move higher.
Relationship of Right and Left Bottom
Time Spacing between Bottoms
According to Bulkowski (2008), the two bottom prices should be
within 2-5% of one another and should be separated in time by 2 to 6
weeks; anything over 8 weeks and the success of the pattern
deteriorates; it should also be noted that the double bottom performs
best when they occur within the bottom third of the yearly low price.
Once prices penetrate above the price level established by the middle
peak, then a buy signal is suggested. It is emphasized in multiple
sources cited on this website, that the middle peak price must be
penetrated for a valid buy signal to be activated.
Psychology of Double Bottom Chart Pattern
The psychology of the double bottom pattern is given next: The
first bottom of the pattern is just a continuation of the previous
downtrend and is a new lower low. The middle peak of the double bottom
is an expected retracement after the lower low. However, trouble arises
when prices move down from the middle peak and attempt to make yet
another lower low for the downtrend. Traders have been able to push
prices progressively lower thus far, but when prices fail to fall past
the previous low, traders become worried. Once the high of the middle
peak is penetrated, the downtrend is considered dead by traders. Prices
were unable to make lower lows (making lower lows is one of the
definitions of a downtrend) and now since the high of the middle peak
(technically a high) has been broken above, now a new high has been
created (making a higher high is one of the definitions of an uptrend).
Now that the downtrend has been broken and a new uptrend has been
created, it is expected that traders will pile onto the new uptrend and
prices will move higher.
Price Target
When calculating price targets after the buy signal is suggested, Bulkowski (2008) promotes the following formula:
Double Bottom Price Target: Price of the Middle Peak + ((Price of the Middle Peak - Price of the Lowest of the Two Bottoms) * 66%)
4 Double Bottom Chart Patterns
There are four anatomically suggestive double bottom patterns:
Adam & Adam, Adam & Eve, Eve & Adam, and Eve & Eve.
Bottoming price bars that are sharp "V"s, usually one day events, are
referred to as "Adam"s. Whereas, rounded "U"s that are usually multiple
day bottoming bars are referred to as "Eve"s.
Eve and Eve Double Bottom
The Eve and Eve (EE) double bottom contains two soft multi-day
"U" bottoms. The research of Bulkowski claims that of the four double
bottoms, the Eve and Eve pattern is the most successful, with the
average highest high (before any retracement of 20% or more) after the
price breakout of the pattern being 40% (2005).
Eve and Eve Double Bottom Chart Example
The Eve and Eve chart example above of Procter & Gamble (PG)
shows two "U" bottoms. With the exception of an anomaly price bar, the
first bottom is created by four bars creating a rounded bottom. Prices
smoothly ascend creating a round middle peak and then flow downward
creating another smooth bottom that consists of roughly a week of price
action. Prices gap up and the price level established by the middle peak
is pierced giving a buy signal. In this example there is no retracement
after the breakout, prices continue higher.
Adam and Adam Double Bottom
The Adam and Adam (AA) double bottom contains two sharp "V"s. The
research of Bulkowski claims that of the four double bottoms, the Adam
and Adam pattern is the least successful; however, the AA pattern is
nevertheless successful, the average highest high (before a retracement
of 20% or more) after the price breakout of the pattern is 35%.
Adam and Adam Double Bottom Chart Example
The chart above of the S&P 500 ETF shows an Adam and Adam
double bottom. The double bottom pattern is preceded by a downtrend and a
two-day sharp move downward forming the first bottom, followed by a two
week retracement upward before moving once again downward. The second
bottom consists of three days but is emphasized with a sharp long bar
that tests the first bottoms low price area. Prices once again move
higher, breaking past the middle peaks high and triggering a buy signal.
But, as is very typical 2/3 of the time, prices pullback after the
breakout (Bulkowski, 2008). However, after this very typical pullback,
prices move ever higher.
Adam and Eve Double Bottom
The Adam and Eve (AE) double bottom pattern consists of a sharp
"V" bottom followed by a more rounded "U" pattern. Bulkowski's (2005)
research states that the AE double bottom pattern is the second best
performing of the four double bottom patterns with an average rise of
37% after the price breakout confirmation before any retracement of 20%
or more occurs.
Adam and Eve Double Bottom Chart Example
The chart above of Boeing (BA) exemplifies a typical Adam and Eve
double bottom. The first bottom is sharp and consists of only two days;
however, the second bottom contains five bars that have roughly the
same low price support level and slowly begin to roll upward. As is
typical in technical analysis, once a resistance line is penetrated it
becomes the new support. The high of the middle peak is penetrated and
hence a buy signal is given. Prices rise, but then begin to rollover.
This is typical per Bulkowski's research, that states that the AE double
bottom should retrace after a breakout 59% of the time (2005). Once the
price hits the prior resistance level, the retracement is complete and
the resistance level switches to support and prices move upward from
there.
Eve and Adam Double Bottom
The Eve and Adam (EA) double bottom pattern consists of a rounded
"U" pattern followed by a sharp "V" bottom. Bulkowski's (2005) research
states that the EA double bottom pattern is the third best performing
of the four double bottom patterns with an average rise of 37% after the
price breakout confirmation before any retracement of 20% or more
occurs.
Eve and Adam Double Bottom Chart Example
The chart above of the Consumer Staples SPDR ETF (XLP) shows a
modified Eve and Adam double bottom. A downtrend begins the pattern that
also contains a, typically bearish, continuation gap down within that
downtrend. The first bottom of the double bottom pattern is a soft curvy
bottom establishing an area of support. This is followed by a move
higher creating the middle peak and additionally filling in the gap.
What looks to be another "Eve" bottom begins to establish itself;
however, a sharp two day "V" ends the bottoming price action. Bottom
prices should typically be within 5% of one another. Prices move higher
approaching the middle peak high. A buy signal is signaled when the
middle peak high is penetrated. Prices shoot up with a large bullish
price bar the day after the first close above the middle peak high.
Typically, there is a retracement after the breakout; Bulkowski research
suggests 57% of the time (2005). However, in this example there was no
retracement, prices rocketed up higher
Source:- http://www.finvids.com/Chart-Pattern/Double-Bottom/
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