Double Bottom Reversal Pattern
The Double Bottom Reversal is opposite to the double top reversal pattern as indicates a bullish reversal. Unlike the double top pattern, the double bottom pattern is comprised of two nearly equal lows with a moderate rise in between. The pattern is confirmed when the price moves higher from the second low and breaks above the resistance line created between the two lows.
Pattern Anatomy
The Double bottom Pattern indicates a possible change in the downtrend. A downtrend indicates that the bears are in control and the supply is overpowering the demand. However, the prices in the financial markets are bound for some correction for several reasons including profit booking, better supply, etc.
So the first low in the Double Bottom Reversal Pattern indicates that the sellers are now existing from the sell trades which causes the price to rise. Following a moderate rise, the bearish forces again try to take control and take the price lower but fail near the first low. The two consecutive failed attempts around the same level indicate that the bears are now exhausted and that is likely to help the bulls to take control and reverse the downtrend. The reversal is confirmed when the price from the second low moves higher and breaks above the resistance line created between the two lows.
The Double bottom is a reversal pattern and like any reversal pattern, there must be an existing trend to reverse. In the case of the Double bottom Reversal pattern, a significant downtrend lasting from a few weeks to a couple of months should be in place.
The first low indicates the lowest point of the ongoing downtrend. The first low is fairly normal and at that point, the downtrend is considered intact.
The rise after the first low is generally 10 to 20%. The high can extend but the overall closing of the market should remain within the range before the start of the second low.
The second low usually remains contained within the first low. Generally, a second low within the 3% of the first low is considered adequate.
The period between the two lows can vary from a couple of weeks to a month. The volume between the two lows generally remains lower.
The rise from the second low shows an expansion in the volume. The high volume may also cause an opening with the gap. Such an opening indicates high demand and the prices may rise sharply.
Even after the rise from the second low, the pattern will not be confirmed until it breaks above the resistance level between the two lows. Generally, the resistance level is breached with a high volume
The pattern is confirmed once the resistance line between the two lows is breached. Following the breach the resistance line act as a support area for future price movement. It is a good idea to have the newly established support line being tested a couple of times before taking an entry.
Using The Pattern
The Double bottom pattern is fairly simple, however, traders should take proper steps to avoid trading deceptive reversal patterns. The lows in the pattern should be separated by at least a couple of weeks. If the lows are too close they could well be normal support areas and may not cause the trend to reverse. Traders must also ensure that the rise between the two lows remains between 10 to 20% of the downtrend. A rise of less than 10% could well be a smaller correction within a larger trend.
The following chart of USD/CHF pair is a good example of the Double bottom Reversal Pattern. The pair had been dropping from 1.2800 until around 1.1300 it showed the first sign of correction and move higher to almost 1.1600. This created the first low in the pattern which then again follows a decline and creates the second low in the pattern. The second drop again holds around the same level and the pair once again starts to rise and finally breaches above the newly created resistance line between the two lows. The break above the resistance line confirms the double bottom reversal pattern and signals a bullish reversal. Following the signal, you can see the pair gradually started to move higher.
Trade Setup Using Double Bottom Reversal Pattern
The double bottom reversal pattern presents an opportunity to benefit from a possible change in the uptrend. One of the simplest ways to trade using this pattern is by entering a long (buy) trade when the resistance line between the two peaks is breached. For additional confirmation of the breakout, you can wait for at least a couple of session sessions before entering the trade.
The stop-loss position largely depends on your risk appetite and trading style. However, as a general rule of thumb, you can either keep your stop-loss below the recently breached resistance line which then acts as a support line or you can keep it below both the two lows in the pattern. The stop-loss below the two lows in the pattern provides an added protection against unexpected price movement.
You can determine the take profit in multiple ways. Usually, the take profit is kept below the next resistance level. You can determine the next resistance level by analyzing the price action and using the trend lines. Another method to determine the take profit is by using a technical indicator like the moving average or RSI. The moving average line act as dynamic support or resistance area. In the case of the Double bottom Reversal pattern, if the moving average line is above the current price you can keep your take profit just below that. Likewise, the RSI can also help to determine the exit level. As a general rule of thumb, if the RSI is above the neutral zone (above 50), you can continue holding your position and close the trade just before the RSI enters the overbought zone (70).