Double Bottom Trading Guide

Posted in: Trading Article

The double bottom pattern is a reversal pattern where a down trend may be evolving to an up trend.

Double bottom formations are also a continuation pattern if it shows up during the corrective move of a market and will be present in a trading range.

Let’s describe the double bottom chart pattern and design a logical trading strategy around it that takes into what this pattern represents.

 

What Is The Double Bottom Pattern?

The best way to define and identify the double bottom actually shows up in its name:  price forms one bottom and then another.double bottom pattern
Let’s break down this Forex chart:

  1. Double bottom is a bullish reversal so we need to see it occur after an extended down trend.  Time frame is not relevant.
  2. The first low is where price finds support and the market rallies
  3. The market rallies and many people think the trend is going to continue and sell the market
  4. Price comes into the zone around the first low where it acts as a support level
  5. Price rallies up and breaks the potential resistance line at 3

In a perfect world, price breaks resistance and the down trend is officially over.

Why?

A down trending market makes lower highs and lower lows.  A break of #3 would be a higher high which begins the definition of an up trending market.

In reality, we could be looking at a rally in price that is set to just resume the down trend.

 

How To Trade The Double Bottom Pattern

There are several ways a trader may choose to trade this reversal pattern and the trick is to find one, and stick with it.

I want to give you several options in terms of strategy and you can pick the best one for you.

One thing we should decide is if we are going to play for a short term trade with limited expectations or look to ride a new trend.

The difference is how you manage the trade and again, this is something you are going to have to decide for yourself.

Some people will suggest using a moving average while others will suggest a channel – either a trend line channel, keltner channel, bollinger bands, and others.

My favorite is a channel, specifically a volatility measure such as the one the keltner provides.

Why?

If I am going to trade a reversal pattern for a longer term, I want to see some sign that the market is over extended.

We will get to the keltner channel strategy later.

 

Pre-Breakout Double Bottom Trading 

The first strategy you could expand on is playing the basing under the neckline or the breakout of the neckline.

What is basing?

Basing is when price is forming a small range just under resistance (or above support).

  • Price is in a down trend and forms a double bottom pattern
  • As price travels up towards resistance, it stalls under resistance and bases (green circle)
  • Traders can place their order to go long prior to the breakout inside the range that forms
  • Stop (red dashed line) would go a distance below the base.  Consider using an ATR or structure (notice if you draw a line to the left from the stop, it is in the area of former support

If you use this method, you would be in the trade prior to the breakout which can, when momentum steps in, give you quick profits.

Traders can dial into a lower time frame and look for bullish price action such as a failure test to enter the trade.

 

Breakout Over Neckline

This strategy would have the double bottom form, breakout over resistance, and traders would look to position either on a pullback or market pause.

stock double bottom breakout
You will also see the previous strategy set up just below the red dotted line.

  • Price breaks out and forms a one day range.  Shorter time frames (multiple time frame trading)  highlights this much better but you can infer the lower time frame price action by the candle
  • Stops would go under the base that formed earlier.
  • Price coming back inside the breakout level does not equal a false breakout.  Price would have to remain below resistance
  • You can see in this example with the green circle, that price did pull back into the breakout price zone

There are dangers that the breakout will not range until further up in price.  This would extend your risk needed for the trade.

If you wait for a pullback, price may have traveled a far distance before the pullback occurs which could demoralize further buyers.  While this pull back in price took almost a month, not all are like this.

 

Double Bottom Divergence Setup

This strategy is going to use a bullish divergence signal in addition to the double bottom.

You can use the relative strength index, stochastic, or my favorite, the MACD.

Bullish divergence will show the indicator making a higher swing low while price makes a lower or same level swing low as the first one.

double bottom bullish divergence
There is a lot going on with this chart so I broke it down with a little more detail.

  1. Compare the two lows and note that the second low, is lower than the first.  This is a lower low after a lower high which is still a down trend market structure
  2. MACD (tuned to the 3/10 oscillator settings) shows that momentum on the lower low is actually more to the upside.  This is bullish divergence
  3. A simple trend line break can be your entry by setting a buy stop order just above it

Here’s an important note:  Because you entered right at the lows, ensure you monitor price as it approaches the top line.

  • If price bases, you can move your stop to where you’d place it if trading the basing strategy
  • If you note price losing steam or see a failure test of highs, you may want to lighten up the position or take profits.

The big plus to this trade is you do get in at a price level that is favorable before it tests resistance and that allows trade management.  If price breaks out and runs, you are making some quick profits.

 

Fake Out Strategy

This strategy gets you in right at the bottom of the pattern.

The great things about this strategy are:

  • You get in at the low of the double bottom
  • Price breaks out to the downside and rejects lower prices – trapping trader short
  • Traders exit their short positions by buying which propels your trade into profit

The big difference in this strategy is seeing a strong rejection of lower prices.

That bar or candlestick that shows the rejection, is actually our entry point.  The break of the double bottom resistance level is confirmation.

What sets this apart is your are looking for a spike below the previous low and the rejection of lower price.  You will then want a close above the support line.

You can enter a buy stop above the rejection candlestick and as you can see, you benefited greatly from the pattern.

Why look for the test of lows and rejection?

Failure to have price acceptance of those lows can force the short breakout traders to get out of their position.  Panicked traders can be like throwing gasoline on a fire.

To find this type of rejection, consider adding a double bottom multiple time frame approach as part of your trading plan.  There will be times that the close may be far off the lows if you wait for a daily candlestick to close.

 

Double Bottom With Keltner Channel Confirmation

You can read more about trading the keltner channel here and I think it works very well with double bottom patterns.

In brief, keltner channels will help measure the volatility of a market.  The upper and lower bands will help show where a market may be prime for a snap back in price.

keltner channel double bottom trading

This market has been in a down trend on this 60 minute chart for about two weeks.  One thing to note is when price travels on the outside part of the keltner channel, we are looking at a powerful trend.

Being strong in the one direction means is quite a lot of downside interest.

When it breaks, it can be severe but we need to have an idea, or some sign, that it may break.

Enter the double bottom.

  1. Price puts in the first low outside the band (not needed)
  2. After a lazy retrace, price shoots to the downside and pierces the band.  In this case, it also sets up the fake out strategy with the keltner confirmation

You can enter at close or use a buy stop above the rejection candlestick.

This is a strategy I highly suggest you test out for a possible trading plan.

Where To Exit Double Bottom Trades

This is a touchy subject because the reality is that you can be looking at a new trend forming.

That is a trend followers dream but most of you won’t be able to stomach much adverse price action that trend followers go through.

A rule of thumb for profit taking for any chart pattern is to look at the height of the double bottom pattern and project from the breakout.

double bottom profit target

This is the same chart from the keltner strategy and you project the height of the pattern (from the resistance to the lowest low of the double bottom) and project from resistance.

You can see that price is well on its way to the profit target and this particular trade as a 1:1.68 risk reward ratio.

You can also use trailing stops which you can read about on this trading tips blog.

 

Vital Points For The Double Bottom

Here are some keys to identifying the double bottom and trading it

  1. Make sure we have an obvious down trend on the market and time frame you are trading
  2. Look for price to put in a low and retrace to form a resistance zone
  3. The second low does not have to be at the exact price as the first low.  We are looking for signs of rejection.
  4. Trading before the resistance break is aggressive however we are using other factors, such as the keltner, to tip the odds in our favor
  5. Ensure your place and respect your stop loss

This is a pattern you can quickly scan for and using the keltner channel is a highly effective way to zero in on a trading opportunity where the odds are in your favor.

Like all trading strategies, ensure you test the double bottom trading strategy you will use, and ensure you follow your trading plan.


 

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CoachShane

Trader at Netpicks
Shane his trading journey in 2005, became a Netpicks customer in 2008 needing structure in his trading approach. His focus is on the technical side of trading filtering in a macro overview and credits a handful of traders that have heavily influenced his relaxed approach to trading. Shane started day trading Forex but has since transitioned to a swing/position focus in most markets including commodities and futures. This has allowed less time in front of the computer without an adverse affect on returns.

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