Double Bottom Pattern in Trading: Meaning and Factors

In our previous chapter, we covered in-depth the formation of the double-top pattern. The roles of bulls and bears in price action were also discussed. In this chapter, our focus shifts from a double-top pattern to a double-bottom pattern. 

The double-bottom pattern can be considered a mirror to the double-top pattern and is a bullish reversal pattern, i.e., it depicts the takeover of bulls over bears (the opposite is true from the double-top)

Let’s explore the different constituents of the double-bottom pattern and how to interpret it. 

What Is the Double-Bottom Pattern?

The double-bottom pattern is a popular bullish reversal pattern that signifies a possible trend reversal in a security’s price movement. This pattern takes the shape of the letter “W'' and typically occurs at the end of a downtrend. You may also read this pattern as a reversal pattern where the stock’s price forms two bottoms around the support level. 

By recognising the components of a double-bottom pattern, traders can identify potential buy and sell opportunities. Let's now explore the key components of the double-bottom pattern –

First Trough: The first trough represents the bottom of the downtrend and acts as the initial support level for the security's price. It occurs when selling pressure reaches a temporary equilibrium, leading to a halt in the downward movement. Traders observe this trough as a potential buying opportunity, signalling the possibility of a trend reversal.
Peak: Following the first trough, the price starts to recover and reaches a peak. The peak represents a resistance level where selling pressure outweighs buying pressure, causing the price to reverse temporarily. This retracement is a normal occurrence in the formation of the ‘W’ shaped pattern.
Second Trough: After reaching the peak, the price declines again and forms the second and final trough. Typically, in most double-bottom patterns, the second trough may not go as low as the first trough and may have a lower volume. 

However, it somewhat confirms the potential trend reversal and forms the second support level of the pattern.

• Advance From Second Trough:

After the formation of a second trough, the price starts to rally again, just like the first peak, but this time, it breaks above the resistance level (created by the peak). 

The advance is a strong bullish signal, suggesting that buying pressure has overcome selling pressure. The volume on this leg of the pattern must be high and traders must look for confirmation of this breakout before considering a long position.

• Support and Resistance:

The first trough acts as the initial support level, while the peak represents the resistance level. Traders must look for a breakout above the resistance level to confirm the pattern's validity and anticipate a further price increase. 

• Neckline:

The neckline is a horizontal line drawn across the peak that connects the two troughs, forming the “W” shape of the pattern. It acts as a critical level of resistance that must be breached for the pattern to be confirmed. Once the price breaks above the neckline with strong volume, a double-bottom can be confirmed. 

Here are some points you must note when concerning the double-bottom pattern –

1. A downtrend should be in place for a reasonable time for this pattern to form.
2. Ideally, the first through is deeper than the second trough.
3. Only when the resistance is breached, the pattern must be considered complete. 
4. Patterns on longer time frames tend to carry more weight and have a higher probability of success than patterns on shorter intraday time frames. These include daily or weekly charts.

How To Interpret Double-Bottom Pattern?

Here is how you can spot a double-bottom pattern:

1. Identifying the Double Bottom Pattern: To begin, traders must first identify the double bottom pattern on a price chart. Look for a ‘W-shaped’ formation with two distinct troughs and peaks in between. The pattern is confirmed when the price breaks above the neckline.
2. Entry and Stop-Loss Levels: Once the traders spot the double bottom pattern, they can consider entering a long position as bulls may be taking over the market. The ideal entry point is typically above the neckline, as it confirms the pattern’s validity. To manage risk, one can set a stop-loss level along the advance of the second trough, ensuring a reasonable buffer in case the pattern fails.
3. Calculation of Target Price: To calculate the target price for a stock exhibiting a double bottom pattern, measure the distance between the lowest point of the pattern (first trough) and the neckline. Then, add the distance of the breakout point above the neckline. This projected distance provides an estimate of the potential price increase.

Let's consider an example. Assume a stock trading at ₹175 falls to ₹135 over a couple of months. The stock then experiences some buying pressure, reversing the downtrend and peaking at ₹168. The double-bottom pattern has now started to emerge. The selling pressure is back and the stock makes a new bottom again, but not as low as the previous bottom at ₹140. Joining the two bottom points gives us the support level.

Now, there is intense buying pressure, and the stock has started to rally. A resistance level or neckline is now formed when the stock nears and passes the previous peak at ₹168. The stock breaks the neckline and has started to rally past ₹170, which becomes the breakout point. 

To calculate the target price, we need to measure the distance between the lowest point (first trough) and the neckline and then add this distance to the breakout point. 

The lowest point in this example is ₹135, and the neckline is formed near ₹168. Therefore, the distance is ₹168- ₹135 = 33. To calculate the target price, we add this distance to the breakout point, which, in this case, is at ₹170. 

Target price = Breakout point + Distance 

=170+33

=203

Did you notice how the formula is exactly what we had used in our previous chapter on double-top? The only difference is that the distance, when concerning a double-bottom, is added, while in a double-top pattern, the distance is subtracted. 

Factors To Consider When Trading a Double-Bottom Pattern?

• Volume:

Volume is arguably the most important factor to be considered to confirm the validity of the double-bottom pattern. 

High volume during breakout above the neckline is a crucial factor to consider. An increase in trading volume indicates strong buying pressure and confirms that market participants are actively participating in the upward move. Conversely, low volume during breakout may suggest weak market interest, potentially weakening the pattern’s reliability.

• Price Confirmation:

Price confirmation is another vital factor to consider. Traders should wait for the price to convincingly break above the neckline before entering a long position. A clear breakout above the neckline validates the pattern and signals a potential trend reversal.

• Pull Retests:

After the breakout, it is common for the price to experience a pullback or retest of the neckline. Traders should closely monitor these pullbacks as they can provide favourable entry points with potentially lower risk. 

A successful retest of the neckline, where the price holds above the breakout level, can further reinforce the pattern’s validity.

With this, we close this chapter. Do note that no chart pattern is foolproof; be careful when reading and interpreting them. In our next, learn about different a charting pattern – rounded top.