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Double Tops & Bottoms: How to Trade Them
04/01/2020 9:31 am EST
With large bidirectional swings in stocks over the last month, there are several double top/bottom formations forming. Suri Duddella explains how to exploit them.
As markets attempted to rally from recent Coronavirus sell-off, many analysts expecting the markets may retest the bottom and form potential double bottom patterns. Here we describe how to trade double bottom patterns with several current examples.
Double top and double bottom patterns are part of classic technical analysis. These patterns are very common and form in all timeframes and in all instruments. They form when prices fail to make new highs or new lows at significant previous levels. Double top and bottom patterns are relatively reliable and easy to trade. When double tops or bottoms form it represents strong support or resistance levels, when they fail it usually leads to a larger move as stop form above and below those levels. The stronger the support or resistance, the stronger the move is when that support or resistance in broken.
When support or resistance at a double top or bottoms holds (or when a long/short traded off of it fails), it may lead to a triple top or bottom patterns. Trading off of these patterns have several variants and these variations involve different trading rules and different pattern recognition methods.
The double bottom pattern is a mirror image of the double top. An extended downtrend results in new lows followed by a moderate rally from the first bottom. After a brief rally, the prices attempt to test the first bottom again. Failure to trade below the first-bottom results in a second-bottom as prices rally and reverse the prior trend. The intermediate swing-high between the two bottoms is called the reaction swing-high. When price trades above this reaction swing-high, it signals a potential long trade (see chart).
Trade: A double bottom can only be traded after confirmation of the pattern breakout. Double bottom patterns are also detected using Auto ABC pattern algorithms. When prices trade a higher high (above two-bar highs) near the second bottom with a strong continuation of trend confirmation or a positive trend divergence, it signals to reverse the current trend. Enter a long trade above the high of the breakout bar (EL above).
Target: The double bottom pattern also has a good risk/reward ratio. The first target would be 62% to 79% and 100% of the swing range of the pattern. The second target would be 127% to 162% of the depth of the double bottom pattern.
Stop: Double bottom patterns do fail. This pattern failure occurs if the price closes below the middle of the pattern for multiple bars. Trading below the bottom of the pattern could signal a triple bottom. Place a stop order below the middle of the pattern to protect the trade.
Double Bottom Examples
Check Point Software Technologies Ltd. (CHKP) recently exhibited a double bottom pattern on its daily chart with a strong trend.
CHKP sold off during the Coronavirus sell-off and formed a double bottom pattern as the second bottom reversed above the entry level of $92.72 with a trend confirmation (see chart below). A long entry is signaled above $92.72 with a stop-loss set below $83.72. Profit targets are $97, $105 and $111.
Potential Double Bottom formation in Boeing
Boeing (BA) is forming a potential double bottom pattern on its daily chart (see below). Boeing dropped during the recent sell-off from $340 to $89 and formed the first bottom. A rally from this low with trend reversal confirmed the first bottom. A potential reversal from $189 is near a test of the first bottom, which could form a second bottom (80-90% retracement of prior swing) from $89 to $95. A reversal to the upside would then confirm a second bottom. Also, a trend reversal or continuation of the trend is also needed to confirm the second bottom.
After the second bottom, if prices reverse and continue higher, a long trade may be entered near $115 with targets of $165 and $200. A stop may be placed below the recent second bottom.
Find more of Suri’s work at surinotes.com.
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