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What Does a Double Bottom Indicate?

W ouldn’t you love to know when exactly to buy or sell securities to make the highest possible amount of money? While you can’t ever know with 100% certainty what a stock’s going to do, there are some excellent tools out there to help you analyze trends and make data-informed investment decisions. Learning to identify double bottom patterns on stock charts is one such tool.

Image via Unsplash by Aditya Vyas

Takeaways:

  • Double bottoms are technical analysis charting patterns.
  • They indicate a trend reversal.
  • Double tops are the opposite of double bottoms.
  • Several factors can help you identify a true double bottom.

What Is a Double Bottom?

A double bottom is a specific technical analysis pattern found on stock charts. This common pattern is a type of reversal, meaning its appearance suggests a momentum reversal for the security in question. It’s called a double bottom because the daily tracking points on the graph create a W shape, with two bottom troughs, before rebounding. Investors can use double bottom trends in both forex and equity markets.

What Does a Double Bottom Mean?

Double bottoms usually signal a stock’s value reversal and the start of a positive, upward trend. This pattern follows a downtrend, either major or minor. Investors use double bottom indicators as a tool for determining when exactly they should buy a company’s stock. If purchased at the right moment, there’s a strong chance to make money in the intermediate or long-term market.

Double Top vs. Double Bottom

Another common reversal pattern is the double top, which is the exact opposite of the double bottom trend. Rather than creating a W shape, a double top creates an M, with two peaks just before a downslide in value. Double tops are indicators of bearish reversals and help investors know when to sell their stock to avoid losing money.

How to Identify a Double Bottom Pattern

Double bottom charting patterns have a very distinct visual sequence, which can make them easy to spot if you know what to look for. However, patience is a necessity when looking for true double bottoms. Follow these steps to ensure the pattern you see emerging truly indicates an upward reversal.

1. Review prior trend

If you think you’ve identified a potential double bottom on a security’s stock chart, your first task is to identify the prior trend. Look for a steady decline over the previous months to confirm there’s a substantial downward trend ripe for reversal.

2. Mark the first trough

Determine the bottom of the downward trend by marking the very lowest point before the first reversal starts. This spot marks the first of the two bottoms. You’ll want to know the specifics of the stock’s valuation at that point so you can compare it to the second bottom.

3. Identify the first peak

Once you’ve identified the bottom of the trend, or the first trough, mark the first peak. This will be the first significant upward valuation post-downward trend. You’re looking for a 10% to 20% advance from the first trough, ideally. Take note of the price point and volume at the height of the peak, since you’ll need to compare this data to that of the second peak.

4. Look for the second trough

After the initial reversal, in a double bottom pattern, the stock’s value will drop again. Mark that second trough and compare it to the first. In an ideal double bottom, the second trough should be within 3% to 4% of the previous trough.

5. Assess the volume

One of the key indicators of a potential double bottom is a substantial increase in volume coming out of the second trough. If you see that second reversal paired with an upswing in share purchase numbers, that’s a great sign you’ve got a true double bottom pattern on your hands.

6. Wait for the resistance break

Before you make any investment or strategy choices, you’ve got to wait for the resistance break. Once the second reversal pushes past the first peak (and purchase volume remains high), chances are really good the security will continue its upward trajectory.

7. Consider your move

After the stock has pushed past the resistance break, it’s time to consider making an investment move. Historically, passing the resistance break in a double bottom is a good signal it’s time to buy a long-term holding.

Other Considerations

Ideally, you want a gap of at least four weeks between each trough in the double bottom. This pattern is a long-term developer. You should use daily or weekly charts rather than intra-daily charts to look for the emergence of the pattern.

Potential Buy Signals

In addition to tracking the double bottom and ensuring the peaks, troughs, and volume all indicate a positive reversal, there are a few other signals you can assess to ensure a low-risk investment move.

  • Confirm the reversal with market fundamentals on the security.
  • Review the trends in the security’s sector.
  • Assess overall market trends for positivity.
  • Watch the volume. Even if the valuation is tracking the shape of the double bottom W, that uptick in purchase volume following the second trough is vital.
  • Look at the closing price on the second rebound. Once it’s even with the first peak, it’s time to sit and wait for that push through the confirmation line.

Types of Stock Charts

Y ou can identify double bottom patterns and benefit from their guidance on stock charts. There are lots of different stock chart styles out there, but the easiest ones to find a double bottom pattern on are line charts, bar charts, and candlestick charts.

Line Charts

Line charts are the simplest and most common type of stock chart out there. Each line chart represents a single security’s valuation by time. The x-axis represents the date or time, while the y-axis represents monetary value. The points plotted on the chart indicate the corresponding security’s value by day, with a line connecting each point for an easy visual read of the stock’s trends over time.

You can easily see a double bottom pattern form on a line chart — the lines connecting the plot points will create the pattern’s signature W shape.

Bar Charts

Bar charts are slightly more complicated stock charts than line charts, but they can also be more useful to investors. They’re also called Open High Low Close, or OHLC charts, because they provide four data points — the stock’s opening price, highest valuation, lowest valuation, and closing price — all in one bar on the chart.

The bars themselves have three parts: a vertical line, and two much smaller horizontal lines. The top of the vertical line indicates the highest price point the stock hit during the day. The bottom indicates the lowest price point for the day. The horizontal line extending from the left of the vertical line indicates the opening price for the stock, and the horizontal line extending from the right side of the line indicates the closing price.

You can use bar charts to identify double bottom patterns, but you might have to scrutinize the graph a bit more closely than you would with a line chart, simply because there’s more data present on the chart to parse through.

Candlestick Charts

Candlestick charts are incredibly similar to bar charts. Their set up is identical but for two elements — rather than a vertical line, the candlestick chart’s bars are open rectangles, and the opening and closing lines are vertical, extending from the top and bottom of the “candle,” rather than horizontally. Candlestick charts use colors to indicate whether the security made or lost money overall by shading the inside of the bar. Usually, green or white shading is positive valuation and red or black is negative.

Like with the bar chart, you can identify double bottom patterns here, but look closely to ensure you can see the patterns clearly through all the included indicators on the graph.

Risk Factors

The biggest risk factor in using the double bottom indicator is the misidentification of a trend. Misreading the pattern could result in a poor investment decision. For that reason, it’s best to remain patient and wait until you have all the identifying elements of a double bottom before making any moves. Look at weekly charts to see that predictive W shape rather than intra-day charts which will have much more volatility.

Other Technical Reversal Patterns

Reversal patterns are super useful tools for identifying powerful investment moments. A few others to know about include:

  • Reverse head and shoulders: This bearish reversal pattern has three peaks, with the far right and far left close to the same height, creating “shoulders,” and the central peak the highest, forming the “head.”
  • Sushi roll reversal pattern: A sushi roll reversal pattern occurs when five consecutive bars are engulfed by the next five bars on the chart.
  • Rounding bottom: A rounding bottom reversal is a bullish pattern in which, after trending down, the valuation slowly curves into an upward trend.

Double bottom charting patterns are a useful tool for those looking for intermediate to long-term investment options. Stay patient and watch the pattern emerge over several weeks before taking any action for a better chance at a successful maneuver.