Last Updated on September 1, 2022 by Oddmund Groette
Learning how to accurately identify and analyze the double bottom chart pattern can help you read market conditions and determine when to look for buying opportunities. But what is this double bottom chart pattern?
The double bottom chart pattern is a price action formation on the chart that consists of two swing lows that end around the same level, and a swing high between them. The pattern is seen in a downtrend and may indicate the end of the downtrend, so it is considered a bullish reversal pattern.
At the end of the article, we provide you with a backtest and a double bottom strategy.
Let’s take a look at this chart pattern to see how it works.
What is a double bottom chart pattern?
The double bottom chart pattern is a price action formation on the chart that consists of two swing lows that end around the same level, and a swing high between them. With the two swing lows ending around the same level, that level becomes an established support level; similarly, the line connecting the swing high with the preceding swing high becomes a resistance level, which is known as the neckline. The pattern is considered completed only when the price breaks above the neckline.
The pattern is seen in a downtrend and may indicate the end of the downtrend or a prolonged pullback in an uptrend, so it is considered a bullish reversal pattern. The pattern shows that the price is about to turn and starts heading upward. Chart pattern traders look for long positions when the price breaks above the neckline.
When trading the pattern, traders estimate the profit target by measuring the size of the pattern and projecting it upward from the neckline. They usually place your stop loss order in the middle of the pattern so they can have a 2:1 reward/risk ratio. Some traders also place the stop loss below the pattern, which is a bit safer, but that offers a poor reward/risk ratio.
Example of a double bottom chart pattern
Let’s look at a graphical example of a double bottom:
Take a look at the chart above. As you can see, the trend before the double bottom pattern was bearish, as indicated by the descending yellow trendline. The downward momentum stopped at the first low (first circle around the blue line at the bottom) and retraces up to the downtrend line. It couldn’t break the trendline and it started to decline again, in line with the existing bearish trend.
The decline continued until the price hit the support level established by the first low where the momentum eventually stopped, and the second low was formed. From there, the price reversed again and continued up through the level of resistance as the neckline.
At this point, a trader watching the double bottom pattern would wait to see whether the price would break the neckline, formed by connecting the preceding swing high to the one preceding it. A breakout would be an opportunity to enter long, as you can see in the chart. Notice that the price dropped a bit again to retest the neckline.
Is the double bottom pattern bullish or bearish?
The double bottom pattern is bullish, as it signals a potential upward price reversal. Usually, the pattern is seen in a downtrend or a prolonged pullback in an uptrend and may indicate the end of the price decline. It shows that the price is about to turn and start heading upward. As a result, the double bottom chart pattern is considered a bullish reversal pattern.
How do you trade a double bottom pattern?
There are various ways to trade the double bottom pattern. Some traders can be aggressive, while others are conservative.
Aggressive traders may want to look for a trading opportunity when the price is making the second low. Knowing that the level is an established support level, they would look for signs of price reversal at that level, such as bullish reversal candlestick patterns or an RSI descending into the oversold region and climbing back out of it.
Conservative traders would wait for the price to break above the neckline which acts as a resistance level. For a breakout to be valid, the price must close above the neckline, and there should be a volume increase.
Whichever method you want to use, it is important to backtest it to see if it is profitable. But the problem is that the strategy is pretty difficult to quantify (see more below).
Double bottom pattern trading rules (and settings)
To summarize, here are the trading rules for the double bottom pattern:
- The trend: There must be an existing downtrend or a prolonged downward movement, even if the overall trend is an uptrend.
- The first bottom: The first swing low of the double bottom pattern should mark the lowest point of the current downtrend as at the time it was formed — so, the downtrend seems to remain in good shape.
- The swing up: After that first trough, the price rallies, retracing 38-50% of the swing low before it; this normally happens on normal volume, but a volume increase could signal early accumulation.
- The second bottom: The decline from the swing up is usually on low volume; it is stopped when it meets support from the previous low — this swing low can be exactly at the same level as the previous one, but anything within 3% of that previous low is fine.
- The price rally from the second bottom: During this rally, there should be clear evidence that volume and buying pressure are accelerating, perhaps marked with a price gap or two — this indicates a potential change in sentiment.
- Neckline breakout: The double bottom pattern is not complete until the price breaks the neckline which acts as a resistance level — this should occur with an increase in volume and/or an accelerated ascent.
- Resistance turned support at neckline: The broken resistance at the neckline becomes potential support. Sometimes, there is a test of this newfound support level with the first correction, which can offer a second chance to open a long position.
- Price target: The target should be estimated by projecting the distance from the neckline to the lows from the neckline breakout.
Amibroker code for the double top pattern
It’s not easy to code a double bottom pattern. However, we have a code that marks double tops and bottoms in the chart and that can be modified to perform a backtest. The code is for sale together with all the other code we for our free and profitable trading strategies.
The chart below is an example of what the code looks like:
Double bottom chart pattern strategy (backtest and example)
As mentioned above, to code a double bottom pattern is a bit complicated as the strategy needs many trading rules and settings. Additionally, it takes a lot of time to code. Is it worth the time? We are not sure.
But to get an indication if it’s worth the time to code, we can look at the research of Thomas Bulkowski. He is an engineer that in the late 1990s sat down to quantify win rate and expected gains for a wide range of classical chart patterns and formations. The book, The Encyclopedia of Chart Patterns, was published in 2000 so it’s a bit old, but we assume chart patterns never stop working (?).
Bulkowski did the following: He picked 500 stocks and studied many chart patterns over a period of 5 years. It has to be said that his study might be liable to survivorship bias in trading. Furthermore, the study and research cover only a period of 5 years – coincidentally a time when the market was in a raging bull period (the late 90s). Last, the formations and patterns were, to our knowledge, picked manually. In other words, the study is based on human interpretation. As such, we regard the results as nothing more than an indication.
Bulkowski’s double top pattern strategy is summarized in the table below:
|#Formations among 500 stocks from 1991 to 1996||542|
|Reversal or consolidation||170 consolidations, 372 reversals|
|#False signals||17 (3%)|
|Average rise of successful formations||40%|
|Most likely rise||20 to 30%|
|#Formations that reached the target||370 (68%)|
|The average length of the formation||70 days|
|Average price difference between bottoms||19%|
The statistics for the double bottom pattern strategy is a lot better than the opposite strategy of double top chart pattern strategy (a short strategy). This is to be expected. A long strategy is “always” better than a short strategy in the stock market because of the tailwind from inflation and increased productivity. We have covered how you can take advantage of this in an article called night trading strategies.
68% of the formations reach their target, and this is almost twice the number compared to the double top pattern.
Double bottom chart pattern strategy – ending remarks
Is the double bottom strategy a viable pattern to be traded? Bulkowski’s research might indicate that, but we would rather prefer to have a complete backtest with 100% quantified trading rules and no human interpretation. Bulkowski used manually detection of the patterns. We believe successful trading comes from 100% specific rules and you are trading a little blind if you rely too much on Bulkowski’s statistics (in our opinion).