The Double Bottom Pattern

The  double bottom pattern is a bullish reversal pattern that occurs at the bottom of a downtrend and signals that the sellers, who were in control of the price action so far, are losing momentum. The pattern resembles the letter “W” due to the two-touched low and a change in the trend direction from a downtrend to an uptrend. 

The aim of this blog post is to describe how to easily identify the double bottom, and most importantly, how to make profits trading this chart pattern by sharing a simple trading strategy.

How the Double Bottom Pattern Is Structured

The double bottom occurs at the end of a downtrend. As the price action moves lower, printing the lower highs and lower lows, the price rebounds higher before returning lower again to retest the previous low. 

As the basic rule of the technical analysis says that the twice-touched low becomes a support level, the sellers are unable to print a new low, below the previous low, which provides the buyers with an opportunity to push the price higher. As a result, we have two lows - two bottoms - that resemble the letter “W”. 

 

 

On the other hand, the highest point of the rebound following the first bottom is considered to be the trigger for the pattern. A horizontal line is drawn at the highest point of a rebound, called the “neckline”.

Given that it’s almost impossible to get two bottoms at the exact same price, as long as these two lows are at a similar price, it is considered to be enough for the validation of a pattern. 

Since the pattern is initiated by the downtrend and finalized in an uptrend, the double bottom pattern is considered to be a bullish reversal pattern. The pattern becomes active once the price action breaks above the neckline. As such, the price action shifts from the situation where it creates the lower lows and lower highs, to a situation where it initiates a trend of the higher lows and higher highs.

 

It is generally considered that two consecutive bottoms with a short duration in between their creation can be problematic, as this means that the downtrend is very strong, thus, the prevailing bearish trend is likely to continue. For this reason, the most effective double bottom patterns are those with a certain amount of time in between two lows.

Strengths and Weaknesses

A double bottom pattern is one of the strongest reversal patterns out there. Since it consists of two bottoms, it’s not a very common pattern. Still, once identified, the pattern is very effective in predicting the change in the trend direction. 

Its greatest strength is that it offers clearly defined levels to play against. The neckline marks the risk and it helps determine the take profit once the pattern is activated. Hence, the correct drawing of the double bottom is very important.

 

The key limitation of the double bottom pattern is that it is a contrarian strategy. Don’t forget that the overall trend is bearish and we are playing the “long” trade here. Hence, the risk is always that the market will continue moving in the same direction. For this reason, it is important to consult supporting factors in the context of other technical indicators before entering the market.

Spotting the Double Bottom Pattern

As noted earlier, identifying and drawing the double bottom pattern is extremely important. We have a USD/CAD hourly chart below, where the pair moved lower before it struggled to break below the horizontal support and further extend the bearish scenario. 

 

Instead, the bulls were able to resist and finally break above the neckline to ultimately erase all previous losses and record gains. We identify two lows that are almost at the exact same price around the $1.30 handle. On the other hand, the price action also created two nearly same highs over the course of a rebound, hence we used this opportunity to draw the resistance line (the neckline) connecting these two highs.

 

 

It is also worth noting that many traders make a crucial mistake in jumping the gun by entering the “buy” trade before the pattern is activated. A double bottom pattern, no matter how perfect it may look, is active only once the buyers break the neck line and secure a close above it.

Trading the Double Bottom Pattern

We will now use the same example to show you how to trade the double bottom pattern. This example also offers great insight into how the failed breakouts work. As you can see in the chart below, as soon as the price action created a second bottom, it surged higher, breaking above the levels where two previous highs were recorded.

 

 

However, this proved to be a failed breakout as the price quickly returned below the neckline. This perfectly shows how important the virtue of patience is in trading. Moreover, this also shows why it is important to wait for a close above the neckline before entering the market. 

The failed breakouts are usually followed by a sharp move lower to punish the buyers for failing to finalize the initial move higher. This is exactly what happened. However, the buyers regrouped at lower prices, and launched another strong push higher to ultimately break above the neckline around the $1.31 handle. 

Hence, our entry is at $1.3110, a level where the USD/CAD closed above the neckline for the first time. The stop-loss should be placed below the neckline, allowing some space for the move similar to a failed breakout where the price action quickly penetrates through the support/resistance without a follow up. 

 

The exact level for stop-loss depends on your risk tolerance, but it can range from 15 to 30 pips below the neckline. Any move and close below the neckline invalidates the activated double bottom pattern. 

The take profit is calculated in the same manner as it is the case with the head and shoulders pattern i.e. measuring the distance between the supporting trend line (double bottoms) and the neckline. The same trend line is then copy-pasted from the point where the breakout occurred, with an end point of the trend line being our take profit. In our case, the trend line ends at $1.3180.

Finally, our take profit order is hit a few days later, banking us around 70 pips. Depending on your risk tolerance and stop loss position, we earned 70 pips by risking 15/30 pips, which represents a great risk-reward ratio.