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Saturday, June 27, 2009

DOUBLE BOTTOM PATTERN – Part 1: Formation

Double Bottom Pattern is a bullish reversal pattern that normally forms after an extended downtrend, which marks a shift in trend from bearish to bullish.
Sometimes, this pattern is called “W pattern” because it looks like one.

The Formation of Double Bottom Pattern



Double Bottom Pattern contains two consecutive, distinct bottoms at about the same price level, with a moderate peak between the bottoms.
This pattern forms when the price is in an existing downtrend. It occurs when the price increases to a support level (forming the 1st bottom), then increase (forming the peak), and then return to the support level again (forming the 2nd bottom) before subsequently the price increases further.

The bottoms can be either sharp & narrow or a bit rounded looking & wider.
Although the price bottoms do not necessarily need to be exactly the same, but it should appear near the same price level.

The pattern is completed and confirmed when the price increases and closes above the highest point of the peak in between the 2 bottoms, which serves as the key resistance level in this pattern. This highest point is called the “Confirmation Point”.

Double Bottom Deception
Although Double Bottom is viewed as a common pattern and quite easy to identify, it’s actually not the case. Many people have actually incorrectly identified patterns that look like “W” shape as Double Bottom, but in fact it is not a Double Bottom formation.
Actually, this pattern can be quite difficult to identify correctly. Even when a pattern follows the characteristics of a Double Bottom, the failure rate is still high particularly when one never waits for the breakout. However, one waits for the breakout through the Confirmation Point, the failure rate would be considerably lower.

Therefore, one should pay close attention & take proper steps to analyze the characteristics of Double Bottom in order to minimize / avoid deceptive Double Bottom.
Some important characteristics of a Double Bottom that need to be paid more attention are the duration / time taken to develop the formation, the height of the peak, the volume during the formation of the pattern, and the breakout from the Confirmation Point

All these characteristics will be discussed in more detail in the next post.

To be continued to Part 2: Important Characteristics of Double Bottom pattern.

To find out more about other Chart Patterns, please refer to:
Learning Charts Patterns

Analysis Tool:
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Related Topics:
* Learning Candlestick Charts
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Option Greeks
* Understanding Implied Volatility (IV)
* Understanding Option’s Time Value

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