A double-bottom reversal is a bullish pattern that could signal the end of a downtrend. As the name suggests, a double-bottom pattern is characterised by two price troughs at around the same level.
The price level at both these troughs represents a key area of support.
Understanding the double bottom
After falling to a new trough as part of an existing bearish trend, the price then rises. However, the price subsequently falls again, as the downward momentum persists. Another rise takes place from the next trough.
The price has troughed at around the same price level twice but was unable to move down past this level, indicating that this is a point of major price support.
Two horizontal lines can be drawn; one intersects the two troughs across the bottom of the pattern, while another can be drawn through the highest price point along the top.
A breakout to the upside above the upper line is generally viewed as a buy signal. As ever, it’s important for us to observe that the breakout is accompanied by higher trading volume. This should lower the odds of us acting on a false breakout.
Trading the double bottom
As an example, suppose we are tracking the price of Amazon shares. As part of a recent bearish trend, we see the price of Amazon’s stock fall to a trough of $1,150 before observing a fairly steep bounce, with the price reaching a peak of $1,306.
We then see the price fall again as sellers come into the market. However, once it reaches $1,150, the price bounces up yet again, signalling that this is a major level of support.
After nearly reaching $1300, the price subsequently zigzags down to $1,248. Amazon’s stock then trades briefly in a narrow range, before rising sharply, in a near vertical jump on higher trading volumes.
The usual way to calculate a profit target for a double bottom is to add the height of the pattern to the breakout price level. In this case the height of the pattern is: $1,306-$1,150 = $156
Our profit target is therefore: $156 + $1,306 = $1,462
We have initiated a buy order at $1,310, just above the $1,306 price level denoted by the upper line of the chart pattern. We exit the trade two days later, extremely pleased with the result, when the price has met our profit target and is trading at $1,462.
As always, we should seek to set a stop-loss order for the trade, just in case there is a price retrace and there proves to have been a false upwards breakout. In this example, $1,248 could be a reasonable level at which to set a stop-loss order as this was a low point that we observed during the consolidation phase.