Chart Pattern Recognition Series - Double Bottom Reversal Pattern
The double bottom is probably the most popular technical pattern of all time and thus worthy of your attention to help better understand its opportunities and correctly judge buying points. One of the most attractive attributes of the double bottom patter is its 35% average rise after confirmation. So lets start with the identification guidelines of the pattern.
- A downward stock motion leading into the pattern
- Two distinct V-shaped (or price spikes) bottoms
- At least 10% rise BETWEEN bottoms
- Bottom prices that do not vary more than 3% apart
- Valley should be approximately 5-weeks apart (for best performance)
- Volume usually higher on the left valley formation
Confirmation of the double bottom is confirmed once the price closes above the peak between the two valleys. This means there are TWO good buying opportunities here. My favorite is that of the second valley bottom with a tight stop just below that the low of the first valley. This maximizes opportunity and limits your downside risk. A seemingly simple objective for any trade but one that too many traders fail to do on a regular basis. The other opportunity is a upon the confirmation of the close above the peak between the two valleys. However, with a 65% pattern throwback rate, taking a position at this point in time serves both opportunity and risk to the investor.
My favorite double bottom opportunities come from stocks that show a strong incline to the left side of the pattern. One that has few or no price consolidations along the way and quickly fall from their highs in a rapid and aggressive fashion. Remember that a small decline from the left side peak means a small opportunity for profit judging by the pattern measuring rule:
Bull Market Target Price:
(highest peak price minus lowest valley price) x 66%
Bear Market Target Price:
(highest peak price minus lowest valley price) x 40%
Of course we are in a bear market right now and will probably be in one through much of 2008 and into early 2009. So how about a real time example of this pattern in action you ask? Sure, but remember that almost all chart patterns perform better when applied to stocks that are industry leaders. With that being said, here is one of my favorites for the 2008 calendar year. VMWare Inc. (VMW:NYSE) - Sector: Technology, Industry: Software & Programming. Due to the nature of this post (chart pattern series), I won't get into the reasoning behind why VMW is an industry leader but rather focus our attention on the pattern itself and allow you to watch its progress in real time rather than giving you a past example.
Notice the very steep and aggressive run the stock made upon its IPO offering and the equally as aggressive sell off to form a nice top left peak. The stock continues to decline to a low around $71/share before bouncing hard. This bounce creates our first valley and what is to be the peak between the valleys. The share prices again fall to the around $71 and a sizable position is taken by me at $72 (with a close stop set just below). Now even in the face of all the market turmoil and volatility, VMW pushes higher and closer to its double bottom breakout confirmation. Of course that confirmation will have to wait until the market stabilizes a bit. Fed cuts rates by 75 basis points this morning helping to ease what would have been a 600 point drop at the open. Again giving investors an opportunity to get into VMW fairly cheap.
VMW proves itself to be an amazing opportunity both technically and fundamentally and I would expect a strong performance from this stock even in the struggling US economy that is 2008.
Full Discloser: Long the shares of VMWare (VMW) and happily long many more double bottom chart patterns.