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How To Trade The Double Bottom Pattern

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December 21, 2011 0 comments

The Double Bottom Pattern is a reversal pattern that indicates a change in trend from a downtrend to an uptrend. Double bottoms are formed when a stock forms a low, recovers some of the losses and then makes another low around the same area as the first low. This gives the chart a look of a rather large “W”. The pattern should form over a minimum of a 7 week period. The second low should be within around 3% of the first low, and volume should increase on the subsequent rally.

The technical buy point for a double bottom pattern is when prices breakout above the middle peak of the “W”. For this reason, it is one of the most commonly misidentified chart patterns. Novice traders will assume-the double bottom has been formed once the second low has been made, but this is incorrect. Occasionally, double bottoms will form a slight handle as the stock tries to breakout above the buy point. In this case the handle should be slightly downward sloping and be no longer than one to seven weeks, otherwise the pattern becomes invalid.

Once the prior resistance at the apex of the pattern has been broken, this becomes the new support level. Stop losses should be placed just below this support level. Below you will see a chart of PFE from 2000 forming a classic double bottom pattern. Once the stock broke out, it rose very quickly from 37 to 43. Notice also that you had a second chance to get into the stock when it dropped back and tested the new support level.

Double Bottom Pattern

Double bottom patterns are useful chart patterns as the second low shakes out the final weak hands who are holding the stock and sets up for a powerful? rally.

In terms of trading this pattern, here is some advice on which strategy to choose depending on your risk tolerance levels:

AGGRESSIVE – Long Call
MEDIUM – Covered Call, Diagonal Call Spread
CONSERVATIVE – Bull Put Spread

Here’s to your trading success!

Gav.

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Options Trading 101 - The Ultimate Beginners Guide To Options

Download The 12,000 Word Guide

Get It Now