Trading the Double Bottom Pattern
Today's topic is on how to use another common chart pattern to pick up pips from the Forex market otherwise known as the DOUBLE BOTTOM. The double bottom is a bullish reversal pattern that signifies when prices have bottomed out and are ready for an upside reversal. It is like the currency pair is saying: “look, I have tried twice to cross this door to the downside, and I am tired. I am going back up.”
The double bottom can be called the opposite of a double top because it occurs just like the double top, only in reverse. The double bottom consists of areas where the price action has formed two successive troughs as follows:
a) There has to be a prior down-trend. If what looks like a double bottom appears in the middle of nowhere on the chart, it will not play out the way it should and will cause the trader major problems.
b) This is followed by a period where the falling prices bounce off a support head upwards to strike a short term resistance (the first trough).
b) prices retreat from this short term resistance and fall back to the same support or to a price region located close to that support level, where they bounce again (the second trough).
c) After the second bounce, prices rise upwards to meet the previous resistance or an area close to it. A line can then be drawn to connect these two points that form the short term resistance to form a neckline, providing the landmark for the trade entry.
The double bottom strategy aims to break the neckline resistance to the upside. Confirmation of this break occurs when a candlestick closes above the neckline after the 2nd trough which completes the double bottom. At this point the pattern has formed.
Entry Rules
Allow the full double bottom pattern to form, then go long at the break of this neckline support.
Alternatively, the trader can set a Buy Stop order about 15 pips above the neckline, waiting for the upside break of the neckline resistance to trigger the trade. Beware of candles that merely cross the neckline without closing above it.
If there is a candlestick (e.g. bullish pinbar) that forms at the break of the neckline resistance, this is further confirmation for the trader to go long without further ado.
Exit Rules
Just like in the double top, the standard rule for exiting a long trade which is profitable is to measure the distance in pips from the neckline to the trough, and use that distance to set the TP (Take Profit) level for the trade. Further price appreciation means that the trader can set a trailing stop 15 pips beyond the profit target and follow the trade to its logical conclusion. However, this rarely plays out for the double bottom and traders are best served exiting at the defined profit target.
The chart below shows a double bottom with the entry and exit points clearly displayed.
On this chart, there are two double bottom formations and the necklines are clearly visible. In both cases, breaks of the neckline signals the trader to go long, and the exit points are seen to correspond to the distance between the neckline and the troughs.
Traders must always be patient when trading the double bottom to make sure that the troughs that form the bottoms are fully formed, and that the necklines are clearly defined. The breaks of the neckline must always be confirmed before an order is placed.
