When trying to identify a potential reversal in the technical direction of the Forex market, one of my go-to patterns is the double bottom pattern.
A double bottom emerges when there is a prolonged move downward, and this formation can be utilized to locate purchasing opportunities when the price begins to move back upward.
As the name suggests, the double bottom pattern is made up of two bottoms that form at a key support level. This price action pattern is unique because it shows a market level where demand is higher than supply, not once but twice in a short time.
In this lesson, we'll talk about how the double bottom pattern works and what it looks like. We'll also discuss how to trade with this pattern by looking at a recent double bottom on the Forex market.
Before we can learn how to trade the double bottom, we must first understand its features. This will allow you to detect the pattern on a chart quickly and easily, as well as comprehend the dynamics underlying this powerful reversal pattern.
The double bottom pattern is generated following an extended slide down, as shown in the figure above. The market discovered buyers at a critical support level (first bottom).
Shortly after the first bottom was formed, the market retested new resistance at the neckline and then established support at the same key support level (second bottom).
One common error made by Forex traders is assuming a double bottom has formed before the market has confirmed the technical pattern.
How the Double Bottom Pattern Is structured?
At the end of a downtrend, there is a double bottom. As the price goes down, making lower highs and lower lows, it bounces back up before going back down to retest the previous low.
As a basic rule of technical analysis, a low that has been touched twice becomes a support level. This means sellers can't make a new low lower than the previous one.
This gives buyers a chance to push the price up. Because of this, we have two bottoms that look like the letter "W."
On the other hand, the pattern is thought to start at the highest point of the bounce back after the first bottom. At the top of a rebound, where it is tallest, a horizontal line is drawn. This line is called the "neckline."
Since it's almost impossible to get two bottoms at exactly the same price, as long as these two lows are at about the same price, that's enough to prove a pattern.
The double bottom pattern is thought to be a bullish reversal pattern because it starts with a downtrend and ends with an uptrend.
Once the price action breaks above the neckline, the pattern is in play. So, the price action goes from making lower lows and lower highs to making higher lows and higher highs.
People usually think that two consecutive bottoms with a short time between them can be a problem. This is because it shows that the downtrend is very strong, which means that the current bearish trend is likely to continue.
Because of this, double-bottom patterns that work best have a certain amount of time between the two lows.
The formation of a double bottom is one of the most crucial chart patterns for spotting longer-term shifts in trends since it indicates that a big low has been established and is likely to remain for the foreseeable future.
After the second low, the pattern usually predicts a 10% to 20% bounce back, but there may be more upside if the fundamentals have changed in the security's favor.
For example, a good outlook for future earnings could start a new uptrend. Visual analysis with relatively long-term charts is the most effective method for spotting double bottoms (daily and weekly).
The lows don't have to be the same, but they should be within 3%–4% of each other at most. As a minimum measure of the upside potential, the highs of the first bounce-back (about 10%) are used.
If the new low is within 3% to 4% of the old low, the pattern is finished with a pullback and a second test of the downside support. Once the double bottom pattern is made, traders should watch for moves back up.
If the high in the middle of the pattern is broken after the second bottom has been made, it means that the price could go up even more and that a new uptrend may be starting.