A Day Trader's "Old Reliable"

A perfectly drawn double bottom on a stock chart resembles a W, for its two matching lows with a brief rally in between, followed by a rally of equal or greater magnitude after the second low. In much the same way, a perfectly drawn double top resembles an M, for its two matching highs with a brief sell-off in between, followed by a sell-off of equal or greater magnitude after the second high. For our purposes here, we'll focus on double bottoms, all the while knowing that the same criteria can be applied to analyzing a double top, just in reverse.

Given their symmetrical nature and defined zig-zag movements, the perfect double bottom is perhaps the most appealing formation that chartists base trades off of. They're fairly easy to spot and anticipate on both a daily and intraday chart. Plus, they present consistent ranges that clearly indicate areas to buy and sell. The problem is, these double pleasures are, for lack of a better term, a-dime-a-dozen. You can find double bottoms all over the charts, like pizzerias in Brooklyn, or chili parlors in Cincinnati, and it's sometimes difficult to determine what the best ones to go for are. Furthermore, not all double bottoms appear to us as a perfect W, yet if we don't recognize them as double bottoms, we risk missing out on a profitable formation. So, let's take a look at some of the characteristics of double bottoms and how we can spot them.

As with most any chart formation, the most effective intraday double bottoms contain at least one of three qualities:

1. A recent point of reference in a matching low from either the last few days or even that very same day.

2. Additional areas of support such as earlier bottoming, high/low formations, and/or gaps (among others).

3. A clear stop to minimize risk.

A key component to successful trading over the long haul (even if not necessarily successful individual trades) is to set your stops. This will allow you to define and, more importantly, control your loss threshold and cleanse your pallet in order to concentrate on other trades that are hopefully profitable. This is why #3 above is the most important of the three qualities for any trade, whether you're charting a double bottom or trading off of some other type of formation. Your stops will save you from getting overwhelmed in a tsunami of activity that goes against your position, particularly when you're trading in an area that's less than optimal. 

Historical double bottoms are harder to spot because they usually only begin to appear to us on a daily chart, or some other historical chart as the first bottom was made at some point further in the past. We'll take a look at how a historical double bottom is formed, and the impact they can have on a stock's longer-term movements, a bit later on in this posting. But for now, let's examine some intraday double bottoms.

The Perfect W

To be sure, an optimal area when trading against a double bottom is somewhere as close as possible to the low end of a trading range, as such an area will usually include all three of the qualities of an effective chart formation. As part of a trading range, it will have a recent point of reference and other areas of support. Plus, being at the low end of the range provides a clear stop.

The chart above is an intraday chart for Intercontinental Exchange (ICE), which shows an example of a perfect W double bottom. Notice how the two bottoms are practically identical, the W shape is clearly defined, and the shape of the formation is basically symmetrical. What makes this double bottom particularly noteworthy is that ICE opened at almost exactly the high point of the rally off the first bottom that ended the previous day, and then traded right down to to the low before immediately rallying, thus composing the double bottom. When evaluating the quality of this double bottom based on our three pieces of criteria, this bottom checks off all three: It has a recent point of reference (the previous day's bottom), additional support (also the previous day's bottom), and there's a clear stop (right below the previous day's bottom). In fact, since there was no additional support further to the left on this chart, it made a buy right around the previous day's low at $131.54 all the more reasonable since that low essentially was the bottom of the range, and the stock was coming down $2 as it is. Had ICE opened closer to the previous day's low, it might not have been as obvious of a buy based on the weakness it was showing. If the previous day's low didn't hold, then we would have been stopped out and had the opportunity to sniff out a possible trade later on.

Depending on your time horizon and how you invest, whether long-term or short-term, the charts you focus on will differ. Day traders who typically hold short-term positions for quick profits (or quick losses) should orient themselves first and foremost towards the intraday charts, whether it's a 5-minute chart, a 30-minute chart, or some other kind, because those show the more immediate areas where trades can be made. Only when a stock breaks out of an immediate range should we go further out, for example an intraday chart with a larger time stamp or a historical chart such as the daily chart, in order to plan the next trade areas. Also, cross-referencing an area on an intraday chart with a historical chart will assist you in determining whether you should hold part of a position for longer than just a day trade, for example to make it more of a portfolio investment. But a double bottom in a good area on a nearterm intraday chart, such as the one seen above in ICE provides a powerful formation from which to trade.

Double Bottoms In Abstract Form

A double bottom does not necessarily have to have that familiar W shape. But that doesn't mean it isn't a true double bottom, or that it isn't as powerful of a formation. In his 1962 classic about charting, How Charts Can Help You in the Stock Market, a book that is still as valuable today as it was 60 years ago, William L. Jiler describes chart formations as often being more Picasso than Renoir. This means that formations can be abstract and off kilter rather than perfect and precise. Such is the case, many double bottoms won't resemble the perfect W that draws so many traders in. But as long as we have a recent bottom in a trading range as a point of reference, then we have a potential double bottom, and if there are added areas of support and/or a clear stop, then the formation is just as sound as any.

As shown above, Goldman Sachs (GS) opened on January 3rd, 2022, the first trading day of the year, at it's low for the day on a gap at $387.34, and then proceeded to rally steadily over most of the next three trading sessions, up to $412.66, before retreating back on January 6th, towards the low. After revisiting the January 3rd low, GS ran up nearly $13 over the next two trading sessions, to just around $400, indicating that at the very least, a short-term double bottom had been put into place. 

This double bottom was not a classic W, but it included two distinct bottoms, which were backed up by a traditional support pattern at around the $387 price point. With additional areas of support a bit lower on the chart, which also supplied the possibility for more double bottoms, the stop for this trade might not have been crystal clear. But with two bottoms and corresponding areas of support, all you had to do was set your stop for at least part of your position a bit below the double bottom and support areas. If GS had formed up somewhere between the original trade price and the areas down below, or if it had retreated all the way down to lower ground, then that would have simply been a different trade. Not all double bottoms on an intraday chart resemble each other. If the ICE formation from our first example was Renoir for its perfect features and realistic representation, then the GS double bottom was certainly Picasso, for its more abstract appearance and uneven features. Regardless, each was as reliable as the other.

Historical Double Bottoms

When a stock breaks out its immediate range(s) it will eventually settle in somewhere, as we have previously seen and as we'll continue to discuss. This is when we need to migrate away from an immediate intraday chart and look to the historical charts for potential trade opportunities. In most instances, a stock that has broken out will match up with a previous low, thus creating a historical double bottom. Double Bottoms such as these are important to be aware of because they lay the foundation for a significant move that can return large profits over an extended period of time.

Brewing company Molson Coors (TAP) had an immediate range between $45 and $45.50 around mid December, 2021. Actually, you may even notice two distinct short-term intraday double bottoms on the chart directly above; the first one to the left closer to $45, and the second one to the right at $45.50. However, shortly before Christmas, on December 20th, TAP broke below this range, meaning that a trader needed to use discipline and look to a historical chart in order to plot an area for a reversal. You'll then notice on this chart that TAP reversed at the low of $42.62, and a peek at the daily historical chart showed us the reason why!

We would not have been able to see it on a nearterm intraday chart, but the December 20th low that TAP made at $42.62, coming off a most recent high of $48.16 (a drop of 11.5%), corresponded beautifully with its low from October 28th of $42.46, forming an almost perfect- albeit Picassoesque -W shaped double bottom. For added verification, the low that TAP made on the next day, at $43.62 was supported by its $43.43 low from back on February 11th, which also happened to be its last low before a run up to a yearly high of $61.48 on June 10th. This is an important facet of the overall trade to file away because if you weren't fortunate enough to catch the double bottom at the low, you could have grabbed a trade a bit above the $43.62 and planned your stop accordingly for somewhere just below $42.46.

After making its $42.62 double bottom on December 20th, TAP has roared to the upside, and has since broken through the high of $49.65 that it made after the October 28th $42.46 bottom. This is a strong indication that significantly higher prices may be... on TAP!

Not only can we find a sound area for a reaction, including a double bottom, on a historical chart; but a reaction from a significant historical area can propel the stock to prices not seen in quite some time. As we can observe with TAP, its double bottom on the historic chart has thus far led to a high not seen in more than two months.

Entering a trade relies on confidence and few formations inspire more confidence in a trader than a double bottom. Combine a double bottom with adequate support and an easy stop, and you won't likely find a more reliable formation that yields winning trades.

 Bottoms Up to that!