took place. Indeed, this seems to be a characteristic of “double” formations:
They are either preceded or followed, or sometimes both, by a very sharp and persistent price move.
Underlying Psychology
Since most double-bottom formations are preceded by a sharp decline, it’s likely that the initial bounce rally, which is usually very sharp, is caused by a lack of selling pressure and a panic move by the shorts to cover their posi- tions. The greater the volume at the initial low, the less will be the overhang from potential sellers. Once the short covering has been achieved and bar- gain hunters have been satisfied, prices once more begin to slip. However, since the bears have just experienced a rough ride, they are less inclined to put out more shorts. This means that selling pressure is not so intense.
Another reason for a lack of selling pressure is that most of the pessimistic holders will already have sold during the initial decline, when they were highly motivated. The second price drop develops more from a lack of bids than anything else. As the price approaches the second bottom, volume often shrinks to almost nothing. This is indicative of a sold outas opposed to an oversoldmarket. There is an old adage on Wall Street that says, “Never short a dull market.” It probably applies to the second low of a double-bot- tom formation. This dearth of activity means that the balance between buy- ers and sellers is extremely closely matched, so the slightest event can have a dramatic effect on the price. At this point all the bad news has been dis- counted and most of the selling is out of the way, so there is only one direc- tion in which the price can move—up.
The final break above the bounce high sets in motion a series of rising peaks and troughs as it becomes evident that the initial rally was more sub- stantial than a dead cat bounce.
Marketplace Examples
Chart 8-3, for Lockheed Martin, shows a double bottom. Note that, as with most of the examples shown here, the pattern is preceded by a sharp and persistent decline. Also, volume at the first bottom is well above that at the second. Indeed, the second bottom is really a small inverse head and shoul- ders, as indicated by the dashed neckline. The contrast between the wild price movements at the November low and the more constrained and rounded low established in February is also characteristic of a double bot- tom.
Chart 8-4, for Nvida, is also a double bottom, since it meets the price and volume characteristics. It is preceded by a sharp decline, then there is a suc- cessful test of the initial low on lighter volume, and finally there is a break above the bounce high. Indeed, volume expands on the day that the price completes the pattern. The only missing ingredient is the time between the two lows, which is relatively small.
Mercury Intract, in Chart 8-5, shows a different type of double bottom.
In this case, the second low is well above the first. However, the three vol- ume characteristics are present: high volume at the initial low, lower volume on the second low, and rising volume on the breakout. Notice once again how the price barely moves during the five days that the second bottom is
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Chart 8-3 Lockheed Martin, 1999–2000, daily.
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Chart 8-4 Nvida, 2000–2001, daily.
being formed. This once again indicates a close balance between buyers and sellers, so that when volume expands, the price simply explodes to the upside.
Chinese Double Bottom
If the price rallies sharply off the second bottom, buying on the breakout could involve a considerable price risk. This is because in many cases, the only viable support point under which to place a stop is the second bottom itself. Such a situation is shown in Fig. 8-3. However, during the formation of many secondary bottoms, the price declines under the constraint of a resistance trendline (Fig. 8-4). When it breaks above the line, more often than not this signals that the pattern will be completed with a break above the bounce rally high. I call these Chinese double bottoms because the retracement toward the secondary low can often be slow and very torturous to those who are long. The great advantage of these Chinese double bot- toms is that they provide a potentially high-reward but low-risk buying oppor- tunity. Generally speaking, the longer the (Chinese) torture, the more bullish the situation when the breakout finally develops. Chart 8-6, featur- ing UST, offers a good example. We see the 1–2–3 volume pattern along with a slow but steady decline held back by the dashed (torture) down trendline.
When the price breaks above the trendline, a sharp rally is triggered. When
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Chart 8-5 Mercury Intract, 1998–1999, daily.
a line is fairly steep, as this one is, a powerful rally often develops. Notice the low risk, measured by the distance from an early breakout to a point just below the second bottom.
Chart 8-7, for MBNA, indicates an even longer “torture” trendline, but the trendline develops at a shallower level than that in the previous chart.
Even so, a worthwhile rally with a relatively low risk develops. Generally
Figure 8-3 Double bottom assessing risk.
Figure 8-4 Double bottom assessing risk.
speaking, the most explosive breakouts seem to come from fairly steep tor- ture trendlines like that in Chart 8-6. It is, however, important for them to have been touched or approached on numerous occasions.
Finally, Chart 8-8, featuring Williams, indicates another Chinese dou- ble bottom. This time the price rises quite a bit, but it does so in a more
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Chart 8-6 UST, 1999–2001, daily.
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controlled manner. When the price finally rallies above the August bounce high, it has really completed a reverse head and shoulders, with the left shoul- der being formed in August, the “second bottom” being the head, and the right shoulder developing in February of 2003. If a line joining the two bot- toms is extended, the whole thing could be interpreted as an ascending tri- angle (covered in Chapter 9). It really doesn’t matter what the formation is called. The important thing is that it was working as we moved into June of 2003.
Platform Double Bottom
A platform double bottom is a variation on the Chinese double bottom.
In this case, the initial bottom develops after a very sharp, panic-oriented decline. The price then rallies and experiences a trading range, usually a rectangle. The trading range forms some way above the panic low and acts as a kind of platform. When a breakout above the platform takes place, the pattern is completed. An example of this concept is shown in Fig. 8-5. A marketplace example appears in Chart 8-9, featuring Sysco.
Normally the stop point would be placed under support just below the bottom of the platform. In this case, a less risky minor low, set in January of 2002, could have been used. Alternatively, if a breakout above the dashed trendline had been used as an entry point, the stop could have
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Chart 8-8 Williams, 2002–2003, weekly.
been placed below the lower solid trendline marking the bottom of the platform. A second example, featuring Albertson’s, is displayed in Chart 8-10. In this case, part of the platform could be interpreted as a consoli- dation reverse head and shoulders. The risk for this trade would have been about 10 percent.
Figure 8-5 Double bottom platform.
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Stop Chart 8-9 Sysco, 2001–2002, daily.
Double Bottoms as Consolidation Patterns
Occasionally a double-bottom formation will show up as a consolidation pat- tern. An example is shown in Chart 8-11, for Keycorp. In this situation, part of the formation turned out to be a head-and-shoulders top (the dashed trend- line on the left), which was quickly canceled as the second bottom was being formed with a small reverse head and shoulders (the second dashed trend- line).
Double-Bottom Failures
Like all patterns, double bottoms are occasionally subject to failed break- outs. Typically this will happen during a bear market, when the breakout is a contra-trend signal. An example is shown in Chart 8-12, for KB Home.
At the time of the breakout, this looked like a perfectly normal reversal- pattern completion. The problem was that this formation developed toward the end of a bear market. In this case, a convenient failure indi- cation was given when the price broke below the dashed support trend- line. It is doubtful if this would have made a good risk/reward trade anyway. This is because the distance between the breakout point ($16) and a place just below the second low at $14 would have involved a risk of about 18 percent.
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Chart 8-10 Albertson’s, 1987–1988, daily.
Double Tops, Double Bottoms, and Triple Patterns 141
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Chart 8-11 Keycorp, 1991–1992, daily.
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Chart 8-12 KB Home, daily.
Whipsaw Double Bottom (“Lucky Seven” Double Bottom)
This is an unusual pattern that is measured in terms of waves and their rela- tionships to previous highs and lows rather than being defined by trendlines.
An example is shown in Fig. 8-6. The pattern can be divided into seven waves, hence the “Lucky Seven” title. Four waves are associated with the first bottom and three with the second. They are indicated in Fig. 8-6 by the dashed and dotted lines. The idea is that prices rally off the first bottom in a robust man- ner as the initial three waves of the pattern form a rising peak and trough.
Then the fourth wave destroys this by breaking below the initial minor bot- tom. This is the whipsaw part of the equation. However, it is not a decisive sig- nal, for at this point the rising peaks are still intact. The second three waves save the day because they result in the rising bottoms being reinstated. The pattern is completed on the seventh (lucky) wave at X. A second, stronger signal develops as the price rallies above the peak of the third wave at Y.
Often you see a pretty sharp or even explosive rally develop after the breakout. Charts 8-13, for Electronic Data, and 8-14, for Intel, show a cou- ple of examples of this formation. The Electronic Data formation turns out to be a borderline reverse head and shoulders because the horizontal trendline almost connects with the late September high. It really doesn’t matter, for anyone who had been following the Lucky Seven formula from the long side would have done quite well. The Intel chart is a more clear- cut example of a double bottom.
Figure 8-6 Whipsaw double bottom.
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Chart 8-13 Electronic Data, 1990–1991, daily.
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These patterns are not that common, but when you can spot them, they usually offer a good risk/reward situation. The best place to go long, refer- ring to Fig. 8-6, is at point X; provided wave 7 is not too long, it is then pos- sible to set a stop just below the bottom of wave 6.