The double bottom pattern is one of my favorite technical patterns to spot a potential reversal in the Forex market. The double bottom forms after an extended move down and can be used to find buying opportunities on the way up.
As the name implies, the double bottom pattern consists of two bottoms that form at a key support level. This price action pattern is unique because it signals a level in the market where demand outweighs supply not once, but twice within a fairly short period of time.
In this lesson we’ll discuss the dynamics and characteristics of the double bottom pattern. We’ll also cover how to trade this pattern by looking at a double bottom that formed recently in the Forex market.
So without further adieu, let’s jump in!
Double Bottom Characteristics
Before we get into how to trade the double bottom, we first need to become familiar with the characteristics of one. This will allow you to quickly and easily identify the pattern on a chart and will also help you to understand the dynamics behind this powerful reversal pattern.
As you can see from the illustration above, the double bottom pattern has formed after an extended move down. The market found buyers at a key support level (first bottom). Shortly after forming the first bottom, the market retested new resistance at the neckline and subsequently found support again at the same key support level (second bottom).
One common mistake among Forex traders is assuming that a double bottom has formed before the market has actually confirmed the technical pattern.
How does the market confirm a double bottom pattern, you ask? Let’s take a look…
Notice in the illustration above that the market is now trading back above the neckline. This confirms a breakout of the double bottom pattern.
Note: Only a close above the neckline confirms a breakout. For example, if you are trading the daily chart you would wait for a daily close above the neckline resistance level.
Double Bottom Example
By this point you should have a good understanding of the characteristics and dynamics behind the double bottom pattern. So now let’s take a look at a real-life example.
The chart above shows a double bottom pattern that formed on the NZDUSD daily chart. Notice how we have a well-defined neckline and two swing lows which form a nice “W” pattern.
Given the pattern above, at what point in the market would this pattern have been confirmed as a double bottom breakout? Scroll down to see the answer.
Notice how the circled close is now back above the neckline. If you’ll notice, there was a daily close above this level two days prior, but it wasn’t a very convincing close. In these situations it’s best to wait for a better, more convincing close which came two days later.
Note: Because this double bottom pattern is best seen on the daily chart, you would want to wait for a close above this level on the daily time frame. As soon as the circled candle closed, we had a confirmed double bottom.
How to Trade a Double Bottom Pattern
So far we have discussed the characteristics of the double bottom pattern as well as the dynamics behind it. We have also covered how to confirm a double bottom breakout.
Now it’s time for the really fun stuff – how to profit from this reversal pattern.
The first thing to know when it comes to trading a double bottom is where to look for the entry signal. A common misconception among traders is that the entry occurs on a breakout of the pattern, when in fact the entry comes on a retest of the neckline.
Here’s an illustration of a neckline retest:
Notice in the illustration above how the market retests the neckline as new support. This retest provides us with an opportunity to buy at support as the market reverses direction.
Let’s go back to our NZDUSD double bottom to find where we could have entered long on a retest of the neckline.
In this example we would have waited for a retest of the neckline as new support. We could then have moved to a lower time frame to look for bullish price action to confirm that this level is likely to hold.
Notice how the market rallied immediately after retesting the neckline as new support.
How to Identify a Target
First and foremost, any potential target should first be identified using simple support and resistance levels. This is true regardless of the price action pattern that has formed.
Having said that, there is a way to identify a potential target when trading a double bottom pattern. It’s called a “measured move” or a “measured move objective”, and the concept is easy to understand.
To find the measured move objective for a double bottom pattern, you simply take the distance from the two bottoms to the neckline and extend that same distance to a higher, future level in the market.
Let’s take a look at how we would measure this objective using the NZDUSD example.
In the chart above, the distance from the double bottom to the neckline is 170 pips. Therefore we would measure an additional 170 pips above the neckline to find our measured objective.
One last point about the measured move on this chart. If we zoom out we can see that the measured objective actually lines up with a previous level in the market. This would give us more confidence that the objective is accurate.
Notice how our measured objective from the double bottom low (170 pips) lines up perfectly with a previous support level in the market.
Summary
We have covered a lot of ground in this lesson, so let’s recap what we’ve learned about double bottom patterns.
The double bottom is a reversal pattern that occurs after an extended move down. The pattern signals that the market is unable to break through a key support level, and thus is likely to move higher.
There are three main characteristics to a double bottom pattern:
- First bottom
- Second bottom
- Neckline
The neckline represents a resistance level that forms after the first bottom. A daily close above the neckline confirms the double bottom pattern. Once the market closes back above the neckline, wait for a retest as new support. This retest signals an opportunity to enter long.
A measured objective can be used to identify a potential target. It can be found by measuring the distance from the double bottom support level to the neckline, and then extending that same distance beyond the neckline to a future, higher level in the market.
To learn more about a reversal pattern that occurs at a swing high, be sure to read the lesson on the double top pattern.