What is a Double Bottom Pattern?

In technical analysis, traders use multiple patterns to find the quick reversal entry. Double Bottom is one such pattern which is known for giving good bullish reversal formations. The pattern is usually very reliable when it comes after a prolonged downtrend.

The main signal of the Double Bottom pattern is the drop in selling pressure, paving the way for a potential uptrend. The Double Bottom pattern resembles the English alphabet "W," where the price tests the same support level twice before bouncing upward.

The pattern has been observed in various National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) stocks, as well as top indices such as NIFTY50, Sensex, and BANKNIFTY. Even commodities on the Multi Commodity Exchange (MCX) often exhibit double bottom patterns before major reversals. Therefore, understanding this pattern can help capture good bullish reversals. 

Visual Anatomy and Identification

This is how a Double Bottom pattern looks -

A double bottom typically develops in these stages:

1. First Bottom: There is a continuous downfall before the price finally rebounds from a support level. This can be assumed to be a temporary bounce.
2. Pullback: The price makes a pullback, which might be because of traders who had shorted the stocks and are booking their profits.
3. Second Bottom: After failing to create a new high, the price dips again. The important thing to note here is that the dip is near the same support level. This forms the second trough.
4. Breakout: The stock rebounds and climbs the second time. However, the upward rally this time is strong, breaking the neckline (the resistance formed at the interim high between the two bottoms).

Traders should look for key characteristics to identify a valid double bottom:

• The two bottoms are at almost the same level.
• The pattern can be seen in any timeframe, whether intraday or daily.
• A breakout occurs above the neckline, typically accompanied by strong volume, for confirmation. 

Market Behaviour Indication

The Double Bottom pattern exhibits a strong shift in the market psychology. During the first decline, at the first bottom, there is a clear dominance of sellers, which pushes the prices down. Then there is a temporary rebound when the buyers step in, but the rally is weak as bears are still in control.

Then the second decline occurs as the sellers try again but fail to push prices below the earlier low. This indicates selling exhaustion. Finally, the buyers are able to regain confidence and overpower sellers, leading to a trend reversal. 

How to Trade the Double Bottom

There are multiple ways to trade the double bottom. The entry can be done in 3 ways:

Method 1: This is a very aggressive method in which the buying entry is taken as soon as the stock makes a double bottom. This is extremely risky because the stock can continue its downfall, which may end up hitting the stop loss very easily.

Method 2: This is the usual buying entry when the stock breaks the resistance neckline. Most of the traders use this method because it is a more conventional way to trade a double bottom pattern.

Method 3: The third and most rewarding entry is the retest entry. Many times, the stock comes back to the neckline after the breakout. It touches the neckline (which is now the support level) and continues the move upwards. This method offers the best risk-to-reward considering the risk taken.

Measuring Targets and Risk Management

The targets and risks vary depending on the chosen entry method.

Method 1: In the case of method 1, the stop loss is the low of the candle, which makes the double bottom. There is a high chance of this getting hit. The target is the neckline, and hence, there is a high-risk and high-reward trade. The risk-to-reward ratio in this case can be around 1:5

Method 2: In this case, the stop loss is the support level (where both the bottoms have been made). The target is much more conventional here at 1:1 or 1:2. The accuracy of this method is higher than the first method.

Method 3: Many traders favour this entry. The stop loss is either the neckline or the candle low, which is touched after the retest. The target again can be perfect here at around 1:3. The accuracy of this method is probably the best. However, many times this entry might get skipped if the stock does not do any retest and just breaks out of the neckline zone. 

However, before trading this pattern, common risk management tips should be undertaken by the traders, such as:

• When trading NIFTY/BANKNIFTY, align with the overall market sentiment based on global cues and FII data.
• If trading in stocks, the traders can get a double confirmation by adding another indicator, such as Supertrend or RSI. 
• Also, if trading in options, avoid chasing patterns because that can lead to significant slippages. 

Common Trading Errors

Traders should be careful about common mistakes, such as:

• Traders sometimes enter too early in method 1, even before the second bottom is made. 
• Volume analysis can give a good idea of whether the move is fake or real. So if the reversal is coming, check how the volume is behaving for the stock.
• At times, traders end up placing extremely tight stop-losses due to the fear of incurring large losses. This should be avoided as it could lead to whipsaws from minor fluctuations.
• Always consider mimicking the trend of the index. So, traders may avoid trading a stock which is against the broader index direction. For example, going long on a stock double bottom while NIFTY is in a confirmed downtrend should be avoided.

Real Examples and Chart Studies

Let's take an example of a double bottom pattern in SBIN on the daily timeframe -

As can be seen from the chart, the SBIN stock was in a downtrend, and then it made the Double Bottom pattern. Now, the traders can opt for any of the three entry methods as described previously. All the methods have been shown on the chart. SBIN made a strong upmove after forming the Double Bottom pattern and would have generated handsome profits using all three methods.

Conclusion

The double bottom is a powerful bullish reversal pattern that can give traders and investors an edge in identifying market turning points. The pattern is more reliable on daily and weekly charts. It works even better with volume confirmation. Traders can also combine it with indicators like RSI, MACD, and support/resistance analysis to increase the probability of success. With practice, the double bottom can become a key part of your trading and investing toolkit.