Here’s 2 ways clever pro traders spot crypto and stock price reversals
Trading in the direction of the trend is one of the best ways to be profitable. If traders learn to spot a new trend early, it provides an opportunity to buy with a good risk to reward ratio. In addition to identifying a trend, traders should also be able to recognize when it has reversed direction.
While several patterns signal a possible trend change, one of the easiest to spot is the double bottom pattern. This can help traders change their strategy when the trend reverses direction from bearish to bullish.
Let’s take a look at the double bottom pattern and identify some of the best ways to trade it.
What is a double bottom?
The double bottom pattern forms after a downtrend and consists of two low points that are roughly formed near a similar horizontal level, with a minor peak in between the troughs. When the price breaks out and closes above the minor peak after the formation of the second trough, the setup is complete. This is a reversal pattern, which results in an intermediate to a long-term trend change. As the pattern resembles the shape of a ‘W’, some also call it a W bottom.
The above image shows the structure of the double bottom pattern. The asset has been in a downtrend but at a certain price level the bulls believe the asset is undervalued and start buying. This helps in the formation of the first bottom where demand exceeds supply and a relief rally begins.
However, most bears are still not convinced that a bottom is in and they initiate short positions again after a pullback. The price turns down but when it nears the level of the first bottom, the bulls again start accumulating, which arrests the decline and starts another relief rally. The second bottom within 3% of the level of the first bottom is usually considered valid. This is not a number set in stone and traders should use their discretion in real-life trading.
When the price rises above the resistance line, it signals a change in trend from down to up. The minimum target objective for the pattern can be arrived at by calculating the distance from the resistance line to the bottom and then adding the number on top of the resistance line.
Let’s view a few examples to better understand the concept.
Tezos (XTZ) price was in a downtrend before hitting the first bottom at $1.78 on Nov. 4, 2020. From there, the XTZ/USDT pair started a relief rally that stalled at $2.96 on Nov. 25, 2020. At this level, the bears again fancied their chances and sold aggressively.
Although the pair broke below the $1.78 support and dipped to $1.57 on Dec. 23, 2020, the bears could not sustain the lower levels. The pair quickly recovered on the next day and started a recovery, forming the second bottom.
The bears aggressively defended the resistance line and tried to trap the eager bulls following the breakout. The bulls purchased the dips and the pair made a strong breakout on Feb. 5, which started the new uptrend.
The depth from the resistance line to the bottom is $1.18. Adding this value to the level of the resistance line at $2.96 gives a minimum pattern target at $4.14. However, in this case, the pair overshot the target objective and rallied to $5.64 on Feb. 14.
Double bottoms also show on the weekly timeframe
Along with the daily chart, the double bottom pattern also works well on the weekly chart. This is because when the reversal setup forms on the weekly chart, it results in a long-term trend change and the new uptrend generally sustains longer.
Ether (ETH) had been in a strong downtrend since topping out at $1,440 in January 2018. The demand exceeded supply when the price hit $81.70 in December 2018, resulting in the formation of the first bottom. Thereafter, the price recovered to $366.80 in June 2019 where bears again stepped in.
The subsequent decline formed the second bottom at $86 in March 2020. The duration between the two bottoms is very large, but in trading, no pattern is set in stone. As both levels were close to each other and the price action forms a clear W, traders can consider this as a double bottom.
The bulls pushed the price above the neckline in July 2020 but that did not start a new uptrend because the bears made one more attempt to trap the bulls. The price dipped below the breakout level but the bears could not sustain the lower levels. This showed that sentiment had changed from sell on rallies to buy on dips.
That completed the reversal and the ETH/USDT pair started a strong uptrend. Although the minimum target objective of the pattern was only $651.90, the pair rose to over $4,300 during the bull run.
This shows that the double bottom is an important reversal pattern, which sometimes leads to strong uptrends.
Some bottoms can be misleading
Many times, traders preempt a double bottom and buy before the price breaks out of the resistance line. That could sometimes result in losses because the pattern may eventually never complete.
Bitcoin (BTC) was in a downtrend since topping out at $19,798.68 in December 2017. The buyers stalled the decline at $6,000.01 on Feb. 6, 2018. Thereafter, the relief rally reached $11,786.01 on Feb. 20, 2018. This level proved to be a resistance and the price again dipped down to $6,430 on April 1, 2018.
This looked like a double bottom but the bulls could not push the price above the $11,786.01 resistance. This meant the double bottom pattern did not complete.
Although the $6,000 level held for a long time, the trend did not turn from down to up. Finally, the BTC/USDT pair plunged below the support and resumed the downtrend on Nov. 14, 2018.
A double bottom is a key reversal pattern, which signals a change in trend but there are some important points to bear in mind.
Before the first bottom forms, the trend should be down because if there is no downtrend then there will not be a reversal. Traders should wait for the pattern to complete by breaking out of the resistance line before buying because many times the pattern fails in a downtrend.
When a long-term trend changes direction, it generally overshoots the pattern target of the setup. Hence, traders may use the target objective as a guideline but should not be in a hurry to close the position on that basis alone.
The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph.com. Every investment and trading move involves risk, you should conduct your own research when making a decision.