You’ve now gained a solid understanding of the double bottom pattern: its definition, visual characteristics, underlying formation, and practical trading strategies. With this knowledge, you’re well-equipped to identify and capitalize on this powerful reversal pattern.
However, before you dive into the markets, let’s recap three crucial points to keep in mind when trading the double bottom pattern:
1) A Double Bottom Often Indicates a Significant Market Reversal or Retracement
Most double bottoms signal a reversal of the current downtrend, but occasionally, a pattern will set off a large retracement.
These patterns look and form in the same way, so you don’t need to change how you trade them.
That said, it’s not possible to know beforehand whether a pattern will cause a retracement or trend reversal – annoying, I know. There are, however, a couple of signs that do hint it’s more likely to be one than the other.
For example, a pattern that forms after an especially long trend.
9 times out of 10, these patterns result in a trend reversal, due to most traders now being short in the trend.
Remember – banks can only profit when most of traders are losing, which happens when price moves against them.
Trends, due their nature, gather pace over time – more people recognise a trend exists, so they trade in the same direction in the hope of making a profit.
All trends eventually reach a point where most traders are entered same direction. Some traders aren’t, obviously, but the majority are. With everyone trading the same way, the banks can’t make any more money because no-one will lose if price keeps falling, as most traders are short already.
It’s at this time they’ll cause a reversal, often via a double bottom forming.
So, if you see a double bottom appear after price has been in a trend for a long time – relative to that time-frame; don’t go off the daily trend if you use the 1-hour for instance – it’ll probably result in a trend reversal, not a retracement.
What about double bottoms that signal a large retracement then?
Well, these patterns usually appear after a long movement, but not a long overall trend – though they can still form during long trends, and set of a large retracement within that.
As I’ve explained, price can’t continuously move in one direction; retracements and consolidations must break up the action to re-set expectations and shake traders out of their trades.
Long movements made up of only minor retracements and consolidations cause traders to get comfortable in their positions. They think:
“Price has been falling for ages; I bet it’ll keep falling”.
Price moving in the same direction for a long time means it’s highly likely to continue in that direction in the future; the longer the movement, the safer they think are.
The reality, however, is just the opposite…
With so many traders entered into trades, the banks must make price either retrace or consolidation to shake them out. If they don’t do that, they won’t be to place any trades nor make any money, with forex being a zero sum game.
So double bottoms that form after a long movement with little to is usually a sjgnal a large reteacement is about to take place, not a trend reversal – though on occasion that can develop.
2) The Neckline Break Is Essential to Validate the Double Bottom Formation
A double bottom ONLY indicates a reversal once price closes past the neckline. Some say a retest is necessary for full confirmation, but a strong close past the neckline is usually enough.
When price closes beyond the neckline, it reveals invalidates the swings highs leading to the bottoms.
Keep in mind: All swing highs and lows are created by the banks buying and selling (highs = selling, lows = buying).
When price closes past a high or low in a strong fashion, it reveals whatever the banks did to cause that high or low to form isn’t valid anymore, making it likely for price to continue in the other direction.
In the case of the double bottom, the two swing highs that lead to the lows form from the banks selling via taking profits.
However, we only know this once price breaks and closes above. Before then, we don’t know (for sure) whether they’ve formed from them taking profits or placing sell trades – they may have placed sell trades because they want price to fall further and continue the trend.
That’s why the pattern is only confirmed when price makes a strong close above.
At that point, we know the banks haven’t got any sell trades placed – why would they push price above the point where they sold? It doesn’t make sense. Which means the highs must have formed due to them taking profits and they want price to keep rising and reverse.
3) Expect a Demand Zone to Appear After the Neckline is Broken
The retest entry is the better strategy for trading the double bottom.
However, getting into a trade is often more difficult than it should be because of the fact price must retest the neckline to signal an entry. Sometimes price won’t reach the neckline before reversing, causing you to miss out on the entry and not get into the reversal.
Luckily, a demand zone will often form around the point where the neckline breaks.
Use this to simplify your entry and increase the chance of getting into a trade.
With a zone, price has a much larger area to show a signal in. With the neckline, which is really a support level, price must touch the level to give us a reversal signal– a big ask with all the randomness at play in the FX market.
A good example of this is found below…
Price never reached the neckline of this double bottom; it reversed just above.
No retest means no entry, so you would’ve missed this reversal trading the pattern with the normal retest entry I explained earlier.
With a zone, however, it’s a different story…
Because price has a much bigger area to reverse in, the bullish engulf forms inside the zone, making it a valid long signal you could use to get into the reversal.
So, keep your eye out for a demand zone that forms on the neckline.
The zones won’t appear often, but when they do, they make the entry significantly easier than the standard retest. The same signals still apply as well – watch for either a big bullish engulf or sharp rise within the zone to indicate the reversal is underway.