DOUBLE BOTTOM

The double bottom is just like the double top, except for one key point. The double bottom is used to signal reversals to the upside. The chart is the battlefield showing the war between people’s greed and fear. Unlike the double top, which watches traders filled with greed drive the price of a stock higher and higher, a double bottom is accompanied with traders filled with fear, scared into selling the stock on the way down. This down-ward draft is characterized with a prolonged period of exertion, which is then met by a period of bottom fishers and traders cov-ering short positions. These traders move in to buy when there is temporary support and cause a pseudo rally to the upside. The rally to the upside is short lived, because people quickly use this opportunity to get out of their positions. The selling takes the stock back to the previous low where the sellers begin to lose momentum again.

This loss of momentum by the sellers puts the buyers back in control, as they feel more comfortable that the previous level held as support. This support level serves as an excellent spring-board for the rally back up (see Chart 3.3).

A look at Broadcom Corporation (BRCM) shows how strongly this stock was trending, as it created both a double top

58 Phase I: Basic Trading Tactics

CHART 3.3 Movement of Broadcom (BRCM) over a 12-month time frame. The concept with the double top is the same as with the double bottom. Typically, the first pullback after the market has bottomed out pro- vides the best shot at playing the move back up. In the case of Broadcom, shown here, the rally after the first pullback following a double bottom provided for some great trading opportunities.

and double bottom within a three-month period. These types of formations provide a great deal of exertion and profitability. The stock ran down for several periods before making a move back up. The move failed, as it ran right into a resistance level (the Fibonacci resistance level, explained in Chapter 4) and headed back down to the previous level of support. However, this time around, the sellers lost momentum and the stock headed back up with a vengeance and tremendous exertion behind it.

Chart 3.4 shows Just Don’t Sell Us (JDSU) taking off on a huge parabolic run.

This stock ran into a wall of resistance at 107 and then pulled back to 75, a well-defined level of support (a .618 Fibonacci support level, explained in Chapter 4) from the previous move up. The stock then climbed back up and ran into a top. This set the table perfectly for taking a short position. The stock then went and formed a perfect double bottom and rallied higher

The next stock showing a strong double bottom is BRCM in June 2000 (see Chart 3.5).

The stock fell hard from a classic double top in March 2000 all the way to 105 a share before putting in a low. Following the fall, the stock bounced back up to 180 a share before making a final move lower to retest the stocks low in the 115 area. After falling around 110 a share, the stock rallied powerfully to make a new 52-week high following the bullish formation.

As I do with the double-top formation, I like to look at five things with the double bottom to play the move back to the upside. In order to not get stampeded by a freight train when attempting to enter a double top, you need to understand the five components to every double bottom that determine whether or not it is worth going long.

The first thing to measure is the exertion behind the stock’s movement before it makes its first low. The longer the time period in which the stock falls, the more fear that is accompany-ing its rise, and hence, the greater potential for greed to emerge on the long position.

The second component to a powerful double-bottom forma-tion is its compression, or the space that exists between the first and second lows. Using a time frame of 10 time periods or less is ideal. A “W” formation is the kind of clarity that you should be looking for to judge the potential for the upside movement.

60 Phase I: Basic Trading Tactics

CHART 3.4 Stocks that move strongly off of double tops and double bottoms typically respond well to Fibonacci levels following a retest of highs and lows.

62 CHART 3.5 Broadcom shows some nice movement as it reacts well off of both a double top and a dou- ble bottom.

However, if a stock pulls back at least 50 percent of the move, and falls to old lows on weakening volume, nice compression, bullish TRI divergence, and breaking out above the 15-period MA, then the likelihood of it holding its support is much better.

The fourth part of a highly probable double bottom is the subsequent rally following the pullback from lows the stock or market will experience on its second selloff. If the stock goes to make new lows on the second run and pulls back, you should be alert for a possible long entry. However, if this pullback is met by more sellers, then the stock may not be ready to rally yet and could very well have another move lower in it. But what if this pullback from lows fails to mount another charge and instead finds support at a rising 15-period MA? You now have a very low risk entry to the upside in a stock that has gone from being sold on strength to now being bought on weakness.

The fifth part of making a successful double bottom is hav-ing the stock break above the previous day’s high followhav-ing the scenario in part four. That is, once the subsequent pullback after it makes a double bottom holds, making a higher low and find-ing more aggressive buyers to what is now a risfind-ing 15-period MA, enter the position when the stock takes out the previous day’s high. This is the spot most professionals are looking to take aggressive long positions, as the risk-to-reward ratio is excellent.