Bulkowski’s Double Bottom Setup

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Overview

I found this setup when doing research on stop placement. I noticed that price after the double bottom breakout climbed higher if the throwback did not plunge very far below the confirmation price. Statistical research into this behavior confirmed the findings.

Details

The above chart shows the ideal setup. A double bottom appears at points 1 and 2. Price breaks out and confirms the double bottom as a valid chart pattern when price closes above the red line. Then, the throwback occurs and returns the stock to the breakout price within a month of the breakout. In this example, price touches the red confirmation line and then lifts off, making a nice move up after that.

Although the rise in many cases after a double bottom is not as clean as it appears in the above figure, research suggests that when price does not drift below the red confirmation line, it predicts (but does not guarantee) a better performing double bottom.

Contrast the ideal trading setup with this one. A double bottom appears at points 1 and 2. Price confirms the chart pattern when it closes above the red confirmation line.

In this situation, notice that the throwback at A drifts below the red confirmation line, suggesting a weaker trading setup. Price climbs to a post-throwback high at B before continuing the decline to C. This is the type of double bottom setup you want to avoid.

Trading Tips

To trade double bottoms, consider the following suggestions.

• If you have not bought the stock, then wait for a throwback to occur and search for situations like that shown in the first figure -- price touches or stays above the red confirmation line during a throwback. The trade may still fail, but the chances improve that you have found a profitable trading setup.
• If you want to trade the double bottom, then place a buy stop a penny above the confirmation line as the double bottom forms (after price makes the second bottom but before rising to the red confirmation line). When price rises and hits the buy stop, that is the entry signal. You get in at the breakout price. If price does not throwback, then you are all set. Ride price higher.
• If price begins to throwback, then consider taking a profit, especially if you are a swing trader. The rise averages 6% to 8% in about 3 days, so it is a quick rise and a quick profit providing you have excellent timing.
• Watch how far price drifts down during the throwback process. If price slides below the confirmation price (the highest peak between the two double bottoms), then the chances diminish that the trade will be wildly profitable. Price will likely slide lower, not immediately, but sometime after the throwback recovers. The rise will likely be bumpy, so do your best to get out at the appropriate time. If the stock returns to the confirmation price for the second time (the first was during the throwback) without showing signs of turning, then consider selling.
• Identify the type of Adam and Eve combination of double bottom and check the associated page for additional trading tips:
  • Double bottom, Adam & Adam
  • Double bottom, Adam & Eve
  • Double bottom, Eve & Adam
  • Double bottom, Eve & Eve

Methodology

I looked at the statistics from the four combinations of double bottoms separately and the following table shows the results.

Let’s take the Adam & Adam row as an example. I asked the question, how far below the confirmation price did the stock move before the chart pattern failed? By ’failed’, I mean that price failed to rise more than 5% after the breakout before tumbling either below the bottom of the pattern or more than 20%.

For the Adam & Adam double bottom, price dropped 1.03% below the confirmation price during the throwback and that led to the first failure.

How far down, on average, must price drop below the confirmation price and still lead to the most powerful rally? For the Adam & Adam double bottom, a throwback that does not drop below the confirmation price led to a rally that saw price rise on average 39%. The average rise for all Adam & Adam double bottoms is 35% (the next column). The last column shows that 20 samples out of 281 samples were involved in the 39% rise.

The table shows that price can drift below the confirmation price (Eve & Adam and Eve & Eve double bottoms) by 3% and 2%, respectively, for the best average rise. This suggests the following trading rule: Only buy into double bottoms when the throwback plunge is shallow. By shallow, I mean price does not drop much (say, 0% to 2% or so) below the confirmation line.

Example

The figure to the right shows another example of the ideal double bottom trading setup. Price during the throwback does not drift below the confirmation price.

Point Buy 1 shows where you would enter if you placed a buy stop a penny above the red confirmation line. That would get you in during the breakout. If you are lucky, price would not throwback and you would be set. For swing traders, buy at Buy 1 and sell when price rounds over at the top of the throwback. I show that as Sell 1, when price gapped lower.

A throwback followed but in this case, it did not touch the red confirmation line. Price formed a pipe bottom on the daily scale (the upper left shows a zoom of this). The twin price spikes suggest a move higher and that is the entry signal. You can buy in at any time you are convinced that price is resuming the up move (resumption of the up move occurs 86% of the time). I show the entry as Buy 2. Price continues moving up.