As of 10/03/2024   Indus: 42,012 -184.93 -0.4%     Trans: 15,745 -226.81 -1.4%     Utils: 1,058 -6.74 -0.6%     Nasdaq: 17,918 -6.64 0.0%     S&P 500: 5,700 -9.60 -0.2%	YTD  +11.5%   -1.0%    +20.0%    +19.4%    +19.5%	Targets    Overview: 09/30/2024     43,500 or 41,600 by 10/15/2024   16,800 or 15,700 by 10/15/2024   1,125 or 1,025 by 10/15/2024   19,000 or 17,600 by 10/15/2024   5,900 or 5,600 by 10/15/2024
Chart Pattern Indicator: on 10/2/24

As of 10/03/2024   Indus: 42,012 -184.93 -0.4%     Trans: 15,745 -226.81 -1.4%     Utils: 1,058 -6.74 -0.6%     Nasdaq: 17,918 -6.64 0.0%     S&P 500: 5,700 -9.60 -0.2%	YTD  +11.5%   -1.0%    +20.0%    +19.4%    +19.5%
Targets    Overview: 09/30/2024     43,500 or 41,600 by 10/15/2024   16,800 or 15,700 by 10/15/2024   1,125 or 1,025 by 10/15/2024   19,000 or 17,600 by 10/15/2024   5,900 or 5,600 by 10/15/2024
Chart Pattern Indicator: on 10/2/24

Bulkowski on Bottom Fishing (for Stocks)

Bottom fishing is hunting for stocks making new lows. This article explains a trading setup that uses ugly double bottoms (a chart pattern) to time the entry.

• Summary
• Background
• Ugly Double Bottom
• Exit Price
• Methodology
• Setup
• Preferred Setup
• Results
• Target Exit, Stop at First Bottom
• Target Exit, Stop at Second Bottom
• Preferred Setup Results
• Trading Example
• See Also.

Bottom Fishing: Summary

The bottom fishing setup described in this article, for use in bull markets, can help you time the market to buy near the bottom. Finding ugly double bottoms trading at the yearly low gives a win/loss percentage from 55% to 75%, but it depends on the type of exit you use. I provide a sample exit based on the height of the ugly double bottom.

The loss using this setup can be large, depending on stop placement. A stop below the first bottom results in a potential loss of about 20% versus an average win between 15% and 61%. Placing a stop below the second, higher bottom cuts the loss in half but hurts the other performance numbers, too (overall profit drops, win/loss percentage drops).

You can test this setup with your own exit strategy and see if you can improve the performance numbers.

This setup suggests that bottom fishing can work, but the road is a risky one. I suggest not using this setup with biotech or drug companies, stocks that suffer dead-cat bounces. Those stocks can approach 0 on a drug failure. That's one reason why the losses from this setup are so big (but there are other reasons, too).

Bottom Fishing: Background

Bottom fishing is finding stocks to buy that are making new lows with the hope that they will recover and zip to new highs.

Bottom fishing is timing the market, so it's not for the faint of heart. The potential loss can be large if the stock continues down. However, tests using ugly double bottoms helps time the entry to minimize losses.

Even so, the setup discussed in this article wins 87% of the time (on average) but that is for perfect trades. Realistic trading results drop the win/loss ratio to 66%.

Bottom Fishing: Ugly Double Bottom

The key to this setup is in the ugly double bottom chart pattern. I show an example of one in the chart on the right.

I tested two stop loss locations and also the percentage difference between the two bottoms of the pattern. I found that patterns with bottoms 1 and 2 that were between 5% and 20% apart were the best candidates to trade.

The price of the stocks didn't matter much. I tested various price ranges ($1, $5, $10 and so on) and found the performance results to be almost equal.

An entry signal is given when price closes above the top of the chart pattern. That means price has to close above the highest peak between bottoms 1 and 2 in the figure.

For the stop location, I used a penny below the first bottom and a penny below the second bottom. The second bottom results in fewer successful trades (you were stopped out more often) but the losses were smaller.

Bottom Fishing: Exit Price

To use the pattern's height as an exit signal, look at the figure on the right.

Compute the height of the pattern from the peak at C to the lowest bottom, A. Add the height to C to get a target price. When the stock hits that target, sell.

I tested various multiples of the pattern's height as exit targets, and they are listed in the Results section.

Bottom Fishing: Methodology

For the tests, I used 59 in sample stocks from my database with data starting 1/1/2000 to June 8, 2015. Although I logged both bull and bear markets, these tests show only bull market results.

Once I had the technique down, I used 425 out of sample stocks over the same time period for the tests. The results of those tests are shown in the Results section.

I experimented with simple moving averages from 10 to 250 days and found that they didn't work. Why? Because price is invariably below the moving average. After getting a buy signal from the ugly double bottom, I waited for the moving average to curl up (think of it as warming up a circuit, ready for blast off) and then for price to climb above it (which engages the stop). A close below the moving average at that point triggered a sale.

I also used a trailing stop of 5% to 25% below the current high as a sell signal (instead of a moving average). This performed better, but still not good enough.

So I settled on a multiplier of the pattern's height as the exit signal.

Bottom Fishing: Setup

Here is the setup that I used for the tests.

1. The stock makes a new yearly low in a bull market.
2. Wait for an ugly double bottom to appear.
3. The second bottom must be 5% to 20% higher than the first. This was the optimum range found through testing (10% to 20% worked best).
4. Compute the height of the chart pattern (A to C in the figure). A multiple of this height (1x, 2x, 3x, etc) added to C, the top of the chart pattern, sets the target price.
5. Buy when price closes above the price of the highest peak between the two bottoms (Price has to close above C in the figure to trigger an entry).
6. Set an order to sell at the target price.
7. Place a stop loss order a penny below either the first bottom (A) or the second, higher one (B).
8. Wait for price to either stop you out or hit the target price.

Bottom Fishing: Preferred Setup

This is the setup that I prefer. The differences are highlighted in red.

1. The stock makes a new yearly low in a bull market.
2. Wait for an ugly double bottom to appear.
3. The second bottom must be 10% to 20% higher than the first.
4. Compute the height of the chart pattern and multiply by 2, then add it to the top of the chart pattern (or entry price) to get the target price.
5. Place a buy stop a penny above the top of the chart pattern.
6. Set an order to sell at the target price.
7. Place a stop loss order a penny below the first bottom.
8. Wait for price to either stop your out or hit the target price.

Bottom Fishing: Results

The bottom fishing setup is really all about the entry, not the exit. When you start to apply exit rules, you are really testing those exit rules. The better the exit, the better the results will be.

I first used the ultimate high as the exit rule. The ultimate high is the highest high before price drops by at least 20% or price closes below the bottom of the ugly double bottom.

Selling at the ultimate high should be considered a perfect trade. You are selling at the highest price before the stock makes a dramatic drop.

The table shows the results for perfect trades.

I found that the setup wins 87% of the time. That means 13% saw price close at least a penny below the first bottom, triggering a sale.

Profitable trades made an average of 48% (the average win row). That compares to losing trades that lost an average of 17%. This loss measures from the buy price to the stop price. The stop price would be the opening price the day after the stock closed below the bottom of the ugly double bottom.

When you combine the winning and losing trades together, the setup made an average of 40%. The median gain is less, 24%. Half the trades made more and half less.

There were 867 trades. Commissions, slippage, dividends, and fees were not included in any of the setups described in this article.

Out of sample trades going back to 1990 gives results that are within one percentage point of those shown in the table, for each category.

Bottom Fishing: Target Exit, Stop at First Bottom

What happens when trades are not perfect?

I used the height of the ugly double bottom as a target exit. In other words I added the height of the ugly double bottom to the pattern's high price to get a target price. The stock was sold when it reached the target price. I used multiples of the height (one times, two times, and so on) to see how the setup performed. The table on the right shows the results for multiples of the height from 1 to 4.

I used a conditional order to sell the day after price closed below the first bottom's low. Since the height of the chart pattern can be tall (the second bottom can be up to 20% above the first bottom and that's still below the buy price), the potential loss can be large.

The win loss ratio starts out high at 75% for trades using one times (1x) the height to 55% for trades exiting at 4 times the height. This makes sense. As the target price gets farther away, fewer stocks will reach the exit price.

Profit from the average win increased the further away the target.

The average loss starts high, at 19%, above the 15% average profit but doesn't change much as the target gets farther away. That is because the height of the pattern doesn't change if you increase the target distance. In other words, the height of the pattern determines the size of the loss.

When you combine profits and losses, the average trade makes between 7% and 24%, depending on the target distance.

The median profit also increases from 12% to 26%, depending on the target distance.

Bottom Fishing: Target Exit, Stop at Second Bottom

The table shows the results for trades with a closer stop. This stop is below the second bottom (the higher of the two). The trade ends when price closes below the second bottom. A sale occurs at the opening price the next day.

The win/loss ratio drops dramatically, about 20 percentage points.

The average win remains about the same (only the 4x drops by a percentage point, probably due to more trades)

The average loss is smaller, dropping from 20% in the prior setup to 11% for this setup. That is because of a closer stop.

The average profit drops and the median profit actually turns into a loss for heights of 2 to 4 as significantly more trades fail.

Bottom Fishing: Preferred Setup Results

The following results use 425 out of sample stocks starting from 1/1/2000 through 6/7/2015. Not all stocks covered the entire period.

The preferred setup is slightly different from the others shown above. Click the link for details on the setup.

Most of this is self explanatory. Using ugly double bottoms with a second bottom at least 10% higher than the first means fewer losses (with a stop a penny below the first bottom), but when they do occur, they are whoppers.

When the trade wins, it also tends to do well, gaining a median of 32% but the average is lower, 19%, because large losses take their toll.

This uses a target exit of twice the pattern's height, so maybe you can use an exit that reduces the loss to something more reasonable (below 10% is best).

Bottom Fishing: Trading Example

I show a picture of Balchem (BCPC) on the daily scale.

The stock made a new yearly low when the ugly double bottom formed. The first bottom of the pattern is at A and the second bottom is at B. The difference between those two bottoms is at least 5% (it's 6% in this case).

The top of the pattern is at C. A buy signals when price closes above C. That happens at D, shown by the red line. Buy at the open the next day (or you could place a buy stop a penny above C. That's usually what I do and trust that the stock will confirm in the coming days by closing above the top of the pattern).

The exit target for this trade uses the height of the pattern. That's C - A or 29.99 - 26.56 or 3.43. Add 3.43 to C to get the target of 33.42. This uses a multiplier of one times the height not because I prefer it, but to be able to fit this trade on the chart.

Price reaches the target at F, making over 10%.

Notice that the stock dipped below the second bottom (which occurred at E, heading lower). A stop placed below the second bottom would have taken you out of the trade for a loss.

-- Thomas Bulkowski

See Also

• Ugly patterns: Do they outperform? Yes.
• If you want to compare the ugly double bottom to pretty ones, click the link where you can select the double bottom of your choice.
• The nature of bottoms.
• Busted chart patterns. The answer to profits?
• Double bottoms, overview. Article explains the 4 varieties.

For some reason, this sentence reminds everyone of Marvin Zelkowitz.