What Is the W Pattern, and How Can You Trade It?
A double bottom, also known as the W trading pattern, is a chart formation that is paired with a double top pattern. Both setups signal a trend reversal, but a double bottom appears only in a downtrend, while a double top is formed in an uptrend. Why do traders confuse the signals? Read the FXOpen article to learn the unique features of the double bottom formation and find out how to use it in trading.
What Is a Double Bottom Chart Pattern?
A double bottom, also referred to as a W bottom pattern, is a technical analysis formation indicating a potential reversal from a downtrend to an uptrend. It is widely used by traders to define future price movements and identify buying opportunities.
The pattern consists of two distinct troughs or lows at approximately the same price level, separated by a peak or moderate rally. The confirmation of the W formation occurs when the price breaks above the peak level, known as the neckline. This breakout signals a bullish reversal, indicating that the asset's price is likely to rise.
Must the Two Bottoms Be the Same? No, the two bottoms in a double bottom do not need to be exactly the same, but they should be close to each other. This slight variation is acceptable and still indicates a significant support level. A higher second bottom can suggest diminishing selling pressure, highlighting the first low as a stronger support point. Despite this variability, identical lows often add greater significance to the support level, reinforcing the potential for a bullish reversal.
A double bottom reversal effectively reveals diminishing selling pressure and growing buying interest, with the potential to kickstart a new bullish trend. The pattern forms when sellers fail to push the price lower after the first low, suggesting weakening bearish momentum. The second low at a similar level shows strong support, leading buyers to enter the market. This shift in sentiment pushes the price up.
A forex double bottom setup is the same as those seen in stocks, commodities, and cryptocurrencies*. Therefore, after you learn this pattern, you can trade it at FXOpen via stock, cryptocurrency*, commodity, and forex CFDs.
A Double Bottom and a Double Top: Differences
A double top pattern signifies an uptrend's end and a potential downward reversal. It appears at the end of a strong uptrend. The first top stands for an uptrend continuation, while the second, formed at the same level, signals the buyers' weakness.
For a deeper understanding of double tops, refer to our detailed article on the pattern.
Remember that a double bottom setup won't work in an upward trend, while a double top setup can't be found in a downtrend.
How to Trade a Double Bottom Breakout
The idea behind the double bottom is to enter a market on the breakout of a neckline, a line drawn through a peak between two bottoms. The same idea applies to many patterns, including double top, triple top, triple bottom, head and shoulders, inverse head and shoulders, and Quasimodo.
Entry
Initially, a trader identifies the double bottom on a chart by spotting two similar lows separated by a peak. They then draw a neckline through the peak and wait for the price to break above this line after the second bottom is formed, known as a double bottom breakout.
A trader can open a position as soon as the price rises above the neckline. In this case, the risks are high because the price often retests the breakout level, like in flag, triangle, and wedge setups.
Another opportunity is to wait for either a breakout candlestick or several candlesticks to close. On the charts with long periods, a trader can wait for the price to form a few candles. However, if the timeframe isnt high and the distance between the bottoms and the neckline is small, a trader may open a position too late, which will result in either small potential returns or a lack of them.
You can open an FXOpen account and practise the double bottom patterns entry.
Take Profit
A take-profit target is equal to the distance between the bottoms and the neckline and is set just from the neckline. A trader may use a trailing take-profit order if the market sentiment is bullish and there are fundamental factors that can push the price up.
Stop Loss
A stop-loss level can be calculated with a risk/reward ratio. The most common ratios are 1:2 and 1:3, but traders can develop their own trading rules.
Double Bottom: Trading Examples
Lets consider an example of a potential double bottom trade.
On the chart above, the price formed a double bottom setup at the end of a downtrend. According to the common rule, the price moved the distance equal to the difference between the neckline and the bottoms (1). If a trader waited for the breakout candlestick to close, they would miss the opportunity to trade with the pattern. Therefore, when noticing a large trading volume, a trader could go long at any time the breakout candle was forming.
A take-profit target would equal the distance between the neckline and the bottoms regardless of the entry point. However, as the rise continued, a trader could trail a take-profit level. The stop-loss would depend on the entry point and the take-profit level, but if it equalled a 1:2 or 1:3 risk/reward ratio, the trade would be effective.
How to Confirm a Double Bottom Chart Pattern
A double bottom setup can be confirmed with standard technical analysis tools. As a trader uses a breakout to enter the market with this formation, trading volumes can be used as a barometer of the bulls' strength. If trading volumes grow when the price rises above the neckline, the price is more likely to continue surging.
On the chart above, the on-balance volume (OBV) indicator is growing, although the price is consolidating. Its the first sign the price will break above the neckline and keep rising.
Another option is to use trend indicators. For instance, traders can apply moving averages to the price chart to find a well-known golden cross signal. In the picture above, moving averages formed a golden cross (1), which signalled a price rise. A trader could use it to confirm a breakout.
Note: most of the trend indicators are lagging, meaning they provide delayed signals. Therefore, if you implement them when trading on a short-period chart, its worth changing their parameters to smaller values.
Use the TickTrader platform to examine which indicators and candlestick patterns can help you confirm the double bottom signals.
Final Thoughts
A double bottom is a reliable pattern for traders aiming to catch trend reversals. While it may sometimes fail, its accuracy improves with practice and confirmation from other technical tools. Ultimately, familiarising yourself with this setup is the first step to mastering your market analysis skills.
Consider opening an FXOpen account to practise and refine your skills using the double bottom and leverage our advanced TickTrader platform's tools to improve your market analysis skills.
FAQ
What Is a Double Bottom in Trading?
The double bottom is a chart pattern used in technical analysis to signal a potential reversal in a downward trend. It consists of two distinct lows at approximately the same price level, separated by a peak. This formation indicates that selling pressure is subsiding and buying interest is growing.
What Does a Double Bottom Indicate?
A double bottom indicates a potential bullish reversal in the market. It shows that the asset's price has hit a support level twice and failed to go lower, suggesting that selling pressure is diminishing and a trend change is likely as buyers step in.
How Do You Identify a W Pattern?
To identify a W pattern, look for two low points forming at roughly the same price level, separated by a peak. Draw a neckline through the peak, and watch for the price to break above this line after forming the second bottom. This breakout confirms the pattern and signals a potential trend reversal.
Is the W Pattern Bullish or Bearish?
The W pattern in trading is bullish. It indicates that the asset's price is likely to rise after completing the pattern, signalling a reversal from a downtrend to an uptrend.
What Is Double Bottom in Stocks?
A double bottom stock pattern, or W stock pattern, indicates the potential end of a downtrend. It is formed when a stock's price drops to a support level, rebounds, and then drops again to the same level before rising. This formation suggests that the stock's price may continue to increase.
What Is the W Pattern in Crypto*?
The W pattern, also known as a double bottom, in crypto* functions similarly to other markets. It indicates a potential reversal in a cryptocurrency's* downtrend. When the price forms two lows at a similar level, separated by a peak, and breaks above the neckline, it signals that the bearish trend may be ending, and a bullish trend could follow.
*At FXOpen UK and FXOpen AU, Cryptocurrency CFDs are only available for trading by those clients categorised as Professional clients under FCA Rules and Professional clients under ASIC Rules, respectively. They are not available for trading by Retail clients.
Read more: https://fxopen.com/blog/en/a-comprehensive-guide-to-double-bottom-pattern-trading/
Text source: Forex Trading Blog
