The Hindu Business Line : Trader's Corner

One of the technical patterns that is most likely to send a thrill of anticipation in dealing rooms is the double bottom pattern since these portend a reversal of a prolonged down trend and a sound entry level for traders.

The security reverses from a protracted decline forming the first bottom. But the recovery is short-lived and the security slips again towards the previous trough forming a minor recovery peak. The slide in price, however, once again gets arrested around the previous trough thus forming the double bottom. This pattern resembles the letter ‘W’. The second low can be 3 per cent higher or lower that the first low. But a higher low would have bullish connotation since it would reflect the buyers’ eagerness to take prices higher.

The volume tends to be the highest while the first trough is formed. The subsequent bounce occurs with lower volume reflecting lack of conviction in the up-trend. The volume dries up absolutely while the second low is formed and expands again while the reversal happens from the second trough.

The psychology behind the pattern is that the pessimism is very high around the first trough and the selling pressure, too, is great. The first reversal is caused mainly by short-covering and, hence, the volumes are minimal. Confidence returns once the stock reverses the second time from the same level and volumes expand.

The pattern is deemed complete only when the recovery peak is surpassed. It would be prudent to wait for the security to move past this level before initiating fresh longs, as these patterns can turn out to be a sideways move that can be followed by yet another leg of the down trend. The projected target for this pattern is the distance between the valley low and the recovery peak added to the recovery peak.

Another factor that needs to be borne in mind is that double bottom formation in the weekly or monthly charts would be more effective than those occurring in the daily or intra day charts. A typical example if the double bottom formation formed between September 2001 and November 2003 in Satyam Computers.— Lokeshwarri S. K.

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