Here Comes the Double Bottom Double Talk

There will soon be talk across the internets about a double bottom. Here is a primer on the elusive chart pattern.

As the Nasdaq has undercut previous lows, there is already talk of a double bottom. It is best to consult William O’Neil’s teachings on this chart pattern. According to WON, a double bottom will start by the index or equity making a new low. The stock then rallys 10-20%. After this sharp rally, the stock reverses, and undercuts the previous low. WON is a tad vague on whether the stock has to undercut the previous low in order for the pattern to be valid. It is stated that the 2nd low must equal, or in most cases, undercut the previous low. As the stock moves back up, the move up must be accompanied with above average volume. The buy point is achieved when the stock moves past the middle point of the W.

The chart above shows a somewhat a-typical double-bottom. This particular chart shows the bottom of the 2000-2002 bear market. Notice that the buy point is never triggered. Sticking to the methodology would have kept traders out of the index for months while it grinded lower.

The chart above shows the SPY’s 1998 bottom. It is a textbook double bottom formation. Notice how the index pauses at the middle point of the W (the buy point) and at moving average resistance. Once the index clears the buy point and moving average resistance, it is off to the races.

Note that in each chart above, the MACD fails to make a new low while the price does. I find positive divergences in the MACD can be one of the best clues that a bottom has been put in.

Above is our current SPY chart. Note that it is lacking in W formation characteristic of the double bottom. More importantly, it has yet to undercut the previous low. Regardless, we can still identify the theoretical buy point.

Important points to ponder:

• Since the characteristic W formation has not occurred, how has that changed the psychology which has shaped the pattern? I think the pattern is likely busted as longs and shorts alike have had ample time to consider the situation and position accordingly.
• The SPY did not quite rally 10% from the first low.
• Bulls will be screaming, “Buy, Buy!” as soon as a new low is made. However, that is not where the double bottom should be bought.
• Should the SPY and DJI undercut previous lows and then rocket back up, price will soon overtake the 50 day average. My system has me enter when the price overtakes, then tests, and holds the 50 day average. As the double bottom buy point will be above the 50 day average, this confluence of signals would make me very bullish.
• Can one index undercut previous lows and undergo a trend change without all the indexes undercutting previous lows?

Finally, I refuse to believe that the worst credit crisis and mortgage meltdown of the last half-century will end with the VIX at the level of 27.5

However, the indexes are nearing oversold, and are likely to bounce soon, but the best scenario for the pig-headed steers is to let everything fall apart before getting into the buying mode. My suspicion is that all the indexes need to undercut the previous lows. Then the bears may start getting nervous and the bulls can start regaining some confidence.

If you enjoy the content at iBankCoin, please follow us on Twitter