Today there are many tools, indicators and guides to navigate through the market and earn more.
One of the most widely used tools is the price graphs, which determine the best points to enter or exit a trade. Many traders are studying these charts using different technical or fundamental means.
The price action can generate various formations on the charts, such as the popular head & shoulders, triangles, wedges, flags, etc. Among the classical patterns, we can also find the M and W price behavior, which are also called double tops and double bottoms.
In this article, we will only focus on the W pattern, also known as a double bottom, and understand know how it works and how to use it.
What is the W pattern?
The W pattern or double bottom pattern is a pattern that in many cases precedes a rise in the market in an exponential way. At the moments when the lows are reached, high demand to buy the asset can occur. The great explosion in buying bids causes prices to rise abruptly thereafter.
The question is to know how to take advantage of the moment and to remain in a favorable position. For many, it is just a matter of waiting for the right kind of behavior and then buying.
Double bottom patterns are essentially the opposite of double top patterns. Results from this pattern have the opposite results and expectations.
A double bottom is formed following a single rounding bottom pattern which can also be the first sign of a potential reversal. Rounding bottom patterns will typically occur at the end of an extended bearish trend. The double bottom formation constructed from two consecutive rounding bottoms can also infer that investors are following the security to capitalize on its last push lower toward a support level.
A double bottom will typically indicate a bullish reversal which provides an opportunity for investors to obtain profits from a bullish rally. After a double bottom or W pattern, common trading strategies include long positions that will profit from a rising security price:
When to trade a W pattern?
You must wait for the right moment, and make sure that the potential increase in price is safe. Wait for the rise to begin and make sure it is time to reverse to move up. Some traders may feel like this is a means to smaller profits, but at the same time, it significantly reduces their risk of being wrong.
It is not uncommon that at the end of a W pattern, a period of resistance begins which could lead to the formation of an M pattern or double top pattern. Such trading cycles that occur in the market can lead to some nice profits if both are traded in the right direction. Of course, such potential trades should be looked at in the larger context and only be considered if there is any prevailing larger trend that may cause one of the patterns to fail.
Ideally, to determine the reversal point, you should aim for higher probability conditions. Define the maximum amount you want to place on your position and also consider the prospective profit targets.
Potential risks when trading the W pattern:
To avoid losses, as a trader you need to establish a maximum point that decreases the risk of loss and that your position is not so compromising. The detail is that it is not infallible, meaning that there could be scenarios where this model could fail. It is essential to prepare for any such case and be on the lookout for another opportunity. The best way would be to determine a proper stop-loss or take-profit order.
The second thing that is recommended is not to put all of your eggs in one basket. In other words, divide your capital wisely and do not invest all of it in a reckless effort to make money. If the market goes against you, you should have some capital on the side to be able to get back to it and do not miss another potential opportunity
As noted, the method is excellent, but not fool-proof, and has a high probability of success. You can combine it with other tools you have available for better trades and higher profits.
Limitations of Double Tops and Bottoms:
Double top (M pattern) and bottom formations (W pattern) are highly effective methods when identified correctly. However, they can be extremely detrimental when they are interpreted the wrong way. Therefore, one must be extremely careful and patient before jumping to conclusions.
For instance, there is a significant difference between a double top that succeeded and one that has failed. A real double top is an extremely bearish technical pattern that can lead to an extremely sharp decline in a stock or asset. However, it is essential to be patient and identify the critical support level to confirm a double top’s identity. Basing a double top solely on the formation of two consecutive peaks could lead to a false reading and cause an early exit from a position.