Picking the very top or bottom of a trend is a bit of an optimistic goal for most traders. However, it is entirely realistic to recognize a reversal as it is shaping up and jump into the trend early. If you can catch 70-80% of a trend, and if you can do that consistently, that is much better than hitting the actual top or bottom on occasion.
These three patterns will help you identify those reversal points. The double bottom, triple bottom, an inverted head, and shoulders are 3 of the best reversal patterns you can learn to identify.
Double bottoms and tops are some of the most popular patterns you will run across in the world of technical analysis. They occur:
A double bottom appears when a trade is already in a downtrend. It finds a support and bounces.
Then after bouncing up in a typical retracement, the bears begin to continue the trend bearish. The only problem on this second attempt is, there’s nowhere to go. Support is building, and despite their best efforts, the bearish traders can’t drive the price down any further. Instead, the buyers show up, and the support is beginning to get established.
As the buying pressure builds, eventually, it attracts enough new buyers that the previous “swing high” is breached. When this happens, the double bottom is confirmed, and a new trend is usually beginning.
This pattern of trading happens very frequently as it is one of the most common and frequent patterns you will find. However, there can be some deceptive peculiarities to this pattern.
First, like all patterns, the double bottom is good, but it’s not perfect. Some trades won’t reverse. Some will sometimes get stuck in a trading range instead of initiating the new trend. Others will break out only to regress into the previous trend. Despite these frustrating realities, often the double bottom will eventually lead to a bullish reversal.
Here’s another peculiar feature of the pattern: often, after the double bottom breaks out to the upside, it will quickly return to test the support area again. Usually, this sets a new higher low, but sometimes it will retrace all the way back to the previous support to test it. If this happens it can be frustrating; however, watch for the move and be prepared for the next buy signal. The good news about this quick retracement is the reality that after it occurs, typically the next wave of the bullish move is about to happen.
No matter how you look at it, the double bottom is a great bullish chart pattern, and you should learn to recognize it and trade it well if you want to profit in a new bullish trend.
The triple bottom is a lot like the double bottom, except there are three support points instead of two. However, with that third point also comes that much more belief in the new support being established. This makes the triple bottom a substantially more powerful chart pattern.
Like the double bottom, the triple bottom will occur in a down-trend. Ideally, this down-trend has been going on for a while. It is probably a primary downtrend. The longer the preceding trend, the higher the probability of the reversal.
After the trade finds support and bounces, it tries again to push to a new low. But a second time the trade is met with support and the bears must retreat and give way to the new bullish pressure that is building.
At this point, if the trade were to break out to the upside, we would call it a double bottom. However, the bears haven’t given up, and they mount a third attempt to make a new low.
After this support holds strong, the bears become very fearful, and the bulls start to gain hope and optimism. The most important part of this pattern is when the bulls manage to drive the stock to break above the “neckline.” This breakout is your signal to trade bullish.
The triple bottom is a stronger pattern than the double bottom because of the three attempts to make a new low. As the bears finally give up, when the bulls take control, it is done so without much push back from the sellers. By this point, the bears have either already liquidated their positions, or they have retreated in fear.
To help this pattern out, many times, short traders are forced to cover their short positions, and this adds to the buying surge early in the trend. After this first break-out surge, like the double bottom, the triple bottom will often see the sellers show up for a quick selling opportunity, only to re-test the previous resistance as a new support. When this happens, it is an excellent signal to buy long.
The triple bottom is not as common as the double bottom, but when it does occur, it tends to play out very favorably for the bullish trade.
The inverted head & shoulders is a very good bullish reversal pattern and is a variation on the triple bottom. This pattern is essentially a triple bottom where the middle selling point succeeds in making a new low. But the follow up selling pressure cannot match much less break down to a new lower low. In the case of this pattern, watch for it to appear in a downtrend of a primary trend. Like the double and triple bottom, you will first see the stock hit support and bounce.
However, on the second attempt to sell off, the trade will make a new low. At this point, most people would never recognize the pattern developing because it appears like it is a simple continuation of the trend.
But this trade is about to reverse, and following this new low, the stock bounces again, typically to the same resistance point set by the previous bounce. Next, the bears again try to drive the price down, but it is too late. The bulls have gained enough strength, and on the third attempt, the bears cannot even match the previous low.
Now the inverted head and shoulders has been setup. Once you see this formation, watch for a break of the neckline. This neckline is the final confirmation of the pattern and the trigger for a bullish trade.
The inverted head and shoulders is a very good pattern; however, one of the potential challenges traders face is the second sell-off. Bonus tip: add an oscillator like the Stochastics or a MACD to your chart. When you see the lower low getting established in the price, but the oscillator does not confirm that lower low, you have what we call Bullish Divergence. That is a warning that this trend is coming to an end.
As you can see in the image above, the Stochastic could not confirm the downtrend and eventually this trade played out as an inverted head & shoulders, complete with the bullish divergence warning from Stochastic.