Trend marks territory by spiking relative highs
and lows within all time frames. This signature behavior can be observed in all markets
and throughout all historical chart activity. As Edwards and Magee point out in their
classic Technical Analysis of Stock Trends, price movement can also be
classified by its relative direction. A series of lower highs and lower lows characterize
downtrends while uptrends reverse this sequence with higher highs and higher lows.
When trend is viewed as a repeating cycle, The Traders Wheel is
born. Since a market cannot travel upward to infinity or downward below zero, a range
develops within each time frame. Driven by fundamental and technical factors, trend
inhales and exhales. Prices drop, inviting a new value crowd. Prices then rise and
momentum players jump on board. On and on it goes.
Double Bottoms exist as a direct result of this
trend physics. The natural movement of impulse and reaction dictates that two unique
patterns must develop at some point within each cycle. The first (in an uptrend), when a
higher high is met with a lower high. And inevitably (in a downtrend), when a lower low is
followed by a higher low. This second event marks the birth of a double bottom.
The predictive power of double bottoms arises out of the trend
that preceded it. As a series of lower lows is sketched on a bar chart, down trends are
reinforced and often accelerate. The subconscious mind develops a gravity bias that
expects the fall to continue unabated. Then suddenly, the last low appears to hold. A
crowd begins to take notice and speculative long money enters positions. Self-fulfilling
prophecy reinforces buying at this point as the potential pattern is recognized by more
and more players.
Percentage growth potential peaks at the very beginning of a new
uptrend. As a result, being "right" at a bottom can produce the highest profit
of any trade. But picking bottoms can be a very dangerous game. The smart trader will
weigh all evidence at her disposal before taking the leap. And while multiple analytic
tools are available to evaluate whether or not the last low will hold, strict risk
discipline must still be exercised to ensure a safe exit if proven wrong.
Powerful buying signaled the start of a rally and successful
re-test of CCE’s prior low. Traders can’t depend on easy confirmation when it
comes to picking bottoms. As a rule, confirm double bottoms through lower
volume at the second low, as volume dries up.
