Sears: Anatomy Of A Double Bottom

07/31/00 03:03:51 PM

by David Penn

At a low during a major bear trend, Dow standby Sears and Roebuck [S] rallied from an intermediate trend double bottom to reach highs of nearly $44 in late April 2000. But a selling climax and weak rally have caught Sears between either a major upside reversal or a resumption of the stock's three-year decline as the market moves toward the fall.

Security: S
Position: N/A

A double bottom is typically characterized by two troughs separated by a price rally. Heavy volume tends to accompany the first trough, with light volume on the second trough and very heavy volume on the subsequent upside breakout. A double bottom, like its cousin the double top, is considered a reversal formation--meaning that when it occurs as part of a bear trend, it is likely to anticipate a short-term bull reaction. Conversely, double tops tend to suggest a short-term bear reaction when they occur as part of an overall bull trend.

Sears, whose bear trend began during the summer of 1997, developed the first trough of a double bottom in October 1999, with over 11 million shares changing hands during the final two trading days of the month. The stock gained from that point until December 1999, going up eight points, before entering a consolidation pattern that lasted from mid-December to mid-January 2000, before sliding into the second trough in late January. Sears rallied from a February low of 25, passing the confirmation point at 34 in early April with heavy volume of almost 18 million shares on April 4-5. This move signaled the bullish indications of the double bottom as Sears rose from 34 to just under 44. (Note that average trading volume for Sears is approximately 1.4 million shares.) A confirmation point, incidentally, is the area where prices break the "neckline", or the highest point of resistance between the two troughs.

Graphic provided by: Window.

What does all of this price movement signify? The first rally--the one that defined the right side of the first trough--typically consists of buyers eager to take advantage of the discounted prices. As prices rise in response to increased demand, sellers step forward to unload shares not previously sold during the first decline (the first trough), taking advantage of the temporarily premium prices. This results in the second trough, as prices react to the renewed selling activity. The upside breakout occurs at the end of the second rally, as buyers step in to absorb even more discounted shares.

What can traders expect out of double bottom formations like the one above? Is the 10-point gain from the confirmation point to the subsequent high (a 30% increase) typical? While there is some temptation to go long during the early stages of a double bottom, the likelihood of profiting from a long position increases dramatically if the trader waits until the prices rise above the confirmation point, as described above. Because double bottoms tend to form as part of bear trends, there is a possibility that the double bottom will fail and that the stock will resume its bearish movement--particularly if the prevailing bear trend has been an extended one. In the case of Sears, which has been in a bearish position for years, caution would have been appropriate, even though a trader who took a long position during the move into Sears' second trough (instead of waiting for confirmation) would have been amply rewarded by the subsequent short-term climb.

Will Sears' bullish response to the double bottom make for a similarly bullish autumn? Unfortunately, it does not appear so. In the second half of this look at Sears and Roebuck, I will point to a selling climax in mid-June that, in concert with a mediocre technical reaction, seems to indicate that Sears will be facing more declines before it enjoys advances in the near term.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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DOUBLE BOTTOMS

Sears: Anatomy Of A Double Bottom

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