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Double Bottom, Double Top

08/26/11 09:06:52 AM
by Koos van der Merwe

How effective is a double top and a double bottom?

Security:   IRBT
Position:   Hold

A double-bottom formation appears as a W on a chart, and a double top appears as an M. Both formations are very popular, but watch out! Many analysts often mislabel and misinterpret double-top and double-bottom formations. The reason? In any uptrend or downtrend, after a reaction, each new wave appears to be making a double-top or bottom formation. Truth be told, there is no evidence pointing to either a double-top or bottom formation until a confirmation has been made. Nine times out of 10, the active trend will remain in force and prices will simply continue to make new highs or new lows. Confirmation occurs only when the middle high/low in the formation is broken.

FIGURE 1: iROBOT, DAILY. iRobot shows a possible double-bottom formation.
Graphic provided by: AdvancedGET.
Figure 1, a chart of iRobot, shows the two formations quite clearly and suggest that a new double bottom could be forming, but confirmation has not yet been made. My chart shows the double-top and double-bottom formations that developed in iRobot. Note how in both instances the confirmation line was broken as the price moved up/down, confirming the pattern. At the moment, the share price could be forming a new double-bottom pattern, but this will only be confirmed should the price break above the confirmation line at $30.24.

Until that happens, the price could move up or down as shown by the red and blue arrows. The relative strength index (RSI), which is moving upward from an oversold position, does suggest that the confirmation line may be broken, but until the price breaks it, nothing can be assumed.

Finally, do note that volume as the price fell recently has fallen, suggesting strength.

Double-top and double-bottom patterns only become real when the confirmation line has been broken. Until then, it can be watched, but the pattern cannot be verified until the confirmation line is broken.

Koos van der Merwe

Has been a technical analyst since 1969, and has worked as a futures and options trader with First Financial Futures in Johannesburg, South Africa.

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