Reading Stock Charts, Part II, continued
Catching The Double Bottom
Click here to view samples of the Double Bottom pattern
The double-bottom pattern resembles a "W," characterized by a price decline, a partial recovery and another decline before the stock returns to its previous price highs. In this pattern, nervous investors are shaken out (they sell) with each drop, eventually clearing the way for new investors to jump in. A double bottom sometimes has a "handle" just like the cup and saucer patterns.
The buy point in this pattern is when the price surpasses the highest point in the handle by at least 1/8 of a point, or the peak price in the middle part of the "W" when a handle has not occurred. In a correctly developed double bottom, the second decline should normally go slightly lower than the first decline to create a shakeout below the first low (first leg down in the "W"), and the middle point of the "W" should not go into new high ground.
- In this example of American Power Conversion, which makes power protection devices for computer networks and other sensitive electronic equipment, the stock had advanced to a high in a prior uptrend (to point 1).
- The stock makes the first bottom, going to $14.25 (point 2).
- The stock makes an initial recovery, reaching $22.75 (point 3).
- From here, American Power Conversion goes into the second sell-off, touching the $14.75 level (point 4). Notice that as the stock was in the process of bottoming, its price leveled off around $17 and volume dried up. This suggests that a selling phase is near conclusion (point 3 to point 4).
- The stock finishes making the last leg up, reaching $22.25 (point 4 to 5).
- From here, the stock forms a short, three-week handle (point 5 to point 6), similar to one you would find in the cup with handle. Note the volume dry up (abnormally low) around the low point of the handle, which means no further selling is coming into the stock.
- Here is the correct buy point, or pivot, as the stock breaks through $22, the highest point of the handle. Also notice the surge in volume as the stock breaks out, indicating a flurry of buying by big investors (point 7).
- After this breakout, American Power Conversion rose 800% over the next 22 months. Its Earnings Per Share Rating was 99 (the highest possible), the Relative Price Strength Rating was 95 (out of 99), its return on equity was a solid 54%, and annual pretax profit margin was a hefty 25% (point 8 and beyond).
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