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.
