Today there are many tools, indicators, and guides to navigate through the market and earn more. One of the most widely used tools is the price graphs, which determine the best points to enter or exit a trade. Many traders are studying these charts using different technical or fundamental means.
The price action can generate various formations on the charts, such as the popular head & shoulders, triangles, wedges, flags, etc. Among the classical patterns, we can also find the M and W price behavior, which are also called double tops and double bottoms.
In this article, we will only focus on the W and M patterns, also known as double bottom and doubler top patterns, and understand know how it works and how to use them.
Key Takeaways:
- A double top is a bearish reversal chart pattern that is formed after an uptrend
- A double bottom is a bullish reversal chart pattern that is formed after the downtrend
- Traders should always use double top and double bottom chart patterns with other indicators such as volume for confirming the reversal before taking a position
- There are certain rules when trading with Double Top and Double Bottom chart patterns
What is the W pattern?
The W pattern or double bottom pattern is a pattern that in many cases precedes a rise in the market in an exponential way. At the moments when the lows are reached, high demand to buy the asset can occur. The great explosion in buying bids causes prices to rise abruptly thereafter. The question is to know how to take advantage of the moment and remain in a favorable position. For many, it is just a matter of waiting for the right kind of behavior and then buying.
Double bottom patterns are essentially the opposite of double top patterns. Results from this pattern have the opposite results and expectations. A double bottom is formed following a single rounding bottom pattern which can also be the first sign of a potential reversal. Rounding bottom patterns will typically occur at the end of an extended bearish trend. The double bottom formation constructed from two consecutive rounding bottoms can also infer that investors are following the security to capitalize on its last push lower toward a support level.
A double bottom will typically indicate a bullish reversal which provides an opportunity for investors to obtain profits from a bullish rally. After a double bottom or W pattern, common trading strategies include long positions that will profit from a rising security price
What is a Double Bottom Pattern?
A double bottom chart pattern is a bullish reversal chart pattern that is formed after the downtrend. This pattern is formed with two lows below its resistance level which is also known as the neckline. The first low is formed after a strong downtrend and then the prices retrace back to the neckline. After reaching back to its neckline, the price becomes bearish and falls again to form the second low. The formation of this pattern is completed when the prices move back to the neckline after forming the second low. When the prices break through the neckline or the resistance level then the bullish trend reversal is confirmed and traders can enter a long position.
When to trade a W pattern?
You must wait for the right moment, and make sure that the potential increase in price is safe. Wait for the rise to begin and make sure it is time to reverse to move up. Some traders may feel like this is a means to smaller profits, but at the same time, it significantly reduces their risk of being wrong.
It is not uncommon that at the end of a W pattern, a period of resistance begins which could lead to the formation of an M pattern or double top pattern. Such trading cycles that occur in the market can lead to some nice profits if both are traded in the right direction. Of course, such potential trades should be looked at in the larger context and only be considered if there is any prevailing larger trend that may cause one of the patterns to fail. Ideally, to determine the reversal point, you should aim for higher probability conditions. Define the maximum amount you want to place on your position and also consider the prospective profit targets.
What does a big W mean in stocks?
The big W in trading is usually a double bottom with tall sides. Price action often confirms the double bottom and approaches the height of the left side trend start before retracing and forming a handle. Once the price action completes the handle, the rise resumes. The big W is a chart pattern with two valleys that bottom near the same price and tall sides. The tall sides distinguished this pattern from a traditional double bottom. When the big W works, the stock can return to the launch price or soar even higher. In other words, you can use it to successfully predict an increase in price.
How To Trade the M Pattern
The “M” and “W” trading pattern is a great little pattern that occurs with enough frequency for you to add it to your trading tool bag. It is very similar to a triple top or triple bottom, but unlike the triple top or bottom, we are trying to enter the market on the bottom of the leg on the “M” pattern and the top of the leg on the “W” pattern. The M Pattern is also known as a double top pattern.
Normally with triple tops or bottoms, you are looking to enter on a break of the neckline line or a pullback to the neckline once the neckline has been breached. With the “W” “M” pattern we will be limiting our risk to a minimum by entering the bottom of the right leg for the “M” pattern and the top of the right leg for the “W” pattern. Next, for the “M” pattern, start with the left leg and draw to the top of the left shoulder. From the top of the left shoulder drawdown to the middle leg and from there draw up to the top of the right shoulder. From the top of the right shoulder drawdown to the bottom of the right leg.
Only once the pattern has all the components of the letter “M” do you have them set up. Once the “M” is nearing completion we are looking for an entry at or very near to the bottom of the right leg. Our entry will be as the market approaches this trend line. You want to enter the market on this trend line with a stop-loss order just below the line. This gives you a minimal risk entry. If it turns out not to be an “M” pattern then your loss will be minimal.
If on the other hand, you do get an entry, your first target is the top of the right shoulder of the “M”. Because the distance between the bottom of the right leg and the top of the right shoulder can be a small range you might want to look for this on larger time frame e.g. 4 hours and up. For the “W” pattern we are going to reverse the procedure. First, draw the left leg down to the bottom of the left shoulder. From there draw a line from the bottom left-hand shoulder to the top of the middle leg. From there you draw a line down to the bottom of the right-hand shoulder. The last stage is to draw a line to the top of the right-hand leg.
As with the “M”, the “W” formation is not complete until all the components of the “W” are in place. Once in place, you can draw a trend line across the tops of the “W”‘ left-hand leg across the middle leg and this is your entry point. A stop is placed just above the trend line to minimize risk with a target of the bottom of the right shoulder. Now, this pattern does pop up frequently on 5 and 1-minute charts but there is not enough room to make a profit on the length of the leg. But, what you can do however is be aware of the fact that an “M” pattern often signifies the bottom of the move and the market is getting ready to move Up. This also applies to the “W” pattern. When you see a “W” pattern the market is often topping out and getting ready for a move down.
You can also monitor what happens at the top of the right shoulder on the “M” pattern and the bottom of the right shoulder on the “W” pattern once you are in the trade. If the move looks strong there is no need to exit. You could measure the distance between the top and bottom of the right leg and project that forward to give you a larger target. This in effect gives you twice the length of the right leg as a target.
Potential risks when trading the W pattern
To avoid losses, as a trader you need to establish a maximum point that decreases the risk of loss and that your position is not so compromising. The detail is that it is not infallible, meaning that there could be scenarios where this model could fail. It is essential to prepare for any such case and be on the lookout for another opportunity. The best way would be to determine a proper stop-loss or take-profit order.
The second thing that is recommended is not to put all of your eggs in one basket. In other words, divide your capital wisely and do not invest all of it in a reckless effort to make money. If the market goes against you, you should have some capital on the side to be able to get back to it and don’t miss another potential opportunity As noted, the method is excellent, but not fool-proof, and has a high probability of success. You can combine it with other tools you have available for better trades and higher profits.
Limitations of Double Tops and Bottoms
Double top(M pattern) and bottom formations(W pattern) are highly effective methods when identified correctly. However, they can be extremely detrimental when they are interpreted the wrong way. Therefore, one must be extremely careful and patient before jumping to conclusions.
For instance, there is a significant difference between a double top that succeeded and one that has failed. A real double top is an extremely bearish technical pattern that can lead to an extremely sharp decline in a stock or asset. However, it is essential to be patient and identify the critical support level to confirm a double top’s identity. Basing a double top solely on the formation of two consecutive peaks could lead to a false reading and cause an early exit from a position.
