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15 Double Bottoms, Eve & Adam E

A

RESULTS SNAPSHOT Upward Breakouts Appearance

Double bottom pattern with the left bottom wide and rounded, the right bottom narrow and V-shaped. Breakout is upward.

Reversal or continuation

Short-term bullish reversal Bull Market

Bear Market

Performance rank

11 out of 23

8 out of 19

Break-even failure rate

4%

8%

Average rise

35%

23%

Change after trend ends

–31%

–36%

Volume trend

Downward

Downward

Throwbacks

57%

56%

Percentage meeting price target

66%

47%

Surprising findings

Patterns without breakout day gaps do better. Narrow patterns perform better than wide ones. Double bottoms with a lower left bottom perform better. Patterns with a falling volume trend, light breakout volume, or heavier volume on the left bottom do better.

244


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Tour See also

245

Double bottoms, Adam & Adam; Double bottoms, Adam & Eve; Double bottoms, Eve & Eve

Of the four combinations of Adam and Eve double bottoms, Eve & Adam is the rarest. I found just 227. It does not perform as well as some of the others, either. Still, the failure rate is small and the average rise posts a good showing in both markets. Eve & Adam double bottoms (EADBs) have a number of surprises, but in the interest of space, I will save them for the Statistics section.

Tour What does an Eve & Adam double bottom look like? Figure 15.1 shows a good example of one. Prices continue down in a steady decline to the low in June. Volume picks up as prices near the low then peg the meter at over 1.1 million shares on June 18, the day prices reach a low of 12.69. From the March high, the stock declines 47% in 3 months. The high volume marks the turning point and the stock moves upward. However, a retest of the low is in store and prices round over and head down again. In late August, prices make another low when the stock drops to 13.06, also on high volume.

Fleetwood Enterprises (Manuf. Housing/Rec. Veh., NYSE, FLE) – 24 – 23 – 22 – 21 – 20 – 19 – 18 – 17 – 16 – 15 Confirmation Line

– 14 – 13

Eve

– 12

Adam

– 11 – 10 – 9 Mar 92

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

– 8 Dec

Figure 15.1 A double bottom occurs after a downward price trend. High volume commonly occurs on the left bottom.


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Double Bottoms, Eve & Adam

The day after the low, on a burst of buying enthusiasm, the stock jumps and reaches the confirmation point in just 2 days. Instead of continuing upward, however, the stock throws back to the breakout point and moves horizontally for just over a week before resuming its move upward. By late January, the stock reaches a high 75% above the breakout price.

Identification Guidelines How do you identify an EADB? While it is easy to find a double bottom, it can be difficult to distinguish between the combinations of Adam and Eve bottoms. Figure 15.2 shows another example of an EADB. Although the figure does not show the pattern confirming (a close above the highest high between the two bottoms), the pattern does confirm (off the chart to the right), meaning that it is a valid double bottom. Notice the different shape between the two bottoms. The Eve bottom is wider and rounded looking. The Adam bottom is more V shaped, narrower, and usually composed of one or two large downward price spikes. The Eve bottom also has spikes, but they are many and short. Figure 15.3 shows another example of an EADB. This Eve bottom has longer spikes than those in Figure 15.2. The Adam bottom appears congested

Biogen Idec (Biotechnology, NASDAQ, BIIB) 47 46 45 44 43 42 41 40 39 38 37 36 35 34 33 32 31 30 29

Adam

28

Eve

27 26 02

Aug

Sep

Oct

Nov

Dec

Jan 03

Feb

Mar

Apr

May

25

Figure 15.2 The Eve bottom appears rounded and wider than the narrow and V-shaped Adam bottom.


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Identification Guidelines

247

Alaska Air Group, Inc (Air Transport, NYSE, ALK) 35 34 33 32 31 30 29 28 27 26 25

Confirmation Line

Adam

24

Eve

23 22 21 20 19 18 17 16

00

Dec

Jan 01

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

15

Figure 15.3 The top of the Eve bottom is wider than the Adam bottom. Eve appears rounded and Adam V shaped. The pattern becomes valid once price closes above the confirmation line.

also. Still, the V shape of the Adam bottom is obvious, especially in contrast to the rounded shape of the Eve bottom. The twin bottom pattern becomes a true EADB when price closes above the confirmation line. That is also called the breakout price and it is the highest high between the two bottoms. Table 15.1 lists identification guidelines for EADB patterns. Downward price trend. The pattern does not form in a rising price trend unless it is part of a correction, usually the corrective phase of a measured move up. More often, though, the double bottom marks the end of a downtrend. The trend need not be very long, but averages about 4 months. I excluded any pattern where there was a dip below the left bottom. Bottom shape. Look at the two bottoms. Do they have the same or different shape? If the bottoms look different, then you are on the right track. The pattern is either an Adam & Eve or Eve & Adam double bottom. The Eve bottom should look rounded and wide (especially near the top of the bottom, if that makes any sense), and if spikes appear, they should be short or bunched together. The Adam bottom should look different from Eve. It should be narrower and V shaped, and usually have a long, one or two day downward spike. Rise between bottoms. Usually tall patterns perform better than do short ones, so look for the rise between the bottoms to be at least 10%. I set no


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Double Bottoms, Eve & Adam Table 15.1 Identification Characteristics

Characteristic

Discussion

Downward price trend

Price trends downward and should not drift below the left bottom.

Bottom shape

The left bottom (Eve) should be wide and rounded. The right bottom (Adam) should be narrow and V shaped, perhaps with one or two downward spikes.

Rise between bottoms

At least 10% from the lowest valley to the highest peak between the two bottoms.

Bottom low prices

Bottom to bottom price variation is small. Best performance is between 0% and 4% variation.

Bottom separation

Bottoms should be at least a few weeks apart. Best performance is 2–7 weeks apart. Wider than 7 weeks and performance deteriorates.

Price rise after right bottom

Price must close above the confirmation point without first falling below the right bottom low.

Bottom volume

Evenly split between right or left bottom showing heavier volume.

Confirmation price

The highest high between the two bottoms. A close above the confirmation point is the breakout and confirms the pattern as a valid double bottom.

Breakout volume

Heavy breakout volume is best.

maximum height restriction, but removed from consideration those EADBs less than 10% high. Bottom low prices. Look for bottoms that have almost the same low price. They need not be the same, but patterns with variations between 0% and 4% perform best after the breakout. Bottom separation. Look for bottoms between 2 to 7 weeks apart for the best results. Bottoms farther apart than that are scarce and perform less well. Since these numbers are averages, your results will vary. Price rise after right bottom. A twin bottom pattern becomes a valid EADB once price closes above the confirmation price. Until that time, price should not make a third bottom. Bottom volume. Some patterns have volume higher on the right bottom (more often in a bull market) and some on the left (usually in a bear market). Confirmation price. Confirmation price is the breakout price, a close above the highest high between the two bottoms. A twin bottom pattern becomes a valid EADB only after price closes above the confirmation price. Breakout volume. Look for heavy breakout volume but do not discard an EADB just because the breakout occurs on below-average volume. Is the twin bottom shown in Figure 15.4 a valid EADB? Running through the characteristics shown in Table 15.1, we find that the pattern appears at the


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Focus on Failures

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Burlington Resources Inc. (Petroleum (Producing), NYSE, BR) 57 56 55 54 53 52 Confirmation Line

51 50 49 48 47 46

Eve

45 Adam

44 43 42 41

03

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

40

Figure 15.4 An Eve & Adam double bottom with volume higher on the right bottom and tepid breakout volume.

bottom of a downward price trend. The two bottoms look different—the first one is wider than is the second and more rounded looking, too. The second bottom is narrow and V shaped, with a two-day downward price plunge. The difference between the two bottom lows is small (1%). The separation measures 43 days from bottom low to low. No dips appear on either side of the pattern that would turn this into a triple bottom. Volume is heavier on the right bottom than the left and the breakout volume is below average. The pattern is a valid EADB.

Focus on Failures What can we learn from failures? Figure 15.5 shows what I call a 5% failure— the failure of price to climb more than 5% after the breakout. Those failures are rare. I found only 12 in 227 patterns. The bottom price variation looks wide, but the difference is only 4%. If you scan through the identification characteristics listed in Table 15.1, you will find that the pattern confirms as a true EADB. Why does price fail to rise much above the confirmation price? The answer is typical for these types of failures: overhead resistance. If you were to look at the historical price series in Figure 15.5, you would find two tops in


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Double Bottoms, Eve & Adam Butler Manufacturing (Building Materials, NYSE, BBR) 42 41 40 39 38

Confirmation Line

37 36 35 34 Earnings Warning, Broker Downgrade

33 32

Eve

31

Adam

30 29

97

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

28

Figure 15.5 This is a 5% failure, where prices fail to climb much above the breakout price.

early to mid-1996, at 37+. Those tops either peak at the EADB confirmation line or show congestion at or above that price. In other words, the peaks highlight a resistance zone right above the breakout. In fact, the overhead resistance is so strong that it turns back prices in mid-1998 (not shown). This EADB gained just 3% before tumbling 47%. On the fundamental side, the company warned in mid-September that full year earnings would fall about 20%, although the company raised its dividend. A broker downgraded the stock. The stock gapped lower on the news.

Statistics Table 15.2 shows general statistics for this chart pattern. Number of formations. EADBs are the rarest pattern of the four double bottom types. I found only 227 in the 500 stocks I looked at covering mid1991 to mid-1996 and the bear market, 2000 to 2003, with additional patterns between those ranges. Reversal or continuation. By definition, this bottom pattern acts as a reversal of the price downtrend. Average rise. The 35% average rise in a bull market is substantially higher than the 23% rise in a bear market. This finding suggests you should stick to trading this pattern in a bull market.


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Statistics

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Table 15.2 General Statistics Description

Bull Market

Bear Market

Number of formations

161

66

Reversal (R), continuation (C)

161 R

66 R

Average rise

35%

23%

Rises over 45%

47 or 29%

10 or 15%

Change after trend ends

–31%

–36% a

–29%a

Busted pattern performance

–31%

Standard & Poor’s 500 change

17%

0%

Days to ultimate high

160

101

Note: Minus sign means decline. a

Fewer than 30 samples.

Rises over 45%. How well does the pattern perform when it performs well? Over a quarter of the patterns (29%) in a bull market climb at least 45%. Just 15% of the bear market patterns rise as far. Change after trend ends. Once price reaches the ultimate high, it tumbles over 30%. In a bear market, the decline is 36%, well above the 23% rise after a confirmed EADB. Thus, you give back all of your winnings and have to dig into your pockets. The results show the importance of limiting your losses. Busted pattern performance. Although the samples are few, the numbers mirror the results after the trend changes. Figure 15.5 shows a busted pattern. If the stock fails to climb and heads down with gusto, consider shorting it. Standard & Poor’s 500 change. The S&P 500 index showed an average change of 17% in a bull market but was flat in a bear market. This finding helps explain the performance difference between the average rise numbers in a bull (35% rise) and bear (23% rise) market. Days to ultimate high. It took 50% longer to reach the ultimate high in a bull market than in a bear market, probably because the rise was 50% higher. The numbers suggest that for a large gain, many times you have to be patient (and lucky). Table 15.3 shows failure rates for EADBs. Notice how they start small but rise quickly. For example, in a bull market, 5% fail to rise at least 5%. Fifteen percent fail to rise 10% after the breakout; that is triple the 5% rate. Comparing the bull and bear markets, we find that bull markets have lower failure rates, as one might expect from a bullish chart pattern. The numbers suggest that you trade with the market trend: Trade bullish patterns in a bull market, bearish patterns in a bear market. And if you expect a large rise, say 50% from an EADB, realize that 76% will fail to climb that far (85% in a bear market).


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Double Bottoms, Eve & Adam Table 15.3 Failure Rates Maximum Price Rise (%)

Bull Market

Bear Market

5 (breakeven)

7 or 5%

5 or 8%

10

24 or 15%

15 or 23%

15

41 or 25%

24 or 36%

20

53 or 33%

31 or 47%

25

71 or 44%

39 or 59%

30

86 or 53%

45 or 68%

35

97 or 60%

47 or 71%

50

122 or 76%

56 or 85%

75

139 or 86%

61 or 92%

Over 75

161 or 100%

66 or 100%

Table 15.4 shows breakout- and postbreakout-related statistics for EADBs. Formation end to breakout. It takes 5 to 7 weeks for prices to rise from the right bottom low (which is the end of the pattern for statistical purposes) to the breakout price, on average. Yearly position. Where do EADBs hide in the yearly price range? In a bull market, you find most in the middle of the yearly trading range. In a bear market, the breakout price is within a third of the yearly high. Table 15.4 Breakout and Postbreakout Statistics Description

Bull Market

Bear Market

Formation end to breakout

46 days

37 days

Percentage of breakouts occurring near the 12-month low (L), center (C), or high (H)

L31%, C40%, H29%

L35%, C23%, H42%

Percentage rise for each 12-month lookback period

L39%, C38%, H32%

L25%a, C25%a, H21%a

Throwbacks

57%

56%

Average time to throwback ends

10 days

8 days

Average rise for patterns with throwback

33%

28%

Average rise for patterns without throwback

39%

19%a

Performance with breakout day gap

32%a

22%a

Performance without breakout day gap

36%

24%

Average gap size

$0.25

$0.50

a

Fewer than 30 samples.


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Statistics

253

Yearly position, performance. Mapping performance over the yearly price range, we find that the best performance comes from patterns with breakouts near the yearly low. Throwbacks. Throwbacks occur about 56% of the time. When they do occur, it takes between 8 and 10 days, on average, for price to return to the breakout price. In a bull market, performance deteriorates when a throwback occurs. That may also be the case with bear markets (which show throwbacks helping performance), but the sample count is too small to make an accurate assessment. For the record, many other chart pattern types have throwbacks that hurt performance in both bull and bear markets. Gaps. Gaps hurt performance in both markets, but the sample size is small. Notice how the gap size is twice as large in a bear market than in a bull market. This suggests you place a buy order just below the confirmation line. Hopefully, that will get you in before a gap occurs without unduly increasing your risk of a pattern failure. Table 15.5 shows a frequency distribution of how long it takes prices after the breakout to reach the ultimate high. In the first week, about 15% of the EADBs reach the ultimate high. Most take over 70 days and they are still searching for the high. Look at 35 days after the breakout in a bear market. There, 14% of the patterns top out for some reason, as if many are surrendering at the same time. Keep an eye on your trade and look for weakness a month after the breakout. You may need to close out your position then to protect your profits. Table 15.6 shows EADB size statistics. Height. Most chart pattern types have tall patterns outperforming short ones, but not EADBs. When the pattern is shorter than the median in a bull market, prices tend to outperform (by 37% to 33%). Bear markets show no performance difference, as if they do not want to take sides. Width. Narrow patterns perform better than wide ones regardless of market conditions. I used the median length as the separator between narrow and wide. Average formation length. The average formation length between bottom lows measures about a month (66 to 69 days). Height and width combinations. Comparing the combinations, we find that short and narrow EADBs do well in a bull market, and tall and narrow ones do well in a bear market. The worst performers are tall and wide patterns, so avoid those. Table 15.5 Frequency Distribution of Days to Ultimate High Days:

7

14

21

28

35

42

49

56

63

70

>70

Bear market

15%

6%

5%

2%

14%

2%

2%

5%

5%

2%

45%

Bull market

14%

7%

2%

5%

2%

6%

1%

4%

3%

5%

51%


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Double Bottoms, Eve & Adam Table 15.6 Size Statistics

Description

Bull Market

Bear Market

Tall pattern performance

33%

23%

Short pattern performance

37%

23%

Median height as a percentage of breakout price

18.03%

21.26%

Narrow pattern performance

39%

31%

Wide pattern performance

32%

16%

Median length

50 days

48 days

Average formation length

69 days

66 days

Short and narrow performance

42%

29%a

Short and wide performance

37%

23%a

Tall and wide performance

32%

16%a

Tall and narrow performance

33%

34%a

Small bottom price variation

37%

21%

Large bottom price variation

34%

26%

Median price variation

1.78%

1.89%

Lower left bottom performance

37%

26%

Lower right bottom performance

33%

19%a

a

Fewer than 30 samples.

Bottom price variation. I computed the price variation from bottom low to bottom low and then measured the performance for those EADBs with a price variation larger and smaller than the median. EADBs with small price variations did well in a bull market, but large variations performed better in a bear market. Lower bottom performance. EADBs with a left bottom below the price of the right bottom tended to perform better after the breakout. Table 15.7 shows volume-related statistics for EADBs. Volume trend. Those EADBs with a falling volume trend did better after the breakout than did those with a rising volume trend. The performance numbers appear in the table. Volume shapes. EADBs usually come in one of three volume shapes: U, domed, and everything else (random). EADBs with dome-shaped volume performed better than other volume shapes in both bull and bear markets. Breakout volume. Does heavy breakout volume suggest better performance? Not for EADBs. When the breakout volume was less than the prior 30day average, the stock climbed 43% after the breakout. EADBs with heavy breakout volume in a bull market climbed just 33%. The same trend was evident in a bear market, but be aware of the small sample size.


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Trading Tactics

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Table 15.7 Volume Statistics Description

Bull Market

Bear Market

Rising volume trend performance

34%

16%a

Falling volume trend performance

37%

25%

U-shaped volume pattern performance

35%

18%

Dome-shaped volume pattern performance

39% a

33%a

Neither U-shaped nor dome-shaped volume pattern performance

30%

27%a

Heavy breakout volume performance

33%

21%

Light breakout volume performance

43%

29%a

Heavy left bottom volume performance

38%

25%

Heavy right bottom volume performance

33%

20%a

a

Fewer than 30 samples.

Bottom volume. EADBs with heavy left bottom volume performed better than did those with volume heavier on the right bottom, as Table, 15.7 shows.

Trading Tactics Table 15.8 shows trading tactics for EADBs, and they are the same for most double bottom types. Measure rule. To determine how far prices may rise, use the measure rule: the height of the EADB added to the breakout price. For example, the EADB shown in Figure 15.6 has a confirmation price of 12.50, and the Adam Table 15.8 Trading Tactics Trading Tactic

Explanation

Measure rule

Compute the height of the pattern from the highest high between the two bottoms to the lowest bottom low. Add the difference to the highest high. The result is the target price. Price hits the target 66% of the time in a bull market, 47% in a bear market.

Wait for breakout

Since price usually continues down, wait for a close above the confirmation point before taking a position.

Trade with market trend

For best results, buy in a bull market.

Check others in the industry

To avoid 5% failures, check other stocks in the same industry and buy if they are showing bottoming patterns or if their stock is rising.


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Double Bottoms, Eve & Adam Checkpoint Systems (Percision Instrument, NYSE, CKP) 18 17 16 15

Ascending Scallop Confirmation Line

14

Sold

13 12

Ascending Scallop

11

Bought Neckline

10 LS

RS

Eve

9 Adam 8

01 Jul

Aug

Sep

Oct

Nov

Dec

Jan 02

Feb

Mar

Apr

May

7

Figure 15.6 As described in the Sample Trade, Willie bought early into this Eve & Adam double bottom. He sold when price dropped below the narrowing, ascending scallop.

bottom is the lowest low at nine. The difference between the two, 3.50, represents the pattern height. Add this value to the breakout price (the confirmation line of 12.50) to get the target of 16. Prices climb to the target in mid-March. Wait for breakout. I conducted a study and found that 64% of the time, price did not close above confirmation before dropping below the right bottom low. In other words, a double bottom fails 64% of the time if you do not wait for confirmation. Confirmation and a breakout occurs when price closes above the highest high between the two bottoms. Always wait for confirmation unless you have a special reason for entering the trade earlier. Trade with market trend. Since EADBs in a bull market handily outperform those in a bear market, trade double bottoms in a bull market. Even if you make mistakes, a rising tide lifts all boats and the market is more forgiving. Check others in the industry. Are other stocks in the same industry climbing? Are they showing bottom reversal patterns (double or triple bottoms, head-and-shoulders bottoms, that sort of thing)? If many companies in the industry are doing well, that should give other investors the courage buy the stock and add to demand. That activity reduces your chance of a small gain. However, if stocks in the industry look sick, what makes you think this EADB will do well after the breakout? It will be swimming against the current.


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For Best Performance

257

Save yourself some money and avoid the stock. Look for a more promising chart pattern in another industry.

Sample Trade Figure 15.6 shows a trade Willie made in the stock. He ran through Table 15.1 and checked the identification characteristics against the pattern. Briefly, the stock price was trending down to the EADB. The Eve bottom caused him concern as the twin spikes were long but separated by a few days. Was that really an Adam bottom? The Adam bottom had a shorter spike. Was it an Eve bottom? He looked above the spikes and saw that the Eve bottom was several weeks wide but the Adam bottom remained narrow. He concluded that the pattern was an EADB. The rise between bottoms was over 10% and the bottoms looked to be about 6 weeks apart. Volume was higher on the left bottom than the right, spelling good news for performance. As he watched the pattern develop, he saw what looked like a head-andshoulders bottom. He drew in the down-sloping neckline and when price closed above it, confirming the head-and-shoulders bottom, he bought and received a fill at 11. After that, it took just 2 days for price to confirm the EADB. Willie rode the stock higher and the price took on the shape of an ascending scallop—a rounded turn with a right handle. When the second, higher scallop appeared, he grew concerned. Sometimes, consecutive ascending scallops get narrower as they appear higher in the price trend. An unusually narrow one sometimes appears just before prices peak. So he decided to sell the stock as soon as price dropped below the scallop bowl. That occurred in early May, and he received a fill at 14.93, for a net gain of 35%—and that was in a bear market.

For Best Performance The following list includes tips and observations to help select EADBs that perform better after the breakout. Consult the associated table for more information. • Review the identification characteristics for correct selection— Table 15.1. • Select patterns in a bull market—Table 15.2. • Bull market patterns have lower failure rates—Table 15.3. • Patterns with breakouts near the yearly low perform best—Table 15.4.


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• Throwbacks hurt performance in a bull market—Table 15.4. • In a bear market, look for price weakness a month after the breakout— Table 15.5. • Select patterns narrower than the median length—Table 15.6. • Pick patterns with a lower left bottom—Table 15.6. • Choose patterns with a falling volume trend—Table 15.7. • Patterns with a dome-shaped volume trend perform well—Table15.7. • EADBs do well after a light volume breakout—Table15.7. • Select patterns with heavier volume on the left bottom—Table15.7.

Encyclopedia of Chart Patterns 15  

RESULTS SNAPSHOT Upward Breakouts Appearance Double bottom pattern with the left bottom wide and rounded, the right bottom narrow and V-shap...

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