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Double-Bottom Trade in Crude Oil

Since Crude Oil began its long-term decline in the early Fall of 2014, the commodity has yet to find meaningful support and forge a sustained reversal. However, the most recent lows in January and February 2016 appear to have formed a double bottom. This pattern can be constructive for future price action.

In Technical Analysis a double bottom is a price pattern that forms after a sustained downtrend makes a low, reverses higher, then retraces back to around the previous low, and finally proceeds to move higher again. The breakout from a double bottom is confirmed when the price moves off the second low to a point that is higher than the reversal peak from the first low. Sometimes the double bottom may be symmetrical and other times there can be some asymmetry between reversals.

Currently, Crude Oil is exhibiting asymmetry in its double bottom. Thomas Bulkowski coined the different price bases “Adam” and “Eve” depending on the shape of the move. “Adam” reversals are typically narrow and V-shaped, whereas “Eve” patterns develop more slowly and are more rounded. As can be seen, Crude Oil is displaying an Adam & Eve Double Bottom. In other words, there are two distinct valleys that look different.


Since the breakout from the double bottom at $36.00, Crude Oil has been consolidating in a range between $36 and $38 below its 100-Day Simple Moving Average. Despite the lack of immediate follow through, this behavior is actually constructive. “Sometimes price will confirm the double bottom and then waffle up and down, forming a handle. When price breaks out of this region it often moves up in a strong trend” (Encyclopedia of Chart Patterns, Bulkowski). At the moment, Crude Oil is forming a handle as described by Bulkowski and based on past experience could be setting up for a sustained move higher.

Historically, the performance of an Adam & Eve Double Bottom is quite favorable. For example, Bulkowski notes that based on his experience the average gain per trade after the pattern completes is +37%. Additionally, double bottoms that form within a third of the yearly low perform the best.

In this example, the first entry point after Crude Oil completed its Double Bottom would have been around $36.00. An additional position could be opened above $38.00, a level that acted as resistance for the handle and corresponds with the 100-Day Simple Moving Average. While the statistics are favorable for this type of Double Bottom breakout, no trade is risk-free. Accordingly, your risk could be limited to either mid-range of the handle around $37.00, or a break of handle support, also the Double Bottom breakout level, of $36.00. The stop-loss choice will depend on your risk tolerance and position sizing algorithm.

After identifying this attractive trade set up and appropriately minimizing your risk, you should feel confident in adding some long exposure in Crude Oil to your account.

As always, please feel free to contact me with any comments or questions. Thanks for reading.


John

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