Investors Can Use This Pattern to Forecast Trend Reversals and Even Calculate Price Targets
As the end of the most recent downswing in marijuana stocks nears its end, investors can utilize technical analysis (TA) to help anticipate when the market or an individual stock is getting ready to reverse its trend. In the past, we’ve covered various TA related topics such as ‘How to Use the Relative Strength Index (RSI)‘ to know when a run is done or just begun as well as ‘How to Spot Bullish Divergence‘ in order to confirm whether a stock has topped or bottomed out.
Given the current market conditions and the potential for a reversal in cannabis equities, today we will continue with our bottom themed analysis and take a look at the actual chart patterns investor should be on the lookout for.
What is a Double Bottom Chart Pattern?
A double bottom is a chart pattern used in technical analysis to characterize a change in the momentum of a trend that leads to an eventual reversal in price action. A double bottom forms when a stock, ETF or index rebounds off the bottom before dropping again to the same or similar level as the initial drop. This is followed by another rebound which completes the pattern and creates ‘W’ shaped chart pattern. The low area where the price twice dropped to is known as the support level.
Double bottom patterns will always form at the end of a downtrend and are used by traders to signify the end of that downtrend and the potential beginning of an uptrend. As a rule of thumb, a strong double bottom pattern should include an initial drop in share price of 10% – 20% followed by a second drop of 3% – 4% either way from the previous low. Keep an eye on volume, it should be on the rise during each rebound and especially the final rebound that completes the pattern.
Normally, the longer the period between the two low points of the pattern, the more reliable the pattern becomes. This applies to the majority of other chart patterns making them most ideal for investors with mid-term to longer-term outlooks. That’s not to say that this pattern cannot be used for shorter-term durations, but just keep this in mind while you’re analyzing your next stock chart.
Consider the Market Conditions
Another thing to keep in mind while you’re preparing to make your next trade, you should be keeping an eye on the market’s overall fundamentals and catalysts as they can play a big role in whether a pattern fully materializes. In the cannabis industry’s case, there is a handful of strong market catalysts on the horizon with Canada’s Legalization 2.0 and the various legalization and reform efforts going on in the United States. Fundamentally speaking the market should continue to improve in the coming quarters.
Keep an eye on future quarterly earnings from companies such as Canopy Growth (TSX: WEED) (NYSE: CGC), Aurora Cannabis (TSX: ACB) (NYSE: ACB), Curaleaf (CSE: CURA) (OTCQX: CURLF) and Trulieve (CSE: TRUL) (OTCQX: TCNNF). Should one of these leading Canadian or U.S. pot stocks post a large surprise earnings beat similar to Aphria’s (TSX: APHA) (NYSE; APHA) profitable Q2 earnings, the market could react extremely favourably.
Investors have made their demand for fiscal responsibility very apparent. Cannabis companies need to fall in line or they could get left behind. The days of posting nine-figure losses are likely over. On a positive note, there is a new large U.S. multi-state operator (MSO) that is gearing up to IPO this month. This company is Red White & Bloom (CSE: RWB – IPO September 2019) and its CEO Brad Rogers has stated publically on many occasions that they will be heavily focused on profitability as they build the next multi-billion dollar U.S. operator. This should be seen as a breath of fresh air for investors.
Double Bottom Chart Examples
Now that we’ve covered the basics, let’s take a look at some examples of past double bottom patterns as well as some current charts that have the potential to materialize.
The chart below of Aurora Cannabis (TSX: ACB) (NYSE: ACB) is a prime example of a successful double bottom pattern. It’s not perfect, but not all patterns will be. The double bottom still materialized and it will serve as a solid example for this article. You can clearly see the two low points followed by a reversal of the downtrend on increased volume. ACB stock then went on a run of over 100%.
Now that we’ve seen a past double bottom example, let’s fast forward to today and have a look at the charts of Canopy Growth (TSX: WEED) (NYSE: CGC) and Organigram Holdings (TSX: OGI) (NASDAQ: OGI). After reviewing a handful of charts, WEED and OGI stood out to me as two stocks that could be in the process of forming a double bottom pattern. In both instances, the stock has hit its initial low point followed by its first rebound. Both stocks are in the process of pulling back and possibly rolling over towards the second low. It’s still early on, but investors may want to add WEED and OGI to their watchlists so they can keep a close eye on them to see if they successfully complete the pattern.
How to Calculate the Price Target of a Double Bottom Pattern
Once you’ve identified a strong double bottom pattern you can then take it a step further and calculate an approximate price target for your trade. This will help give traders a better idea of when to take profits.
In order to estimate a price target, we first need to measure the distance between the line connecting the two bottom low points ($6.21) and the pattern’s neckline ($8.31). The neckline is the area of resistance that causes the first rebound to stop and rollover. We’ll use Aurora’s chart again and expand upon it for this example. Once we establish the distance between the lows and the neckline ($2.10), we simply extend that measurement from the top of the neckline. By adding $2.10 (distance between lows and neckline) to $8.31 (neckline) it will give you a price target of $10.41.
As is often the case in these types of scenarios, before the share price reaches the price target, there is often a retest of the neckline which should now serve as support instead of resistance. This retest of the neckline offers more conservative investors an opportunity to enter the stock as well as providing traders who missed out on the initial breakout, a second chance to open a long position. As you can see from the visual below, ACB stock reached this price target on February 5, 2019, before pulling back and moving even higher as the uptrend continued.
I hope you enjoyed this article and can implement these tactics in your trading plan moving forward. I’ll leave you with one additional piece of advice. Be sure to use a stop loss when trading these patterns in order to protect yourself in the event of a failed pattern. Even a seemingly perfect chart pattern can fall apart for a variety of reasons such as negative news, poor earnings, a large shareholder liquidating a position or simply macroeconomic issues that put pressure on the entire sector. It’s always good to use a safety net just in case.
In the next technical analysis article, we’ll take a look at the double bottom’s close relative, the triple bottom.
Best of luck to you all and happy investing.
Editor in Chief | The Cannabis Investor
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