What is W Pattern Trading?

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A W pattern, also known as a double bottom, is a bullish reversal chart pattern. It signals a potential change from a downtrend to an uptrend, and it’s a fundamental skill in technical analysis. 

The pattern gets its name from its shape, which resembles the letter “W” and consists of two consecutive valleys (bottoms) at about the same price level, separated by a peak. 

The formation suggests that sellers have tried and failed twice to push the price lower than a specific support level, indicating that buyers are gaining control. 

This guide will explore the formation of the W pattern and how traders use it to make informed decisions. 

The Double Bottom Pattern

The first low of the W shape in a double bottom is a new low for the current trend, followed by a bounce up to an intermediate high. The price then falls to retest the previous low but fails to break below it, creating the second low. A strong rally from the second low is what confirms the pattern and signals a potential trend reversal. 

The double bottom pattern is considered a strong signal because it shows repeated buying pressure at a key support level, which the sellers are unable to break. 

Key Components

The formation of a W pattern has several key components: 

• Prior downtrend: The pattern must follow a clear downtrend. A double bottom in a sideways or uptrend is not as reliable and doesn’t carry the same reversal implications.
  
  
• Two lows: The pattern consists of two distinct troughs, or lows, that are about the same price level. The second low may be slightly higher or lower than the first, but a significant difference invalidates the pattern.
  
  
• Intermediate peak: The high point between the two lows is crucial and forms what is known as the neckline, or resistance level. This is the key level that traders watch for a breakout.
  
  
• Volume confirmation: Volume often plays a key role in confirming the pattern. Ideally, volume will be high on the initial decline to the first bottom, lower during the rally to the neckline and the second decline, and then surge on the breakout above the neckline.

How It Works

The psychology behind the W pattern is simple. 

During a downtrend, sellers are in control. The price drops to the first low, where some buyers step in, causing a bounce. The bounce is a temporary relief rally. 

But sellers regain control and push the price back down. When the price retests the previous low, the buyers who were active before show up again, preventing it from breaking to a new low. 

The inability to fall further is a sign that the selling pressure is waning. When the price breaks above the neckline, it signals a decisive victory for the buyers because the market is now making higher lows and higher highs,which is the definition of an uptrend. 

Examples: Trading the W Pattern

A trader spots a stock that has been in a prolonged downtrend. The stock falls to $25, then bounces to $30. It then falls back to $25 but finds strong support and starts to rally. The trader identifies this as a potential W pattern, with the neckline at the $30 resistance level. 

The trader then waits for the price to break convincingly above the $30 neckline before making a trade. The breakout is confirmed when the stock’s price closes above $30 on high volume. The trader might place a buy order at $30.50, setting a stop-loss just below the neckline at $29.50 to limit potential losses if the breakout fails. 

The target price for the trade is often calculated by measuring the distance from the bottoms to the neckline and projecting that distance upward from the breakout point. 

Key Takeaways

The W pattern is a widely recognized bullish reversal pattern in technical analysis. It’s characterized by two lows at a similar price level, followed by a breakout above a resistance neckline. 

The pattern signals that the sellers who were in control of a downtrend have lost their momentum, and buyers are taking over. Traders use this pattern to time potential long (buy) entries after the price breaks above the neckline, often with volume confirmation. 

The psychological logic behind it is the repeated failure of the price to make new lows, which strengthens the conviction of buyers. 

Understanding and identifying the W pattern can provide traders with high-probability trade setups and is a fundamental skill in chart analysis. It’s important to use it in conjunction with other indicators and proper risk management. 

Frequently Asked Questions

The post What is W Pattern Trading? by Margaret Jackson appeared first on Benzinga. Visit Benzinga to get more great content like this.