PurelyTechnical

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INTRODUCTION:

The Triple Bottom is a bullish reversal chart pattern. It is considered a variation of the Head & Shoulders Bottom. The most significant difference from its more famous counterpart is that each trough in a triple bottom is formed at approximately the same level. The Triple Bottom usually takes 3-6 months, on occasion much longer, to form and has significantly bullish implications.

Intuitively, the Triple Bottom can be thought of as a process of "accumulation", wherein 'smart money' is buying into market weakness as price oscillates between support and resistance until resolute buying is able to push prices above resistance (a.k.a. the "neckline") and a new uptrend begins in full force.

FORMATION

Prior Trend

In the lead-up to a bottoming formation that would later turn out to be a triple bottom, the chartist witnesses a major downtrend, wherein price is showing a series of lower highs and lower lows.

The market would have declined substantially when it forms a minor trough (A) and then starts a reaction rally. This rally does not last for long before price starts to decline after forming a peak (X). The ensuing decline is not able to break below the level of the previous low, which acts as the first significant support to the market.

Prevented from falling further, the market puts in another minor trough (B) when buyers step in, forcing prices to rebound and, in the process, break the declining trendline (formed by extending the line joining X with the previous reaction high). This is seen as the first sign of a potential change in trend.

Yet, at this stage it is still not clear whether the new trend is going to be one of sideways consolidation or, indeed, of a reversal to the upside.

Three Troughs

After the breaking of the downtrend, prices rally a little further but quickly find resistance at or near the level of the first intervening peak (X) and then proceed to decline once again leaving behind another peak (Y). The descent from the second intervening peak eventually reaches the level of support provided by the first two troughs.

Despite a best attempt on the part of the sellers, support proves impenetrable as the market puts in another trough (C) and starts to rally yet again. At this point, the technician, in realizing the steadfastness of the support level, has probably liquidated pre-existing short positions and is on full alert for a bullish reversal.

Breaking of Resistance and Return Move

After the rally out of the third trough, the technician is still not certain as to whether the market is trading within a continuation pattern (such as a bearish rectangle) or a bullish reversal pattern. However, that question is quickly answered when price breaks the resistance line (or neckline) in a surge of trading activity.

This breakout serves as the first confirmatory sign that the market has changed trend and is now ready to regain lost ground. These developments serve as a cue for the trader to initiate a long position.

While triple bottoms are relatively rare occurrences, some studies have shown that when they do show up, a retesting of the broken triple bottom neckline is experienced as often as 70% of the time.

OTHER SIGNIFICANT ASPECTS

Volume

The trend in volume witnessed during a triple bottom formation is similar to that seen during a triple top. Volume generally declines as the pattern wears on, often with each trough experiencing progressively lesser trading action.

Additionally, trading volume is typically light at each of the intervening peaks. This lack of buying and selling interest means that the market finds itself meandering between peaks and troughs until either resistance or support is broken.

A breaking of resistance that comes together with a burst in trading activity confirms the bullish reversal and is a suitable opportunity to enter long positions. Any return move that develops usually does so on low volume and provides the trader another opportunity to enter (or to add to) long positions.

Duration

A triple bottom usually takes 3 to 6 months - often much longer - to develop. The longer the duration of the pattern, the greater is its significance and the greater is the potential price move.

VARIATIONS IN FORM

While the “textbook perfect” triple bottom might possess troughs that all line up with each other and intervening peaks that form at the same price level (a certain distance above that of the troughs), a perfect formation rarely occurs in real market situations. Often, the peak seen between the first pair of troughs will be at a level higher, or lower, than the peak in between the second pair.

As a result, a triple bottom might have more than one resistance line. When there is more than one resistance line, i.e. when the intervening peaks have formed at different levels, the generally accepted practice is to view the level of the highest intervening peak as the resistance level that will serve as the neckline for the pattern (the significance of the neckline comes from its role in projecting a target for the pattern).

Other variations in form include hybrid patterns (such as a hybrid double/triple bottom) and multiple-trough bottoms (commonly referred to as triple bottoms).

SETTING UP THE TRADE & FINDING A PROFIT OBJECTIVE

The most common method by which a technician trades a potential triple bottom is by entering long positions upon a breaking of the neckline. Another method consists of entering a long position during the occurrence of any return move to the neckline.

The price objective for long positions initiated in response to a triple bottom breakout is arrived at by using the vertical distance or height method.

Herein, the trader measures the vertical distance (in terms of absolute points or percentage points) between resistance (D) and support (E) and then projects that distance upward from the level of the breakout (F), to arrive at a target for the trade. Once prices start to rally, the trader protects his long position by placing a stop just below the level of the broken resistance line.

EXAMPLE

RIG displayed a Triple Bottom over a period of five months in late-2003.

The stock was in the midst of a significant downtrend in mid-'03.

A (first) trough formed at 18.5 in late-Jul, after which the stock rallied to form a reaction peak (later to be the first intervening peak) at 21.5, in late-Aug/early-Sept.

The stock then started to decline again, but was able to find support between 18.5 and 19.0 later in Sept., forming a second trough as buyers stepped in.

The ensuing rally was not able to reach the level of the previous peak before prices declined once again, leaving a second peak at 21.0.

Prices declined once again, this time all the way to previous support at 18.5 but, despite several attempts to break below that level over the first 3 weeks of Nov., support held and prices eventually moved upwards on high volume, leaving a third (and final) bottom in place.

Notice how volume decreased at each trough, and was generally low during the intervening peaks. This is the typical case. Additionally, volume started to grow strongly on the move out of the third trough.

Early-Dec saw price bursting through the neckline, which was the level of the highest intervening peak (21.5). The stock look didn't look back until the target was achieved.

The new trend was so strong as to not even have allowed a return move, in this instance of the triple bottom.

The target - calculated by projecting the “height” of the pattern (21.5-18.5= 3.0 pts ) upwards from the level of the neckline (21.5) - was 24.5. This price was easily attained by late-Dec., barely 2 weeks after the breakout.