The 1,2,3 bottom pattern
Though many Spikers do not to use patterns as trading set ups; I have a couple that are near and dear to my heart. One of my favorites is a retest of a bottom, sometimes known as a double-bottom. I prefer the term “1,2,3” bottom, which comes from Trader Vic Sperandeo’s work. The idea is simple—most intermediate or long-term trend reversals will involve a retest of the original lows. If this retest holds, than the odds are high that we will bounce enough for a trade, and if we manage to establish a higher low, than the trend is up and we can look for a more significant recovery. The rules are straightforward:
1) Price must be in a significant down trend, at least for 7 bars.
2) The first stab down (Point 1) must be followed with a recovery bounce, which retraces (Point 2) at least 4 bars.
3) The retest must come on lower volume and/or momentum. It can reverse above the initial low (1,2,3 or higher low); at the same price as the first low (classic double-bottom); or below the initial bottom (1,2,3 on lower low). The last is trickier and requires a move up passed the initial bottom low to be valid.
The buy point is above the second, or retest, stab down, on the day’s close. The stop goes at the bottom of the pattern bottom or some reasonable percentage.
In the MBI example, the first stab down on 11/20 has a low of 3.50, but reverses to a close at 4.07—short sellers are covering and bottom-fishers are grabbing shares. We double in price to around 7 on 12/04. Now we’ve drifted back down to 4, with reduced volume and bullish divergence in FI and MACD-H, on both weekly and daily charts. We’ll know in a couple of days how this will turn out, but note that MBI has formed two of these 1,2,3 bottoms (first in October) in its overall bottoming process.
These 1,2,3 bottoms don’t always show such strong bullish divergences, but I always look for divergences as confirmation of the pattern. If volume doesn’t shrink on the retest, just move along to the next trade and don’t risk it. This set up has been around as long as markets’ have, and most importantly, it continues to make money.
As a follow up to this set up, I exited three days later at 4.32 for a +6 % gain. Under normal circumstances, I would have felt comfortable holding for a few days and letting the pattern play out a little more. However, as I set this trade up around the New Year's holiday and volume was extremely thin and the market short-term overbought, I decided to take a quick profit. The set up is still valid, and I'll look to reenter the trade on some sort of pull back, once the market volume returns.
ReplyDeleteGrant,
ReplyDeleteThank you for this excellent pick and the clear explanations.
Your blog served as a catalyst for me to read Vic Sperandeo's interview in "The New Market Wizards". In that interview he talks about his studies about the duration of bull and bear markets and the normal percentage price moves a market makes before it forms a top or a bottom.
Do you know which of his books explains these studies in more depth? "Trader Vic" or "Trader Vic II"?
Regards,
Rodryk
I think 1-2-3 is in his first book...
ReplyDeleteAlex
Grant,
ReplyDeleteThanks for sharing this.
This week, there were some incredible gains amongst the spikers and members - especially those who picked stocks from the financial sector. The trade that I learned the most from however was your pick of MBI. The stock went up 68%, yet you didn't chase it. You planned your trade and traded your plan - with extreme discipline. That's what it takes to be good. I have a tendancy to chase them up and often get burned as a result. Thanks for your decision to scratch and therin teach this great example of discipline.
Steve M.