“X marks the spot” might be true for treasure maps, but on stock charts, the W is the letter some traders look for. W pattern trading is a common strategy employed by swing traders looking for trend reversals, but the concept is a little more complicated than just spotting a letter shape. Traders still need to understand the signals and have the ideal platform to facilitate their transactions.
What Is W Pattern Trading?
W pattern trading is also known as a double-top pattern or double-bottom pattern depending on the direction of the trend. The W refers to the physical shape that appears on the stock chart in this situation, namely the double-bottom pattern. The double-top pattern forms an M on the stock chart, but the idea is the same. The points of the W or M form an area of support where some buyers may enter and push prices back up.
The W pattern tends to be a bullish signal as the double-bottom signifies that the low point may have been reached and the downtrend could be headed for a reversal. W pattern trading is a technical trading strategy using stock market indicators to help locate entry and exit points. A favorite of swing traders, the W pattern can be formed over a period of days, weeks or months.
Understanding the W Pattern
Here’s what to look for when analyzing the W pattern using technical analysis:
Look for a Pattern Resembling a W
Seems simple enough, right? When you start looking for W patterns, you’ll likely begin to notice them frequently. The W must form around the same low points on the stock chart; this indication signifies that support is present at that level and a reversal could be forthcoming.
Confirm Trend Direction
W pattern trading is a trend-reversal strategy, not a trend-following one. If the W pattern forms on a stock that’s already in an uptrend, it’s likely just noise and shouldn’t be used as a trading signal. Make sure the stock is currently in a downtrend if using the W formation.
Identify an Entry Point
Not every W pattern will result in a breakout, so traders must be patient and wait for the breakout to materialize. Timing these trades is crucial, and the W pattern is generally most useful if the stock price rises above the previous high points on the W shape some experienced traders may enter a position when the breakout has been confirmed; otherwise, they might need to quickly exit the position on a false positive.
Know Your Exit Point
Many swing traders know that time in a position is usually short, so make sure you have an exit strategy and an entry one. Setting profit goals is a good way to keep emotions in check and exit a position at a calculated time.
How to Identify the W Pattern
Here are a few key factors to keep in mind when looking for the W pattern in trading.
Shape or Formation
Seeing might not always be believing in stock trading, but the W pattern tends to stick out once you start looking for it. Be sure the W contains two nearly identical low points as a support level, as well as three similar high points for resistance. When this resistance level is broken after the W forms, that could be a sign of a breakout.
Volume
You can’t have large price moves without sufficient volume. A W pattern forming on a stock without much accompanying volume could create a misleading scenario. Use volume as confirmation that the W pattern is likely a double bottom.
Price trend
The W pattern is a trend reversal indicator, so ensure the stock is trending in the right direction before using it as a potential trading signal. If the stock was already trending up when the W formed, it’s likely just noise and shouldn’t be used as a potential trading signal.
Potential Advantages of Double-Bottom Pattern Trading
The W pattern can be useful because it can help identify potential trend reversals. If an investor can locate the W pattern early on, they may be able to enter a position before the breakout is realized and potentially capitalize on gains as other investors are likely to pour in once the breakout has occurred.
To help illustrate, here’s a hypothetical example. Imagine if a down-trending stock begins to form a W pattern, an investor decides to keep a close eye on it as it approaches the previous resistance level after the double bottom. As the stock approaches this level, this investor decides to enter the position with a tight stop loss. If the breakout occurs, they’ll likely benefit. If the breakout fails, they can cut losses quickly.
Trading Risks When Using a Double-Bottom Pattern
Technical analysis is far from perfect, and trading risks are present even in the most refined strategies. In terms of W pattern trading, the risk of false breakouts and misidentified trends is common.
Here’s an example: The W pattern will form often, but it must be confirmed by other factors considering it as a possible signal . Many investors make the mistake of attempting to trade a W pattern in a stock that’s not in a downtrend. A breakout could still happen in this scenario, but it’s not a true double-bottom trade unless the pattern and trend are confirmed.
Double Top Pattern vs. Double Bottom Pattern Trading
Double-top trading is the cousin of double-bottom trading. When looking for a double-top trade, apply the components of double-bottom trading in reverse. The M pattern should be present on the stock chart with the two top points of the letter signifying the resistance level. When an M pattern is present, that could signal a potential breakout to the downside.
And as with W pattern trading, make sure to confirm the trend direction before considering it as a possible signal before executing. Remember, these are trend reversal strategies — if the M pattern forms on a stock chart with price pressure already moving downward, it could be another false positive and the breakout may never arrive.
W Pattern Trading Can be a Useful Analysis Tool for Traders
Investors who consider using the double bottom as part of their technical analysis will need to grasp concepts like support and resistance to properly identify the pattern. Trading the W pattern may provide an opportunity to build a bullish position before the trend begins to reverse, but traders must be fast in pattern and trend identification and be able to quickly manage the position should the breakout not materialize.
W pattern trading isn’t a cheat code and not all W’s in declining stocks will result in trend reversals. This should typically be used together with other indicators to help avoid the risk of false breakouts and misidentifying trends.
Frequently Asked Questions
Is the W pattern bullish?
Yes, the W pattern is a bullish one as it signifies a potential reversal of a downtrend.
Is the W pattern trading a good strategy ?
The W pattern is a well-known technical analysis pattern that some traders use to identify potential trend reversal points. However, like all technical analysis patterns, it is not a guarantee of future price movements and traders should always use additional tools and analysis to make informed trading decisions.
What can happen after a double-bottom pattern?
In an ideal trade scenario, the double-bottom pattern would signal the end of a downtrend, which means the stock price would rise following the breakout from the W shape. But not all W patterns result in breakouts, so traders must use discretion and quick entry/exit techniques.
About Dan Schmidt
Dan Schmidt is a finance writer passionate about helping readers understand how assets and markets work. He has over six years of writing experience, focused on stocks. His work has been published by Vanguard, Capital One, PenFed Credit Union, MarketBeat, and Fora Financial. Dan lives in Bucks County, PA with his wife and enjoys summers at Citizens Bank Park cheering on the Phillies.