Analysis

Double bottom/top formations have low predictive power in the medium long term

Published 24 March 2017

Double bottom and double top formations in Investtech's medium long term charts have low predictive power. This is shown in a research report from Investtech based on 19 years of data from the Oslo Stock Exchange in Norway.

A double top formation is a top formation which marks the end of a rising period. The formation consists of two tops of approximately the same width and height, see figure 1. The formation of a double top mirrors increasing pessimism among investors and signals the beginning of a falling trend. Double top formations are especially useful in predicting long term market trend reversals, but are also used in the shorter term.

There is an opposite version of this formation; the double bottom formation, see figure 2. This is a bottom formation which marks the end of a falling period. A double bottom formation signals increasing optimism among investors and the start of a rising trend.

Double top formation - sell

Figure 1: Sell signal from double top formation.

Double bottom formation - buy

Figure 2: Buy signal from double bottom formation.

In technical analysis terminology, a break down from a double top formation triggers a sell signal. Similarly a break upwards from a double bottom formation triggers a buy signal.

We have studied the price movements that have followed such buy and sell signals on Norway’s Oslo Stock Exchange in a period of 19 years, from 1996 to 2014.

Investtech’s computers identified 653 buy signals and 744 sell signals in medium long term charts in this period.

Figure 3: Price development after buy and sell signals from double bottom and double top formations on the Oslo Stock Exchange identified by Investtech’s automatic algorithms in medium long term price charts. Click the image for bigger version.

The chart shows average price development 66 days after buy signals from double bottom formations and sell signals from double top formations. The signals are triggered on day 0. Only days when the exchange is open are included, so 66 days equal approximately 3 months. Buy signals are the blue line and the sell signals are the red one. The shaded areas show the standard deviation for these calculations. The black line is the benchmark index.

Figure 3 shows that both buy and sell signals have been followed by price development in line with average benchmark development. There are some differences, but the buy and sell signals differ in the same direction and based on statistical t-values they are not statistically significant. Previous studies indicate that double top and double bottom formations have good predictive power in the longer term. Thus the results indicate that such formations are better suited for long term charts than shorter term ones.

Read the complete research report here for more results and details.

 

Written by

Geir Linløkken
Head of Research and Analysis
at Investtech

"Investtech analyses the psychology of the market and gives concrete trading suggestions every day."

Espen Grønstad
Partner & Senior Advisor - Investtech
 


Investtech guarantees neither the entirety nor accuracy of the analyses. Any consequent exposure related to the advice / signals which emerge in the analyses is completely and entirely at the investors own expense and risk. Investtech is not responsible for any loss, either directly or indirectly, which arises as a result of the use of Investtechs analyses. Details of any arising conflicts of interest will always appear in the investment recommendations. Further information about Investtechs analyses can be found here disclaimer. The content provided by Investtech.com is NOT SEC or FSA regulated and is therefore not intended for US or UK consumers.


Investtech guarantees neither the entirety nor accuracy of the analyses. Any consequent exposure related to the advice / signals which emerge in the analyses is completely and entirely at the investors own expense and risk. Investtech is not responsible for any loss, either directly or indirectly, which arises as a result of the use of Investtechs analyses. Details of any arising conflicts of interest will always appear in the investment recommendations. Further information about Investtechs analyses can be found here disclaimer. The content provided by Investtech.com is NOT SEC or FSA regulated and is therefore not intended for US or UK consumers.

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