Fly Fishing the Stock Market: How to Search for, Catch, and Net the Market's Best Trades

THE DECEPTIONS OF V-BOTTOMS

A V-bottom is a reversal pattern that forms a deep cavity where prices sell off on heavy volume, then reach a point at which they abruptly reverse and surge upward in a rally that is symmetrical with the preceding decline. The result is a V-shaped bottom (Figure 6.2).

FIGURE 6.2 The V-bottom.

$DXY, weekly, 20- and 50-day EMAs, Impulse system, MACD (12, 26, 9). The technical features of a V-bottom:   • Prices rise to a high, confirmed by an extreme peak of MACD lines (area A).   • Following a retreat to value, prices rise to a higher high (area B) and trace a bearish MACD divergence (A–B).   • A severe sell-off ensues, dropping prices sharply below value and moving MACD lines deeply below their zero line. At point C, they cross over and turn up, confirming a V-bottom.   • The resulting rally carries prices toward their previous peak and the MACD lines high above their zero line (area D).

Inexperienced traders often jump into stocks that have traced a reversal from a sharp sell-off. The thing to keep in mind is that V-bottoms are frequently retested. They almost always evolve into double bottoms with a bullish divergence before the trend reliably changes. The pros accept this fact; the amateurs ignore it at their own expense. Typically, the pros do not cover their short positions on a dead-cat bounce. Imagine buying near top B—just before prices turn ...