V bottoms take two forms: the more classic or true V, and the extended V. In the former formation, three essential components must be present:
- Prices must be in a downtrend and a futures contract is more apt to be in a free fall, or near vertical decline.
- A pivot point is reached which will mark the extreme low price level. While this will most commonly be a single trading session wherein the selling pressure reaches a climax, it may in fact be composed of a few days of activity at or near the low price. Trading volume should be high.
- The third condition requires the most judgment. It is the sudden emergence of an uptrend. One may not be certain that a new trend is underway until the price advance has progressed too far to be of further significant value.
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An aid in recognizing this uptrend at an early stage is to compare the slope of prices during the decline to the slope of prices after the pivot. If the angle of advance is approximately equal to the angle of decline, the pattern is more likely to be valid. Volume during the initial price rise typically tends to show a gradual increase.
Extended V bottom
The extended V bottom displays the same three components as the true V bottom, plus an important fourth component which makes it easier to identify: a downward sloping, or horizontal, price platform that develops after the V-turn. When prices exceed the upper boundary of the platform’s trading range, the formation is considered completed and prices advance. Heavy volume on this upside breakout confirms the validity of the formation.
Market psychology
The action of the market participants is easy to predict. Since the market is likely to be in a steep decline prior to the V-turn, we find the shorts are making money and the longs are being wiped out.
When the turn comes, the psychology of the market instantly turns 180°. At the bottom, the shorts are reaping profits and the longs are being battered. Suddenly, without any hesitation, a dramatic shift in psychology drives the shorts to cover (buy back) their positions. They find they have plenty of company, as potential new longs also want in.
When the pattern occurs in the absence of any news or explanation, it could initially be less dynamic, but the motivation to preserve profits quickly takes hold. Without news to explain the sudden turn, shorts may at first misjudge the turn as being merely a “dead cat bounce.” With profits on the books, they are going to wait and see what happens — a big mistake! The market is propelled higher by aggressive new longs and suddenly the race is on, with shorts trying to make the best of a rapidly deteriorating position.
Canola prices have rallied $63 per tonne since the extended V bottom formation confirmed a major bottom nine weeks ago. There is an old adage, “the trend is your friend,” and the trend is up. The longs are in no hurry to get out, as they sit back and let their profits ride.
The shorts, on the other hand, are losing more money with each passing week that prices grind higher. Their only recourse is to buy back their losing positions. This get-me-out buying (short covering), combined with existing longs adding to their profitable positions, and other potential longs looking to get in on the act, supports the rally. The next objective on the accompanying weekly nearby chart is a 38.2 per cent fibonacci retracement to $506.50. Support is the January high at $448.70.
