This occurs when a price forms two ”bottoms” as shown in the figure below. The pattern is confirmed when on a daily scale we observe that the price managed to break above the highest point in the structure, that is, point A.
This indicates that we may buy the security. Often the price will dip after that, but we stay bullish. We exit the trade in two cases:
(1) the price falls down below the lowest of the bottoms (stop loss); in this case we lose more or less the amount of dollars equal to “a” as seen in the figure above
(2) the prices goes up and we exit the trade as soon as we earn the amount of dollars equal to ”b” (profit)
This indicates that we risk ”a” in order to earn ”b”, so that the profit/loss ratio is a/b.
The results of backtesting are presented here.