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How to Spot a stock market bottom.

Posted on | December 17, 2008 |

A market bottom is a long lasting, pervasive bottom that affects multiple sectors and stocks. These kinds of bottoms usually follow bubble bursts. Notable recent market bottoms include the ‘87 market crash, ‘90 Iraq war bottom, the 2000 dot-com bubble burst bottom, and the 2008 mortgage meltdown/credit crisis bottom. Note that the bottoms associated with the market crash may not have occurred in the same year as the crash. Case in point: the 2000 dot-com bubble bottom actually hit in 2002-2003.

Indicators of a market bottom:

1. Market sentiment.

If every one of the following conditions is met, it’s likely near a bottom:

  • The economic pain makes the cover page of the NYT or USA Today. Ignore the business and financial news sections as they pay too much attention. You know sentiment is low when it’s in your face on the cover page.
  • “Investors intelligence survey of money managers“. This survey is given by Investors Intelligence. It’s a counter-sign. When this poll is bearish, it may be a bottom. < 40% bulls is good. It can be found in the Investor’s Business Daily and every Thursday in papers, or you can get it at Market Harmonics here.
  • Increased Mutual fund withdrawals. A steady increase of withdrawals from mutual funds for at least 2 months. This data is available on Fridays from AMG, in papers on Saturday or Monday.
  • The VIX is up. The ^VIX (volatility index) is a measure of stress in system. If the VIX is over 40, panic is present and usually accompanies a bottom.
  • -5 or lower on meisler oscillator indicator. This oscillator indicator is a measure of the relative over-bought or over-sold value of the market. When this indicator reaches -5 or lower, there has been a disproportionate amount of selling and this usually accompanies a market bottom. Unfortunately, this data is a paid service, but you can get more info about it and other oscillators at The Street and Investopedia.

2. Capitulation.

Market capitulation occurs with a crescendo sell off. The crescendo sell off is the final purging of the markets before stocks can begin rising again. Long time investors who had been holding out for a rebound finally throw in the towel and get out. Crescendo sell offs appear as an increased ratio of new lows to new highs. A good example would be 400-700 new lows, with only a handful of new highs.

3. Catalyst.

What will make the market go up? In 1991 and 2003 it was war with Iraq. Many times it is a rate cut by the Federal reserve. It’s often impossible to know what the catalyst will be, but once it happens it often seems like the only thing that could have happened and stocks take off. The trick is to be prepared, systematically invest in the market when all indications are that it is at or very near a bottom. Then whenever the catalyst appears, you will be ready to reap the rewards.

Market bottoms are an essential part of the stock market roller coaster. Many investors fear them and panic when they see their stocks plummet in value. The prudent investor uses Stops Loss orders to limit the carnage, and buys again at the bottom. It is the essence of buy low, sell high. Of course, the practice is much harder than the theory, but I think you will agree that having the theory and creating a plan to work from it is better than no plan at all.

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Comments

4 Responses to “How to Spot a stock market bottom.”

  1. Jim Cramer's Tips for Detecting Individual Stock Bottoms | Simple Debt-Free Finance
    January 20th, 2009 @ 10:01 am

    [...] a companion to How to Spot a Stock Market Bottom. That article is about the stock market as a whole, whereas this is about individual stocks. It [...]

  2. Jim Cramer's Tips for Detecting Sector Rotation Stock Bottoms | Simple Debt-Free Finance
    January 22nd, 2009 @ 12:18 pm

    [...] covered Cramer’s tips for detecting individual stock bottoms and overall stock market mega-bottoms, but there’s one last type of stock market  bottom: the Sector Rotation [...]

  3. Travis
    May 16th, 2009 @ 2:36 am

    Have you heard of William J Oneil’s method?

  4. Joe
    May 19th, 2009 @ 4:26 pm

    @Travis,

    No I haven’t. I will have to delve into that… thanks for the tip!

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