Spotting Bear Market Bottoms

A Stock Market or Bear Market Bottom marks the end of a bear market - or even an entire bear market rally - or just a light short-term market downturn and the beginning of an upturn.

A bottom may occur because of presence of a cycle, the end of a recession or because of overselling in reaction to a development in the markets.

It is easy to spot a bear market bottom after an upturn and price rally is well underway. However, it can be hard to predict a bottom when a market is still in the decline. At some point, an attempt by investors to break the downward cycle will be made. These attempts more often than not end in failure because the resulting upturn is sometimes a false upturn - also known as a Bull Trap -, after which the decline resumes.

I always like saying that "One Swallow Doesn't Make A Spring! So just because a market rallies higher for a day or two, doesn't mean that it's the end of the economic low or whatever may have caused the bear market or downturn. In every market you will have days of opposite direction, meaning that in a bear market there will be days where prices go up again before the downturn continues just like you will have days where prices go down in a bull market before resuming its upturn.

The challenge is to see if we can not be fooled by the false turns. When one of these possible turns continues, it is evidenced by follow through which describes the continuation of prices in the new direction. This is why you cannot say that a market turn has taken place after just a few days of rally (in the case of a Bear Market turning into a Bull Market).

There are many ways that one can spot a bear market bottom. Here's a simple technical analysis method I like using. It works to 80% of all times.

1. The process begins when there is a market close above the previous days close. The lowest point in trading of the first rally day is used to establish a support line.
2. If trading on any of the next four to six days falls below the intraday low of the first rally day, the market turn identification has ended. We now wait for a new beginning rally day.
3. The second, third and fourth days now must each stay above the support line established on the first rally day, throughout their respective trading days.
4. The change from a down trend to an up trend is confirmed when the prices of the fourth day close above that of the third day, with an increase of volume as compared to the third day, and the close achieves a 1% or more increase in the total index being studied. This confirmation day may occur on the fourth through seventh day.

Lets review:

1. Look for an up day when the existing trend has been down.
2. The lowest point in intraday trading of the first rally day becomes the support line that you will use throughout the process.
3. The next two days of trading must both stay above the support line of the first day.
4. Confirmation of the market bottom is established when:
   • The price close on the fourth day is above the price close of the third day.
   • Volume on the fourth day surpasses the volume of the third day.
   • The increase in price on the fourth day represents 1% or more of the index being studied.

This day of 1% market increase on higher volume is termed the "follow through" day. Follow through can occur on the fourth through seventh days. After the seventh day the signal is much weaker.

Yours in Successful Trading

Ricky Schmidt