What is a Market Bottom?
Market bottom, an event that signals termination of a downtrend, or correction. Emerging from a market bottom are the greatest investment opportunities. Limited risk, with mouth watering potential. However, bottom fishing is dangerous. This page lays out how to identify a market bottom through time honored Point & Figure charting, complemented by a handful of simple tools.
Supply and Demand at a Price Base
A market bottom, or a price base with respect to a stock, initially appears as a sideways range on the Point & Figure chart.
During a market bottoming phase, supply (sellers) and demand (buyers) are fairly balanced. Brief surges in supply or demand are common during a bottoming period resulting in their characteristic volatile appearance. Alternating columns of Os and Xs, swinging up and down every few weeks.
A common market bottom trait is failed level breaks. Through the range ceiling or breakdowns through the range floor. Head-fake moves are highly transitory, often news or rumour driven. Plotted above is the market bottom following the NASDAQ's bear market of 2007 through 2009.
The bottoming phase can last anything from weeks to years, it really depends on the chart's time frame, and the climate itself. Eventually, demand exceeds supply, and a juvenile uptrend is born. Trading pulls out of the price bottom, the uptrend evolves, eventually maturing via a price top.
How to identify a Market Bottom using Point & Figure?
In order to answer the question of how to identify a market bottom one needs to begin with the chart action. The price chart is primary, reflecting the emotion of the market, the participants, in its purest form. The Point & Figure chart is a simple, objective, means to achieve visual representation. If you are not familiar with P&F charts, we recommend you follow our free tutorial on how to read them.
Bottoms consist of a floor and ceiling
Support and resistance on a price chart provide the floor and ceiling of a market bottom respectively. Levels stand out with great clarity on a Point & Figure chart - more so than any other technique. Achieved by Point & Figure's ability to eliminate trading noise. Needless to say, at market bottoms there is plenty of noise!
A base is confirmed when trading pulls above the bottom's ceiling and holds, beyond a couple of weeks at least. However, following P&F consultation, with bullish confirmation, consideration of secondary methods is essential.
Bottoms are preceded by tired internals
A market bottom appears following downtrend maturity. A mature downtrend nearly always shows sign of tiredness and technical exhaustion, the secondary evidence.
The Tired Downtrend
A waning downtrend may be sensed through bullish divergences on momentum indicators, such as the 14-day RSI or MACD. Volume indicators such as on-balance-volume may also form bullish divergences. A bullish divergence is where the price, or index, makes a lower low, yet the indicator makes a higher low.
Downside exhaustion is a period in which sellers who are going to throw in the towel, have already done so. Often referred to as capitulation. Exhaustion may see heavy downside volume, awful breadth and heavy bearish sentiment.
Finally, Avoid Bottom Fishing!
Bottom fishing in the stock market denotes an investor buying haphazardly on the way down. A bad investor views every pause in a downtrend as the bottom. However, by following the analytical steps above, an investor should be sufficiently empowered. Thereby, avoiding calamitous bottom fishing. An investor must collate the evidence needed to confirm a market bottom; as opposed to buying on hope. Hope is not an investment strategy!
In order to identify a market bottom, an analyst begins with the Point & Figure chart for the market in question. That is the first port of call. Secondary evidence is next. Sentiment analysis is a priority, followed by internal clues from breadth, volume and momentum indicators.
At 3boXreversaL we have created a proprietary master indicator to assess all the secondary data points. Our ContraGauge provides one value, ranging from 0 to 360 degrees. The ContraGauge may be used alongside the P&F chart only, effectively simplifying the whole market bottom identification process.