Jul 07 2009

How to Tell When the Stock Market is at the Bottom.

When bubbles burst, markets tumble. Sometimes the tumble is long and pervasive. Other times it’s a fast a furious free fall. Whatever form a market crash takes, it will eventually end and the market bottoms.

What follows is a set of common indicators that the market may be at or near a bottom.

Extremely pessimistic market sentiment.

Mega bottoms include everyone of the following, but more standard bottoms can exist with some, but not of these conditions having been met:

Market woes are all over the non-business headlines.
Market woes are always on the cover of the financial papers, you’re looking for the USA today and local/regional news. When you cannot escape the economic gloom, you’ve met this indicator.

The “Investors intelligence survey of money managers” is decidedly bearish.
The “Investors intelligence survey of money managers” is a survey given by Investors Intelligence, and it often acts as a counter-sign. Meaning, when the survey turns bearish, the end may be near. You’re looking for less than 40% bulls. It can usually be found in Thursday papers or at the Market Harmonics web site.

Mutual fund withdrawals increasing.
When investors are steadily withdrawing their money from mutual funds for at least 2 months, then consider this indicator met. You can check out this data at  AMG every Friday.

An increase in the VIX.

The ^VIX (CBOE VOLATILITY  ) is a measure of stress in the financial system. If the VIX is over 40, then panic is present in the investment community and usually accompanies a bottom. The trick is knowing how high it will go. For example, the 2008 crash saw a spike in the VIX of 80 in the fall of 2008, yet the bottom was still months away.

The Meisler Oscillator indicator.

I know, it sounds a lot like the flux capacitor that powered the time machine in Back to the Future, but this indicator is actually a measure of how over-bought or over-sold the market is. When this indicator reaches -5 or lower, more people have sold than are willing to buy and a bottom may be near. This is the only indicator on this list that isn’t free, but you can get some info on it at The Street.com and Investopedia.

Capitulation.

Once investors become pessimistic and see little hope, capitulation follows. This is seen as a crescendo sell off. Psychologically, it’s the final purging of those who are willing to sell and it is required fro stocks to start rising again. It brings out the bears and bottom feeders looking for a bargain. Crescendo sell offs present themselves as an increased ratio of new lows to new highs. You’re looking for something in the ballpark of 500 or 600 new lows and only a handful of new highs.

Catalyst.

Once the pessimism has set in, and the purging has taken place you need a catalyst to start the process again. Without a catalyst, you’d have stagnation at the bottom. It makes sense, right? All the people sick of investing have taken their money off the table, and there’s no reason to get back in.

At this point, you’re looking for what will make the market rise again, and you may not know it until it’s happened. Meaning – don’t try to time the catalyst! Work on recognizing the bottom, and get back in to be ready when the catalyst appears and the market recovers.

During more normal times, the catalyst is often the Federal Reserve cutting rates. But these are not normal times, and who knows what the catalyst will be this time.

Bottoms are a natural part of the stock market, just as are peeks. But if you can learn to recognize each, and use the right techniques and discipline, they can become your best friend.


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