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  • Bear market bounces can be powerful, but they're fleeting.
  • Tools can help you identify when odds suggest stocks may find their footing.
  • To spot turning points, focus on many indicators rather than only one of them.
  • Indicators can remain oversold for long periods, making it tough to identify the exact moment of a turn. 
  • Bottom-picking is risky, so consider waiting for easier money-making opportunities.

On Monday, stocks rallied sharply higher after contrarian sentiment signals flashed brightly last week. As of this writing, the S&P 500 is up 5.5% from Friday's low, and many stocks are up double-digit percentages. 

The returns associated with bear market bounces make them worth spotting, but, unfortunately, nobody rings a bell signaling them. So instead, investors must weigh the evidence and act accordingly. The key is knowing what to look for, then building positions early into the turn. 

In "There Are Many Ways to Search for a Market Bottom: Here's What I Look For," Real Money's Bruce Kamich, a technician with over forty years of experience, provides a synopsis of evidence-based ways to identify bottoms. He covers a lot of ground in this piece, so I'm presenting his article in its entirety. 

Kamich writes:

"Not all that many people called for a top in the stock market back in December 2021, but lately, EVERYONE is trying their hand at trying to pick a bottom. No one wants to be late as they fear they will miss the turn, which forces analysts to reach for any glimmer of a potential durable low.

Some market watchers have declared that June was THE Low. Some people are impressed with the price action in late September and think the fourth quarter can bring a recovery on their theory that the Fed will be influenced to pause or reverse direction by falling futures prices for various commodities.

Value-oriented investors have come on CNBC and said they are finding stocks worth investing in with a longer-term horizon.

Jeffrey Gundlach has told viewers that some Treasury bonds are worth buying now. Stanley Druckenmiller stands out as a bear. There's no lack of opinions.

What is a retail investor to do?

The Many Ways to Identify a Market Bottom

Let's take a look at some of the methods that technical analysts and others have used to try to identify a market bottom.

Many people like to use various sentiment measures -- like the number of investment letter writers being bearish or the AAII survey of investment clubs. Some look at the amount of cash held by mutual funds. Some want to see a Lehman event to create a crash and buying opportunity. Think capitulation with blood in the streets ala the Rothschilds. Is our banking system in better shape than it was in 2008? Just asking for a friend.

I know of several analysts who would like to see a hedge fund "implode" or blow up as their buy signal. Should we be on the lookout for Chapter XI filings? Included here in this category would be heavy put buying and a skewed put/call ratio. Recently I heard a comment from one of our neighbors that she was starting to worry that she might outlive her retirement savings -- this is a subtle comment on the state of the stock market. Did anyone worry like that a year ago? Sentiment measures are useful at times but just part of the story.

Many traders look for a sharply rising VIX as another clue to a potential market low. Similar to the VIX spiking, there are many traders waiting for a cluster of 90% downside days to tell us that a low has been reached, with 90% of the total up and down volume being down volume. I have found that 90% down days are useful to identify a trading low but not particularly useful to identify a major bottom.

Math is important to some investors. Some use percentage retracement numbers like 1/3, 1/2, and 2/3 or the previous rally or "fib" numbers and fib retracements. Moving averages and "old school" trend lines are useful at times. Some use P/E numbers that have been seen at historical lows.

Some analysts use time cycles like the 4-4.5 year cycle (sometimes called the Presidential Cycle) to identify key bottoms. I would include seasonal patterns that are easily found in the Stock Trader's Almanac.

I would bet you have seen various analogs in market letters and on financial websites. These would be comparisons to the market moves in 2008, 2000, 1974...whatever past market they think this current market environment might match -- move for move. I have never found this approach to be useful.

One of the simplest tools is a 4% up day. Go long whenever the DJIA goes up 4% in one trading session. This is a pretty dramatic move, and if you go long the market and hold for the next 12 months, the average gain has been around 13% -- not bad for such a simple tool.

The last hour indicator rising in a declining market is a sign that longer-term investors are buying weakness. Stan Weinstein created this tool back in the 1970s, and I have found it useful.

Japanese candlestick reversal patterns like a big hammer or a harami and some others can help.

Today in this current bear market, there are many market observers looking for the Fed to "blink" or even reverse their tightening as their buy signal.

One method I use is watching the number of new 52-week lows as the market declines.

For example, in the past few days:

Sept 22 726 new 52-week lows

Sept 23 1,106 new lows

Sept 26 1.082 new lows

Sept 27 893 new lows

Sept 28 294 new lows

Around October 2008, relatively late in the 2008-09 slide, the number of new lows reached 3,000 plus -- most of the stocks listed on the NYSE.

Each subsequent low in November, December, and March 2009 in the averages had fewer new 52-week lows. The averages are relatively narrow and kept declining, but the number of new lows shrunk, telling us that beneath the surface, there was buying -- otherwise, the new lows would have remained high.

There are lots of ways or clues to aid in identifying a bottom, so why do so many people say you cannot time the markets?

The Bottom Line on Market Bottoms

Greed is found at market tops, and fear and panic at market bottoms. Greed influences people differently and is harder to identify. Fear is easier to recognize, but each bottom is different. Stay tuned.

Keep your seat belt on low and tight. Hopefully, others will panic, and we can keep our cool and our brokerage account intact."

The Smart Play

The takeaway, particularly for investors without decades of experience, is to make decisions based on information, not emotion. Too many investors wipe out because they make seat-of-pants choices during bear markets with dire consequences. Instead, pick the indicators that resonate with your style, then track them to identify extreme readings.

Consider starting with the information Kamich specifically calls helpful, including the 4% up-day indicator, the last hour of trading indicator, Japanese candlestick reversal patterns, like a big hammer, and 52-week lows.

Additionally, consider keeping tabs on indicators I've found helpful during my 25-year career advising professional portfolio managers, including extreme readings on the AAII Sentiment Survey, CBOE put call ratio, the volatility index VIX, and the percentage of stocks trading over 5% above and below the 200-day moving average.

You should also follow in the footsteps of technical guru Helene Meisler, who shares her decades of charting experience on Top Stocks and Real Money. Meisler often highlights breadth data (advancing stocks minus declining stocks) over short, medium, and longer periods to inform turning points. For example, the McClellan Oscillator is a common breadth measure of advancing to declining stocks you can track.

Indicators like these can help you spot bear market lows, but a few words of caution. First, stocks can get more oversold than expected and remain oversold for long periods. For this reason, it's best to tilt slowly when signals are flashing and risk control, such as smaller than normal positions and using stop losses, is critical. 

Also, focus on what multiple indicators tell you rather than putting all your eggs in one basket with one indicator. A single input can easily fail, but odds improve when many indicators say the same thing. Tracking many inputs can provide you with lots of data, but be careful because all that data could cause analysis paralysis.

Another option? Don't worry about picking bottoms at all. If you don't have the time or mindset necessary to track all these data points or exit if you're wrong, leave the bottom-picking business to others. You don't have to nail the low to make a lot of money in the market, and waiting for conviction could improve your win rate by exposing you to fewer false positives. Furthermore, it's easier to sleep at night when you're content making the easy money rather than the hard money associated with trying to pick bottoms.

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