Top 5 Signs of a Market Bottom

Top 5 Signs of a Market Bottom - Watching Stocks and the Economy
By Aaron Smith, published Jul 30, 2008

It never fails that when the market is in free fall there are always those who are trying to call the bottom perfectly. Quite frankly, there is no strategist or analyst who has the ability to call the exact bottom. The best guide we have for finding a bottom is looking at how the stock market has acted historically near its lows. By compiling a source of data from other major bear market lows it helps investors find the top things to be looking for when the market may be bottoming out. What are the top five signs that the bottom is near?

Top 5 signs of a market bottom

1. Everyone on Wall Street is extremely negative about stocks and the economy-

This is the most obvious of the five signs, and it is probably the most important. The fact is, the more people get really negative about the prospects for stocks and the economy the higher the chance that the low is very near. One sentiment gets so low it has to swing the other way, and those who are contrarians can do very well in this environment. The best way to gauge negativity is through the Investor's Intelligence Bull/Bear ratio. This ratio has spotted many bottoms as well as tops. Whenever you see a huge departure from the norm in either direction a snapback is likely pretty soon.

2. A spike in the Volatility Index (VIX)

The Volatility Index (VIX) is a measure of the implied volatility of S&P 500 index options. Many call this the fear index since it is typically seen as a great guide for how much fear is in the market. Past market bottoms have often coincided with a major spike in the VIX. This is likely caused by the fact that too many short-term traders are betting against the market and as soon as some buying occurs there is a massive short covering which can be a big wind to the sails of the bulls.

3. Huge volume panic selling

One of the main signs I look for in finding a bottom is the volume of the major indices. It is much healthier to see some very strong volume on big moves to the downside than it is to see light volume downward moves. The big volume panic selling is a great sign that the weak investors are all getting "washed out." Once these panic sellers are washed out the market often recovers.

4. Leadership groups fall

In a bear market the last group to get hit hard is the leadership group. For example, if tech stocks have been the major out performer while the industrial stocks have been plunging, tech stocks will get hit last. When the techs fall, they will likely fall very quickly and hard, but this generally means we are nearing a bottom.

5. Intra day turnarounds on huge volume

Countless time the market has put in a major bottom around noon. The sellers control the morning and there appears to be no buyers whatsoever, then around the middle of the day the sellers appear to slack off and some buying results in a major intra day turnaround. Very often a huge down volume sell off and a huge up volume rebound is a great sign that the bottom could be in the market.

Market bottoms are extremely hard to find so don't try to be a hero and spot the bottom on the nose. Keep an eye on these indicators and buy into the market slowly