The Bottom of the Bear Market, Spotting Trends, and How You Can Profit from It All

Have we hit market bottom?

I'm going to show you how to do some basic technical analysis using trendlines, and how these lines could indicate that this is the bottom of the current bear market. After I show you my analysis I'm going to tell you what this means for you, and how you can profit from conditions such as these.

The graph below is the 6-month performance of the S&P 500 Index going back to early October, 2007. You may find it helpful to print that out and, using a ruler, draw some of the very basic trendline analysis I'm going to be walking you through. You could just use my own trendlines, but I feel that in the interests of pedagogy drawing your own would be fun and useful.

Basically what we see here is the overall market performance, and beneath that you see a series of bars. These bars indicate the Volume, or number of shares exchanging hands on that particular day of trading. Volume is a key component of technical analysis, so I like to have it at the bottom of all my charts.

Now if we connect the low points on the downslope, the bottoms of what are known as the troughs, then we can get an idea of the basic trend. This bottom line is what's known as a trendline. We can also draw a line on the highs, or the peaks, and that will provide us with a rough guideline as to where the market fluctuations are going to be during this period. We refer to this top line as a resistance level, since the market will often rally up yet be unable to breach this level. Remember those Volume bars? Notice how they increase as the market sells off. I've gone ahead and drawn them for you on the graph below. I know I don't draw absolutely perfect lines, but market analysis is as much of an art as it is a science.

Notice how the S&P cuts above our resistance level in December.  This is called an exhaustion point, the rally has been exhausted and it is not a clear break of our overall trend.
Notice how the S&P cuts above our resistance level in December. This is called an exhaustion point, the rally has been exhausted and it is not a clear break of our overall trend.

We can clearly see two troughs in March that both dip down to to about 1275. You can go ahead and draw a horizontal line on the bottom of those, and since it doesn't follow our trend I generally used dashed lines until I get confirmation of a reversal. This horizontal line in March could be what is known as support, meaning that if the market dips down again in April there is a good chance it can bounce off this line.

There are a couple of things that lend support to the notion that this is possibly the bottom of the bear market, at least for now. First of all you'll notice that there's another exhaustion point towards the end of March. Now I know I said these exhaustion points don't always indicate a break in the trend, but in the overall picture this looks like a good sign. I could also use this peak as well as the peak of the previous exhaustion point in late December to re-draw a new resistance level to my trendline but you'll often find it useful to extend old trendlines and wait for confirmation of the bigger picture.

The trough following the March exhaustion point as we approach April does not break, touch, or even approach our support at 1275. In fact, it doesn't even break 1300. Instead it rallies back up and breaks through our resistance level at about 1330. Now let's go ahead and draw in another dotted resistance level to see where this new trend might take us.

Remember how I said drawing trendlines is an art as well as a science? We could draw all new trendlines for this apparent shift using the new peaks and troughs created in March. This would give us a clear upwards trend, but I generally like to wait for more confirmation first before I go ahead and do that. I can always keep those trendlines in mind, but until then I'm just going to go ahead and draw my new possible support and resistance levels in dotted lines.

The reason that I don't rush to draw new trendlines is that if you look at the overall picture there could be a couple things going on here. This could be temporary sideways momentum, to be followed by another bearish pull to new lows following our original downward trendlines. Or this could be a stabilization, or consolidation, period and the market's going to float on horizontally for a bit, bouncing up and down a little between our dotted lines. Both of these conditions would soon destroy any new upward trendlines we may have drawn.

So where do we go from here?

It's difficult to say where the market will go from here, but from the evidence we can say that this may be a market bottom for now. Markets and stocks tend to test support levels a couple times, three times or more being a very clear indication of a bottom. As you can see our support (bottom dotted line) has been tested twice so far in March. Our resistance (top dotted line) hasn't been tested much, but we'll have to wait for April to show us what's going to happen with that line.

We can look to other indicators. Remember those volume bars? This is where they can come in real handy. From early December through to about the third week of January we can see the volume is really increasing. As the S&P is falling there is a much greater sell-off going on here, hence the volume increase. More people are selling shares in fear of a crash. This sell-off peaks in mid-January with a trough right around the middle of our soon-to-be trading range (between the dotted lines.)

As we go from February to April the volume is pretty much a horizontal line. Since the volume is rather stable going into April it is likely a sign that the market is stabilizing in this new range and will likely bounce up and down for a while before a new up- or downward trend emerges. If we start to see a pick-up in volume in April then something is probably going to change, up or down. My guess is up, and I'll tell you why.

If we use our technical analysis this is a fairly good indication of what we call a reversal. Our downward trend has slowed, stopped, and stabilized. The bottom has been tested twice, and the peaks have broken our resistance twice (first at about 1340, again at around 1330.) But when we combine that with fundamental analysis then we start to see a bigger picture.

Let's talk a little bit about the economy. The Federal Reserve recently cut rates by 0.75%. Rate cuts mean cheaper money for those who want to borrow it - loans to people, businesses, and also to investors who essentially borrow money to buy more shares. In other words a rate cut is often followed by a market rally. While we cannot predict the size of the rally we can often predict that it may happen. The Fed is likely going to slash rates again in mid-April, probably by about 0.50% this time. This could be followed by a market rally.

Another reason: the consumer. There are two key things about us consumers that are very interesting right now. We surprised many analysts last quarter with some better-than-expected retail returns. Analysts have a tendency to low-ball their estimates anyway, but there were some happy surprises. Second thing is tax returns. Despite your political leanings, and we won't get into the budgetary crisis of this move, Bush gave a lot of people in this country a small chunk of change this year. While it isn't much, our country has proven time and time again that we are not savers. Money burns holes in our pockets. If the government gives us even a little we're likely to go out and spend it. If we do, and if we beat analyst estimates for a second quarter, a rally is likely to come.

What this all means is that there are indications of a market bottom. I like to think of market bottoms as bargain bins. Some really excellent companies are having extraordinary clearance sales right now as far as their stock is concerned. A savvy investor accumulates these deals and then rides the upswing. A more conservative investor will wait a little bit to see if this truly is a market bottom and then go back in when all signs point up. Whatever your investment style, don't fret. Recessions have to happen in order for future economic growth to occur. You need the bad days to make the good days good. It's your call as to how you spend the bad days, and being an optimist I like to turn them around... and in market conditions like this that spells P-R-O-F-I-T.

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Comments 6 comments

Ralph Deeds profile image

Ralph Deeds 8 years ago

Try reading Dr. Seuss's "The Sneeches," or this

http://www.nytimes.com/2008/04/06/weekinreview/06c...

Calling market turns is one of the hardest things to do. Moreover you have two opportunities to be wrong--when to get out at the top and when to get back in at the bottom. And in recent years market volatility has increased. So, if you miss the bottom by one day, the market may have gone up 400 or 500 points before you get back in. Ditto for the top.


JarrodHaze profile image

JarrodHaze 8 years ago Author

I appreciate the comment, Ralph, and thanks for the link to the article about herd mentality. I totally agree with what you're saying about spotting market trends, however technical analysis is based on the current psychology of the market so the trendlines I draw above are actually an indication of that herd mentality... and the bigger the volume, the bigger the herd.

Using this analysis it appears as though a stabilization is occuring- whether it be a momentary stall of an even greater downwards trend, a horizontal whipsaw, or a reversal is hard to say. But looking at emerging support and resistance levels as well as some fundamental analysis gives a fairly good indication that a bottom may be emerging.

I didn't explain everything in my analysis in-depth so as to keep it brief enough for the average reader to understand. It is not likely that market technicians or analysts will end up reading this, but I would gladly go into more detail about my position if there is greater desire for me to do so.

Generally I don't use the type of chart I show here, a simple line graph, but prefer to use bar and candelstick charts. Pattern analysis on both of those also points towards an emerging bottom with a potential reversal in place, and resistance levels as shown above.

Here you can see an example of a candlestick chart of the S&P for the exact same time period, confirming my resistance levels yet with a slight downward trend (also note the classic Hammer on March 17th, combined with the belt-hold lines on March 11th and March 18th this only leads one to speculate that a bottom is being forged):

http://paintfantasy.com/images/spx040108.jpg

And here is another example of a candlestick chart from the S&P during the same time period, also confirming my analysis with a more horizontal trend:

http://dormroomdaytrader.wordpress.com/

I hope you take a look at these, and if you want me to go into more detail about the full analysis I would do so in another Hub if there is enough reader interest.


Ralph Deeds profile image

Ralph Deeds 8 years ago

Interesting information. I swore off trying to trade or time the market some time ago. I don't doubt that you and others can do it successfully, but it's not easy. Be sure and let us know the day before the bottom! :-)


Gadzooks profile image

Gadzooks 8 years ago from United Kingdom

Yeah if you can be sure things are at rock bottom and buy back in there is a lot of money to be made... but that is exactly what thousands of people are looking to do, with a lot of money to spend. Timing is everything, and in the present climate, who knows where rock bottom will be!


JarrodHaze profile image

JarrodHaze 8 years ago Author

If one is looking to set up some key positions for a longer-term hold then absolute rock bottom is irrelevant. No market technician could ever predict rock bottom. All we can hope to do is analyze market psychology to find potential reversals.

The conditions of March leading into April show a "classic bottom" pattern. Support and resistance levels at approximately 1275 and 1385 should hold throughout some whipsaw movements before a likely trend reversal with a Fed rate cut and second quarter earnings reporting.

The thousands of people with money to spend are already accumulating some excellent positions. The unfortunate thing is if long-term investors want toride a bit of the next upswing they're going to be significantly left behind when the millions of people with money to spend herd towards bullish news.

Also, if one does not look entirely towards timing the market and actually taking an interest in which sectors are outperforming others then, again, an absolute bottom becomes irrelevant. If one were to buy into the other 8 sectors right now and leave Financials (XLF) out of it, while remaining heavy on materials, discretionary, and energy then one can outperform several bearish market conditions. The market may be down, but by buying at historic lows in an oversold market one can only stand to gain even if it dips further.

I'm currently doing research, pending publication, back testing tens of thousands of historical data points using optimal weighting of these aforementioned 9 sectors. The data span several years and a variety of market conditions to get an idea of a more efficient way to weight one's portfolio rather than buying into "the market" and being at its mercy. You don't need to get this technical to see market-beating returns in your own portfolios, but a sophisticated investor will see a bear market, and especially the potential signs of a reversal, as a positive sign.

Volatility is not to be feared. Were it not for volatility one would never make a buck in the market. The choice is yours as to how one uses an opportunity such as this. My advice would be to put money you can afford to invest into a cheap market. Buy low, sell high?


Cassie 8 years ago

I agree with you. It may not say for sure that this is the absolute bottom of the bear market but the technicals point to a reversal. Also I think there's undue criticism here cuz its not as if you drew your new trendlines upwards. You made a point to draw them horizontally, and that the market will bounce around this range for a while. Interesting about the rate cut. Looking forward to it. If you look at the last couple days it has been bouncing less drastically but all above 1350.

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