How to Know a Bottom When You Don't See One 33 comments
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At my request, Teresa Lo of InVivoAnalytics prepared the following market commentary for my readers:
In early January, a number of technical analysts thought they had spied a head and shoulders bottom forming on the daily chart of the S&P 500 Index: The consistent ingredients of a bear market that leads to an important bottom are the following:
At the time, I wrote, "I've seen variants of this chart all over," and provided an example of a more textbook formation. As I pondered the reasons why such an unorthodox pattern would come to be interpreted by so many as a head and shoulders bottom, it occurred to me that the art of forecasting also requires the practitioner to be an impartial witness to price action, someone with a solid understanding of market psychology.
In my opinion, the best book ever written on the subject is the one by Justin Mamis. In The Nature of Risk
Points B and D join to form the neckline while Point F is made on the upside breakout. 
This bear market has been tough on everyone; it was even difficult for me to make the call. On February 5, I wrote:
If we look at the descriptions of Point C and Point E, it would seem like we have a pretty close match. And if we draw a line to connect these two points, we would even have a triangle. Right now, it sure feels like Point E, the "give-up phase during which the pain increases because the 'known' reasons seem to be getting worse and worse, and feel as if they will be even worse tomorrow."
But at the same time, there is a good possibility that we are only at Point B (and the Discouragement phase is still ahead of us) because just look at the news flow and how the market reacts -- the good bank/bad bank last week, the "relax mark-to-market" thing today, the stimulus bill tomorrow -- everyone is still holding onto hope. . . . Let's put it this way: They feel like it's Point E, but I am not so sure; it might be closer to Point B. We need to see some decisive price action to the upside. Big time.
The Nature of Risk contains a schematic diagram labeled with two Points B, and it is precisely by joining these that other analysts made the call for an unorthodox head and shoulders bottom. Listening to the market might have made it easier to correctly identify Point A as the so-called Art Hogan bottom. My impression was that market participants were still hopeful when the lower low formed in November 2008 and when it was taken out followed by the big panic gap down on March 2, 2009, the stage was set for surrender. Last week's price action was replete with stories filled with the fear that no bottom could be found above zero:
- March 2: AIG rescued again as top economies shrink - The latest revision of the AIG bailout includes a $30 billion equity commitment from the U.S. government that AIG can draw on as needed. Investors feared the U.S. government would have to stand by AIG no matter how much it bleeds because its collapse would ripple across borders. AIG guarantees about $300 billion of asset-backed securities and U.S. and European banks are counterparties on many of AIG's outstanding derivative contracts.
- March 5: Slump Humbling Blue-Chip Stocks - The banking giant Citigroup commanded a stock price of $55 just two years ago. But at one point Thursday, as markets hurtled to their lowest close in 12 years, the shares were worth less than an item at the Dollar Store.
- March 6: See What People Are Saying About The Elusive Market Bottom
- March 6: Picking a Market Bottom: Why the Pros Are All Wrong - Some of the smartest minds on both Wall Street and Washington have tried numerous times to identify an ultimate low for stocks and have failed -- in some cases miserably. The bookend collapses of both Bear Stearns and Lehman Brothers served in the minds of some as critical points of capitulation. For others, the "bottom" was election-related. Still others tied their bottom calls to various legislative developments. So far such pronouncements have had one thing in common: They have all been wrong.
When the penultimate sentiment indicator kicked in on March 6 -- big downward projections -- I wrote:
One of the kisses of death on the upside are analysts projecting ever higher highs after a huge move up. Remember $250 QCOM? $250 oil? The same thing happens near significant, tradeable bottoms and what did we see today? Big percentage downward projections. Louise Yamada was on Bloomberg, CNBC, New York Times, Barron's, Forbes, MSN Money, etc. She was everywhere. The skinny lady belting out downside targets has to be a big sign.
At this juncture, all eyes will be on the major stock indexes to see if price can continue upward. If they can trade trade back into the November 2008 low, pay close attention to commentators and analysts featured on CNBC. We'll know Point D has been reached if the bounce "is dismissed as 'merely technical,' and thus is deceptive enough to keep the crowd too fearful to believe."
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This article has 33 comments:
Historical means and mediums are about as accurate/helpful as the FEDury's ability to report initial GDP and unemployment numbers.
And ... with saw in hand ... technical analysis presumes stable linkages between variables. In today's chaotic environment, spurious conclusions litter the floor.
madoffwatch.org/?p=424
Several comments. First: the chart should be logarithmic given the massive % changes we are looking at. Second, in that case if ya draw an upper trendline thru B and B in your diagram and then draw a PARALLEL line from the late november bottom (not labeled in your graph) you get yesterdays rally right off that line. So this rally may just be another rally in your bear market, off lower support.
Time will tell. Till then, learn your ABC's and keep those good articles coming.
cyclingscholar
Attempting to pick an exact 'bottom' is about the most dangerous pastime a trader can engage in! Market bottoms are NOT a singular event! Market bottoming is a process whereby deeply wounded markets are healed through price and time!
Thus we see again and again and again those 'double-bottoms' and 'triple-bottoms' over and over and over again; each false alarm bringing with it the specter of greater and greater 'whipsaw degradation' of portfolios as short-term profits are taken and trailing-stops are filled.
Forget about calling bottoms! Look for those higher highs and higher lows on increasing volume and improved fundamentals and we'll all do just fine!
I don't care where the market will be tomorrow or next week, as long as I have a good sense of where it'll be 10 years from now.
On Mar 11 01:20 PM ArkansasAngie wrote:
> I'm not sure as an investor that I need to know when the market bottoms.
>
>
> Historical means and mediums are about as accurate/helpful as the
> FEDury's ability to report initial GDP and unemployment numbers.
>
>
> And ... with saw in hand ... technical analysis presumes stable linkages
> between variables. In today's chaotic environment, spurious conclusions
> litter the floor.
The "bottom" will firm-up and hold after the Uptick rule in in place, next month. Until then the shorters will rule.
question, WHy and for whom was that taken out in 07 almost at the top of the bubble--someone knew and they made a lot of money.
I can guarnatee you one thing. When the market reaches the true bottom, most people will miss it. Most people will be taken by surprise, including me.
I am not ready to take the plung yet however, even though I have been out of the market since november of 2007. I keep my eyes on the macro economic picture. For now, the fact that we still have a lot of uncertainties, make it very risky to invest. We still do not know what the banks are hiding. We also know that the foreclosure crisis is growing. So for now I have decided to continue to stay on the side line, but ready to enter with maybe 10% of cash. I will keep you posted :)
Please, unless your a day trader, are clairvoyant with special ESP powers, and have the white house and treasury department phones tappes - get your money out and retirement 401k into stable value funds ASAP. You might miss the 20% upside after the 50% downside but at least you missed the 50% DOWNSIDE...
One must always have a clear and fact-based awareness of the macro economy and where it is headed. This awareness should include as much historical analysis and data as possible so that the current data may be put into perspective.
You mention that you have seen 20 years of markets and that is a big clue for me; you need to put our current situation into its proper place and that is right alongside the big, generational readjustments that only happen once every 70-80 years and was last seen in the 1930's.
Applying points to charts is very dangerous in times like these. I rely on the best at such things and that means I am listening to Louise Yamada. Even Carter Worth and other top-rated technical analysts have lost their luster as they have failed to take a wide enough perspective on the market we have in front of us.
> This guy has got it right... maybe I have the new blue print for
> being a SA contributor... if one keeps calling bottoms everytime
> the possibility of one comes up eventually said commenter will be
> right!
>
> Please, unless your a day trader, are clairvoyant with special ESP
> powers, and have the white house and treasury department phones tappes
> - get your money out and retirement 401k into stable value funds
> ASAP. You might miss the 20% upside after the 50% downside but at
> least you missed the 50% DOWNSIDE...
So true.
I had my first article posted yesterday by providing real data from Standard & Poor's and made the point that the real P/E is currently at about 40 - seekingalpha.com/artic...
...and rising fast; you would have thought I said the world is going to end tomorrow the way people reacted. The only DATA I got back to show I was wrong is that the SDS, an ETF I have a position in, was down for the day...a single day. None of them of course noticed that it is up for the month, year and for the past year-and-a-half.
D E F L A T I O N.... Happening NOW and for the next 1 to 2 years. Quit making stupid predictions. Instead do something worthwhile and read what Dr. Robert Shiller wrote about where the bottom will take place. The S&P bottoms at 460-300 or we will have a flat market at some level that is higher than 460 until corporate earnings grow considerably. I think I will listen to the man who with absolute accuracy predicted the tech and real estate bubbles before they burst over you and your stupid chart.
> Why don't we just admit that we don't know.. no one has a crystal
> ball. Only God Knows what the future holds..
And we were given brains and are meant to use them.
Taking such an approach is foolish with investing. The thing that cost most people to lose money is not that they can't figure out where the market is headed it is that they won't. They won't accept facts and data that tell them that things are changing.
I knew, and many other people knew, in 2007 that things were getting bad and that all the leverage from past decades was about to unwind. It was no secret and there was plenty of evidence.
Bury your head in the sand if you wish but don't then insist that the rest of us can't see, we can, we see clearly and and if I see this economy shows signs of life I will become a bull again faster than you can say, "sell my SDS".
Expecting some "technical analyst" to post something on the internet announcing the bottom for you is not a realistic plan.
"The secret to your financial success is inside yourself. If you become a critical thinker who takes no Wall Street "fact" on faith, and you invest with patient confidence, you can take steady advantage of even the worst bear markets. By developing your discipline and courage, you can refuse to let other people's mood swings govern your financial destiny. In the end, how your investments behave is much less important than how you behave."
ill leave you with some Benjamin Graham---->
"The secret to your financial success is inside yourself. If you become a critical thinker who takes no Wall Street "fact" on faith, and you invest with patient confidence, you can take steady advantage of even the worst bear markets. By developing your discipline and courage, you can refuse to let other people's mood swings govern your financial destiny. In the end, how your investments behave is much less important than how you behave."
Some investors are content with looking smart over several years.
Others are more interested in getting instant validation from internet chat boards from people who spell "your" as "ur" and call others losers.
On Mar 11 03:22 PM Elk Tart wrote:
> You've gotta be kidding. I thought it was generally accepted that
> past chart movements cannot predict the future. This is way too much
> superstition for me. Good luck with the hocus pocus. I'll stick with
> valuation theory and modern portfolio analysis, though who knows
> how many years it may be until that looks smart again?
People have been saying "is this the bottom" for months now.
I have no idea whether Jason is right or wrong, but at least he put his name to his thoughts and put them out there for us to discuss. The opposing views are often as useful as the original article.
As some have noted, Jason may have missed or overlooked some important data. I don't think the vitriol sheds any light, though.
I like to think of myself as investing for long-term results based on fundamentals, but I have to admit I'm fascinated with technical analysis. So I'll keep reading the bottom calls and taking the predictions with a grain of salt.
On Mar 11 01:53 PM xomalley wrote:
>
> The "bottom" will firm-up and hold after the Uptick rule in in place,
> next month. Until then the shorters will rule.
> question, WHy and for whom was that taken out in 07 almost at the
> top of the bubble--someone knew and they made a lot of money.
My real point is that there are so many imbalances in the system today that we can't really rely on historical relationships.
And ... as an investor and NOT a speculator, I'm not going to try and hit the bottom. I'm going to bet MY money when I believe that companies are going to make me money.
Disclosure -- IMO: Shorting and currencies and commodities 10 year notes and... and ...and ... are certainly as entertaining as Vegas
I don't care if this is the bottom. I care that the stocks I buy will show me good returns several years down the road. If they don't, either I've chosen badly or we'll all have bigger things to worry about.
www.videojug.com/artic...
There are many patterns bottoms are usually formed the most popular of which is the inverted Head and Shoulders pattern used by common pattern analysis traders, it has a 65% probability rate which is considered high.
For pure technical play, using Elliott Waves analysis proves much more accurate in finding the other different types of bottoms such as counting the last 5 sub-waves of 5th wave of the last decline and comparing it with the 1st wave at the top for fibonacci price projection relationship. Not a perfect way since sometimes the 5th wave do extend and over-extends in other times, but the majority of bottoms do not extend nor over-extend . This is usually called capitulation sell-off by less technically oriented analysts or the divergence buy signal by most momentum indicator traders. This type of pattern usually morphs into an inverted Head and Shoulders patterns that non-EW analysts can recognize. This is the most common bottom because it allows a lot of traders and investors to enter closer to the bottom when the inverted HnS started to form. They know this pattern very well and they tend to trade or invest in it with higher confidence when they finally see it. EW analysts can pinpoint the exact bottom when it finally happens, while divergence traders will suffer several small losses before they succeed.
Another pattern is the termination triangle which is devilishly hard to analyze until it has completed. It is much less common than the capitulation type of bottom. Some analysts call this the L shape bottom since the bottom takes an in-ordinate amount of type before the initial rally starts which is usually spectacular in nature and scope. The rally usually leaves a lot of traders and investors far behind before they can re-act. Some other analysts call this the triple divergence bottom, they are the ones with much better chance of entering at or near the exact bottom but it will cause a lot of failed trades with small losses before the triangle finally completes. This type of bottom forms when confusion is the general norm. Nobody really knows what was happening and conflicting data will be presented in successive waves before "somebody" finally decides to bet the farm.
Some analysts are calling for W bottoms or double bottoms. Technically speaking, it is a truncated 5th wave in most cases. This happens when the 3rd wave over-extends and the 4th wave pullback becomes so great due to the reflex reaction to the extremely oversold condition of the 3rd wave so that the 5th wave cannot break thru the bottom of the 3rd wave even if the 5th wave was able to achieve it's normal run rate. W pattern happens after an extreme panic grips the market and participants started throwing everything they can at any cost.
Some are calling for U bottoms. Unfortunately for them, U bottoms are extremely rare and is not worth anticipating for until we finally see it.
A rule of thumb in analysing the probability of a final bottom is to measure the supposedly "bear rally". This applies only to those capitulation sell-off that do no morph to an inverted Head and Shoulders. After several bear rallies; most traders and investors start assuming every next rally is going to be a bear rally. So a better way to get ahead of the crowd when not using Elliott Waves analysis is to measure the extent of the last rally. If the last rally retraces more than 61.8% of the last capitulation sell-off, then probability goes high a bottom has already been set and a shallow pullback is the next entry opportunity that usually retraces 32.8% to 50% of the last rally. Inverted HnS usually retraces 61.8% to 79% of the last supposedly bear rally.
For our current situation. The Dow Jones, SnP500 and Nasdaq are going thru the usual 4th wave pattern. Unfortunately, 4th waves are the most consufing part of the patten even most EW analysts can only hopefully try to understand as it progresses thru its usual slow pace. In our case, we look at the pace as alarmingly fast since we have never experience this type of magnitude of sell-off nor this type of market volatility on the daily basis. But in EW macro analysis, the 4th wave is extremely slow and boring at best with lots of confusing bear rallies, minor consolidations and inevitable short lived sell-offs.
Dow Jones is defining an expanding flat on the yearly and quarterly charts - this is the jungle so to speak. The trees can be seen on the monthly and weekly charts while the daily chart can only confuse those non-EW traders and will see worms and centipedes and other nasties all the time - so to speak.
Welcome to the 4th wave. Good luck if we can see the final bottom within the next 6 six months. High probability based on rough time analysis is that the final bottom will be closer to the end of the year or early next year under normal C wave conditions of an A-B-C pattern or the expanding flat pattern.
The 4th wave consolidation has a job to do, which is basically to determine how bad or how serious the effects of the massive sell-off of the 3rd wave (which was the Oct, Nov, Dec 2008 sell-off) have impacted our economy. It cannot and should not be rushed.
I am more interest in direction than bottom, trying to time bottoms and tops is beyond me.
I believe the S&P is going to go below 700. When I see signs that earnings will turn around. I will go long.
2. Bottoms: Bottom will only come when you stop looking for them – complete apathy and resignation. Nobody rings a bell at the bottom, right now too many people are ringing the gong everyday for weeks (and months). Most money recently has been lost by bottom pickers (including Buffet).
3. Fundamentals: S&P earnings forecasts for ’09 range from $35 - $65. I personally predict $40, however taking the average of $50, and taking a multiple of 10 – we get S&P at 500. I know some of you would argue for a higher multiple (some perhaps for lower), bear market trough multiples have ranged from 6 – 12; 10 is a pretty high multiple in today’s environment.
I am not touching the index before it hits 500. With play (risk) money I do trade every once in a while. Will sell the next rally if it happens.
However, fundamental analysis has a very wide range of probabilities and is not acceptable to many big investors such as institutional investors specially investment banks who trade on leveraged capital. That is why they hire technical analysts. For individual traders or investors who use leverage with no technical analysis skills, they get killed most of the time.
Technical analysis narrows that wide gap that fundamental analysis cannot solve. It provides the means to minimize the potential loses when trying to find a bottom.
However, nothing is still perfect. Only those who dream of a Holy Grail kept on getting hammered and will finally go thru the usual stages of hope, despair, disdain, then finally understanding if they pursue or are able to survive the initial stages in this type of vocation.
This article was improperly edited when taken from my site. It was NOT written by me, it was written by Teresa Lo of InVivoAnalytics for my site. See the original at tinyurl.com/c47w2p.
The reason Teresa's chart does not contain all of Mamis's marked points on a bottom pattern is that we haven't traced far enough along yet. The purpose of Teresa's article is to show in real time that a potential bottom formation is taking shape. We are up to point C, now we have to see if the other points of the classic Mamis bottom fall into place.
Finally, don't fall for the low-hanging fruit of criticizing any search for a bottom as a search for THE bottom. First of all, we've done quite well finding trading bottoms and trading tops along the way. Second, spending time formulating an idea for what THE bottom will like in this bear market is time well spent, because it will probably be the lowest stock market of our lifetimes.
Focus on that concept. This current bear market will probably end with the cheapest stock valuations you'll ever see. If you're not preparing for that in some way, you're not an investor.
But that said, there are three quite fundamental things that still preclude a recovery:
1. Obviously failed businesses are being kept alive,
2. The true extent of valueless debt in other busineses is being hidden, and
3. Both businesses and individuals are still deleveraging.
Namely, the economy is not competitive and it is not being forced or even allowed to become competitive and it contains all sorts of potential suprises (probably more negative ones than positive ones or businesses would be strutting their stuff for all to see) and that old driver of the economy called debt (credit if one wants to put a positive spin on it) has become anathema to any entity except government, as government is the only entity on earth willing to knowingly invest in mal-investment providing it puts a smile on people's dials for a while.
Putting money into stocks just now is called being hopeful for the long term future. And to me, even that is highly questionable given the huge looming problems re unfunded pension liabilities, health care and large numbers of upcoming retirees who will be drawing down on their stock investments rather than putting more money into them.
And psychologically, stock market investors have not walked away saying I'll never invest again ... They are calling the bottom again and again and again - Encouraged by government at every possible turn. To me that is a very bad sign - We are still at a point where hope triumphs over loathing.
Maybe those who are hopeful will be correct. But if so, the bear that bites in 2014 will make this cute little cub's nip look like something out of a fairy tale romance story.
Commonsense says the economy can't withstand the sort of progressive degradation we've seen for the last 15 years. Governments need to change something very fundamental - Not keep trying to force feed us more of the same.
"picking bottoms will get you smelly fingers."
"yeah, I'm only good at picking bottoms and tops on a sunny day in South Beach."
"The give-up phase during which the pain increases because the "known" reasons seem to be getting worse and worse, and feel as if they will be even worse tomorrow. (Point C)"