Over the weekend I did a piece where I examined past bottoms to see if they shared similar characteristics in an attempt to learn from them and decide when it might make sense to put some money back to work. What I found is nothing new under the sun as many books have been written about capitulation, but here are my discoveries that some of the most recent market meltdowns of my time share:
- Period of high volatility before stocks really fell hard.
- Watershed decline (Cliff).
- Highest volume of entire decline occurring on day of bottom.
- RSI in oversold territory. All of them were at 20 or lower.
At the time I wrote that article, the Dow was at 10325 and appeared to be in the first phase with high volatility. The bailout bill had just been passed that Friday and the market sold off hard on the news.
Looking at the charts over the weekend, I felt like we had significant downside risk as it seemed to be approaching the “cliff” phase where prices just fell hard with everybody rushing to the gates. There is a good article over at Trader’s Narrative about the market being in forced liquidation that I totally agree with.
(click to enlarge)
The Dow closed yesterday at 8579, which is 1746 points lower than my previous analysis and I would say the “Cliff” part of the equation is being formed as we speak. How much lower can we go?
That will be up to how much investors can take dealing with their losses or how long value investors can hold off snapping up some of the deals that are out there right now.
I had picked up some tiny positions in iShares Russell 2000 Index (NYSEARCA:IWM), NASDAQ 100 Trust Shares (QQQQ), and DIAMONDS Trust Series 1 (NYSEARCA:DIA) on Wednesday at the close, and added SPY (NYSEARCA:SPY) in the after hours last night.
Was I surprised to see the big sell-off yesterday? Not really, but to give you an idea of how confident my market timing was when I opened those positions, my total losses for the week are less than 1% of my portfolio, even after two down days of holding those ETF’s.
The reason I decided to enter when I did is because no two bottoms look alike, and the market could have easily rallied instead of conforming to previous bottom patterns. It’s essential to keep your position sizes small until we see some buying pressure come in and stop this bleeding. If I would have had full positions, I never would have been able to withstand today without being forced to sell out and take my losses.
The next phase of this bottoming process will be to watch for the RSI to go under twenty. When this indicator moves below 30 it is considered to be oversold and it just recently moved below that magic number.
It’s not necessary for this relative strength index to go below 20, but it would indicate extreme weakness as all the previous bottoms moved below 20 at one point in the whole process, even if it was only intraday. It currently stands at 23, so it won’t take much movement to push it lower. In fact its own downward momentum should move it a few points if the market opens weak.
Volume is the last piece of the puzzle. I think it’s going to happen one of two ways. One way has today being our first huge down day, maybe 1000+ with volume being magnanimous and closing at the lows. Not the preferred scenario, but it is a possibility.
The other is with the markets selling off hard in the A.M. session with a rebound coming in the afternoon, and volume being the largest since this decline, ushering in the next….wait for it….bear market rally. I don’t feel like a new bull market is just around the corner with all the negatives and question marks about our economy, but I do think a snap back rally is just around the corner.
Disclosure: Small positions in IWM, QQQQ, DIA, SPY