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How To Find A Stock Market Bottom

|Includes:SPDR S&P 500 Trust ETF (SPY)

The old saying goes "don't try to catch a falling knife." Then how does one know when to jump back into a falling market? I like to use the Relative Strength Index (RSI). You must wait for the RSI to bottom first (it's currently still falling). In a strong sell off the RSI (14) should drop below 30, but you must wait for it to bottom. That is what I call the warning. After the warning, the market should have at least one more drop to levels below the previous drop. If the RSI at that point is higher, it signals a (short term) buy.

Just look at the most recent example, June 1. This was an easy signal to identify and what I would call easy money.

2012 YTDBut you might be asking, what about the market's move right now? It's pretty easy, we are in a warning signal on the RSI right now. You need to wait for it to bottom. Was the bottom yesterday (11/15)? Maybe? We have to wait and see. My gut says no way, 11/15 wasn't the warning bottom for the RSI. See that big red candle pushing this market way below it's 200-day moving average? That's a big problem! A very bearish indicator on the short term. Of course the wild card in this environment is fiscal cliff talks - it could reverse at any moment. But take a look at the last time the S&P (NYSEARCA:SPY) really fell apart at the 200-day moving average.

2011The RSI got even lower and the market had a huge sell off in August 2011. Will this pattern repeat itself on this current drop? Possibly, but the fiscal cliff negotiations would have me worried if I were short.

Regardless, I strongly feel we have yet to bottom, it might bounce from these current levels, but if it does, the market should go even lower; if the RSI is higher at that point and the market is lower, I say that is the bottom and a strong buy indicator.

In summary, remember, wait for the RSI to bottom - which as of yesterday, it may or may not have. Once it has bottomed, wait for another pullback which puts the market at a lower price, but higher RSI then when the RSI had bottomed.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Stocks: SPY