Double Bottom? This Powerful, Positive Indicator Could Be Forming

Aug. 19, 2011 2:09 PM ETDIA13 Comments
John Tobey, CFA profile picture
John Tobey, CFA

Sine waves

The formation of a double bottom (a second drop to, but not below, a previous low) is a well-liked, positive indicator. This price support in the face of previous weakness shows that buyers are stepping in and offsetting sellers. This sign, in turn, can produce confidence that the previous decline is ending, thereby bringing sidelined investors back into the market.

Thursday’s sell-off has the look and timing of such a double bottom formation. While the day began with a large drop, it progressed reasonably orderly. More importantly, buyers were willing to participate at prices generally higher than last Monday’s and Wednesday’s low closes. As I previously described about Home Depot (HD), this action implies investors are beginning to rely more on company fundamentals and less on macro-fears. Prices have certainly been taken to levels that are normally viewed as very attractive.

The stock market backdrop

Here is how the S&P 500 Stock Index has performed this month to date. Note the mini-double bottom last week that set the important lows of the recent stock market drop. Now look at Thursday’s decline. The close was 2% above the lows of last week.

[Click all to enlarge]

S&P 500 double dip graph

This table shows how the Dow Jones Industrial Average is similarly positioned, along with the varying levels of the DJIA’s 30 stocks. Note that only three closed below last week’s low closes.

DJIA double dip table

We read that technology stocks are weak, and two of those negative DJIA stocks are tech: Hewlett-Packard (HPQ) and Intel (INTC). They aren’t the only ones, either. Amazon (AMZN) closed 5.8% below last week’s low close, and Google (GOOG) closed 7.5% below. However, Apple (AAPL) closed 3.6% above. Therefore, it could be that we are seeing differentiation at work, not a generalized underperformance. If so, that would be another indicator that investors are focusing more on fundamentals.

The bottom line

Double bottoms are always easily visible in hindsight, but are tricky to spot as they occur. However, they do have some common characteristics, and we are beginning to see some now.

What is the value of acting at the first sign of a double bottom? The move up can be dramatic – and fast. The risk? That selling once again overwhelms buying, driving would-be buyers back to the waiting room once again. However, with valuations being so good, the risk of making a poor long-term investment purchase has been reduced by the stock market’s latest drop.

Disclosure: I am long AAPL, XOM, KO, JPM, MRK, CAT, BA, HD, INTC.

This article was written by

John Tobey, CFA profile picture
I am the founder and editor of Investment Directions. My career has been managing and consulting to multi-billion dollar funds. Using the widely accepted “multi-manager” approach, I have worked with top investment managers throughout the country, gaining a high level of expertise. My career has spanned many market environments, and I have hands-on experience searching out opportunities and avoiding risks in all of them. I now devote my time to Investment Directions, with the goal of helping investors further their understanding and improve their investing skills. I am currently serving on: The AAUW Investment Advisers Committee and The City of Vista Investment Advisory Committee.

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