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Market Bottom or Top?

One of the more daunting tasks for any trader or investor is knowing when a stock or a market has bottomed. An equally challenging part of trading or investing is knowing when to sell. After all, the objective of everyone is to buy low and sell high. Buying securities or the market at or near a major bottom can lead to profitable trades, but most importantly, prevent substantial losses.


So how will one know if a stock or a market has reached a bottom?


While there is no way to know when a security/market has reached a bottom, there are technical indications to monitor.

Price and volume analyses can detect an inflection point or a turning point in a downturn. Stocks tend to bottom when there are fewer sellers left to sell. Although this sounds simplistic, if few sellers are let, subtle changes in buyers can push the stock price higher. Price momentum indicators also tend to bottom ahead of a major price bottom. Volume analysis can also determine the sustainability of the rally. The volume will often pick up steadily into a sharp and explosive stock market decline. Big volume spikes at critical market lows can be an excellent sign of selling exhaustion or selling climax.

Many overlooks one of the crucial factors to uncover a stock and market bottom is the study of market sentiments and behavioral finance. A stock and stock market bottom often depends on the perception of the general masses and herd mentality. When everyone is bearish or bullish in a security or the stock market there is a chance that there is an impending bottom or top. An entire group of investors specifically focus on going against the crowd, commonly referred to as contrarian investing. Investing against the grain can be highly profitable but can be equally frustrating. Sentiment indicators such as the AAII survey, Investors Intelligence, VIX, and others are popular contrarian indicators.


Keep in mind successfully calling a stock or market bottom is like putting a puzzle together. The trick to completing a jigsaw puzzle quickly and effectively is to be methodical and disciplined.


First, sort out the pieces into groups consisting of edge pieces, corner pieces, and centerpieces. Second, arrange the corner pieces into a large square to create the foundation. Finally, connect the edge pieces to fill in the corners. Like solving a puzzle, market declines are not always V-type bottoms or visible key reversal bottoms. It is often the process or technical base that substantiates a concrete market low.


The steps to establish a major market bottom or the “process” are infinitely more valuable and far more important than the goal or the result (“the market bottom”).

SPX has suffered one of its worst starts since the pandemic-induced cyclical bear market sell-off two years ago. It has been an auspicious start to the new year after experiencing one of the strongest and most explosive rallies (March 2020-Jan 2022) in recent memories.


Market pundits and talking heads are again trying to predict another market bottom. Everyone wants to know if the worst of the selling is behind us.


The bullish camp believes a market has occurred on 1/24/22 (4,222.62). They based their optimistic views on the following technical developments:


(1) The 1/4/22-1/24/22 SPX correction to 4,222.62 (1/24/22) led to a drop of 596-points or -12.37%, fulling the definition of deep correction (10-20%).


(2) The abrupt Jan 2022 selling led to an explosion in volume during 1/24/22, matching the extreme high-volume readings established during Sept, Nov, Dec 2021 timeframes.


(3) SPX fell to 4,222.62 (1/24/22) in thirteen trading days, coming close to the two prior SPX reaction lows (4,278.94 – 10/4/21) and (4,233.13 – 7/19/21).


(4) The 3-month head and shoulders top breakdown below neckline support at 4,495.12 (1/20/22) suggests -325 points or a downside SPX target at 4,171.5. The intraday low in 1/24/22 at 4,222.62 came within 1.21% of the h/s top breakdown projection.


(5) The nearly 1-month sell-off also came within striking distance (2.24% - 3.5%) of the extension of the 2018 broadening top/megaphone trendline (4,074-4,128).


(6) With nearly 1-week before the end of the month, if SPX closed Jan 2022 above its 10-month ma currently at 4,420.33, this would confirm a successful test of the long-term moving average.


(7) The 1/24/22 low achieved the 50-61.8% retracement from Mar 2021-Feb 2022 rally at 4,141.5-4,271.


(8) Sentiment surveys such as AAII, Investors Intelligence, Wall Street Bull/Bear Sentiment, University of Michigan Consumer Sentiment Index, VIX Index, and others are approaching extreme bearish readings, suggesting a potential bottom.


The bearish camp remains adamant that further selling is likely. They based their pessimistic views on the following technical developments:


(1) SPX has broken the 50-day ma (4,655) and the 200-day ma (4,431.5). The 50-day ma trend has rolled over (trending down). The 200-day ma trend is also flattening. The above warns of an intermediate-term trend reversal.


(2) SPX has broken its 2020/2021 uptrend below 4,695, reversing the uptrend.


(3) A lower-low pattern has developed as SPX has breached its 10/4/21 reaction low (4,278.94) during 1/24/22 (4,222.62).


(4) Although SPX may have achieved its 3-month head and shoulders top breakdown target (4,171.5), a potentially big 7-month head and shoulders top has appeared. The head is 4,818.62 (1/4/22 high), the left shoulder is 4,545.85 (9/2/21 high), the right shoulder is to be determined, and the neckline is 4,223-4,279 (Jul/Oct 2021 lows). Violation of neckline support below 4,223 warns of -596 points or a downside target to 3,627.

(5) The daily chart shows the RSI trading at 25.81, suggesting an oversold condition on a near-term basis. However, the weekly RSI (42.45) and the monthly RSI (61.53) warn of modest overbought conditions, signaling further selling is necessary to alleviate the excesses incurred during the Mar 2020-Jan 2022 rally.

(6) The 38.2% retracement (3,815) from Mar 2020-Jan 2022 is still far from the recent 1/24/22 low, suggesting the risk for another 9.65% decline.


(7) The middle of the 2009 uptrend channel or fair market or equilibrium of SPX is 3,715 or 12.02% away from the 1/24/22 low.


(8) The spread between the 10-month ma (4,420) and the 30-mo ma (3,654) or 766-points remains one of the widest spreads in history. Failure to maintain the 10-month ma warns of the risk of a decline toward the 30-month ma or 13.46% from the 1/24/22 low.


As you can see, the bulls and bears have high convictions in their respective bullish and bearish calls. However, as we have alluded to before, market bottoms ex V-type bottoms are often a process. A capitulation or selling climax bottom typically requires extensive time and considerable efforts to exhaust the sellers.


The market actions over the next few days or weeks are critical. A technical base, if it develops, can convince traders and return, allowing for the next sustainable SPX rally.


At the minimum, SPX must maintain above the 1/24/22 low (4,222.62), preferably with a higher-low pattern. Secondly, SPX needs to surge convincingly above key initial resistance coinciding with the 38.2% retracement (4,431.69) from 1/4/22 to 1/22/22 decline and the prior 1/20/22 neckline breakdown (4,495). A breakout above the previous technical breakdown hints at an SPX recovery toward secondary resistance at 4,520.5-4,531 (50% retracement and 12/20/21 low).


The line in the sand resistance that would convince traders to return would be a strong surge above 4,591-4,655, coinciding with the 61.8% retracement and the 50-day ma. A higher-high pattern above the 1/4/22 all-time high (4,818.62) would convince investors to jump back into the marketplace with high conviction.


Source: Charts courtesy of StockCharts.com

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