After a long and brutal bear market, investors naturally wonder how do I identify a stock market bottom. Many analysts do not believe you can tell when the stock market has bottomed. Yet you still see many predictions that the market has bottomed out. Identifying whether we have reached a bottom in the stock market is important to investors who want to beat the market. It is also important to know whether we have reached a bottom in the stock market, so you can reduce your risk of entering to soon. This article provides two methods that you might find useful to identify a stock market bottom.
Many of you who have been reading these articles will find this method identify a stock market bottom familiar. Using the monthly chart of the S&P 500, we use the 24-month Exponential Moving Average (EMA) and three other indicators to identify the stock market bottom. While this method will not get you into the market at the bottom of the stock market, it will keep you from committing to early during a bear market rally, yet allowing you to enjoy the bulk of the new bull market. Many investors get trapped by entering a bear market to early.
As noted below, the bull market that began in 2003 when the S&P 500 rose through the 24 month EMA, a sign of a new bull market. In addition, when the RSI rises through 50, it is another sign the bull market has found a bottom. When MACD rises through the 9-month moving average, it will be another sign the bear market is over. The Slow Stochastic needs to rise through 20 to give another indication the bear market has bottomed out.
In reviewing the current period of the chart, it will take several months before the monthly S&P 500 approaches the 24-month EMA. The same holds for the RSI, MACD, and Slow Stochastic indicators. This is telling us the stock market has not bottomed yet and the stock market will remain in a bear market for a while longer.
The 150-day Exponential Moving Average (EMA) is useful to help a stock market bottom. When the 150-day EMA transitions from moving down, flattens, and then moves up, it is a sign the stock market has bottomed and a new bull market has begun. The chart below shows the transition from a bear to bull market that took place in late 2002 and early 2003. The 150-day EMA flattened once in November 2002 and then again in January 2003, as the result of bear market rallies. In each case the 150-day EMA only flattened, it did not turn up, meaning the stock market had not yet bottomed.
In April 2003, the 150-day EMA flattened once again and then turned up. This meant the stock market had finally bottomed and a new bull market had begun. In this case, the 150-day EMA signal came two months earlier than the signal given by the monthly view in the chart of the S&P 500 above.
For the most recent bear market, the 150 EMA turned up in early June 2009 identifying the stock market bottom and was now in rally mode. For investors who follow this indicator, they were able to participate in the bulk of the rally of 2009.
By the way, the 150-day Exponential Moving Average also works well for other indexes as well as market sectors.
Calling the bottom of the stock market is a game played by many investors. Investors do not want to be left out, once the bear market is over and the stock market bottom is in place. The problem is the market tends to shake out investors with bear market rallies that hold promise, but then fail. Often these bear market rallies shake out most of the remaining believers in the market. Once the stock market has finally bottomed out, it rallies once again. Only this time it is the start of a new up trend as predicated by the indicators mentioned.
The most successful investors apply discipline when using market indicators to identify the stock market bottom. Be sure you do the same to mark when the market has hit bottom.
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