How to Spot a Stock Market Bottom

Knowing When the Bear Goes into Hibernation...

Calling a stock market bottom is tough, to say the least.

However, the method I'm about to share with you can increase your chances of spotting a market bottom early enough to cash in on the first big moves.

A stock market bottom will always signify the end of a Bear Market. A Bear Market is a condition where stock market prices have been falling over an extended period of time.

The start of a Bear Market is generally defined as a major stock market index, or indices, dropping in price by 20% or more over at least a 2-month period of time.

The length and severity of Bear Markets vary, but one thing is for certain, people's investment accounts drop in value substantially.

No one likes losing money, so overall Bear Markets are not welcomed with open arms. As an options trader you will make a lot of money during a bear market.

There is however, a small group of sophisticated investors that rejoice during Bear Markets because they realize that everything is on sale.

They also realize that fortunes are either lost or made during Bear Markets and they plan on being on the gain side of the equation.

I plan on teaching you to be that kind of investor. So while everyone is losing money and cashing out their investment accounts, you'll know when it's time to go discount shopping.

Spotting a Stock Market Bottom

Most investors listen to the news to find out when we're at the end of a Bear Market and have reached a stock market bottom.

The sad part is that the news is a lagging indicator as to the true condition of the stock market.

Here is the truth. News channels always reveal things substantially after the fact and by the time they share the news with you, you've missed out on all the big moves.

No one truly knows when a Bear Market will end. If anyone says they do, run the other way.

• So how do you know when the stock market has bottomed out and is moving on to higher territory?
• How do you know when it's safe to start investing in an index fund?
• How do you know when your account, which has been bleeding money, will finally start gaining ground again?

It's a technique called The Counting Method. It was taught to me by my trading mentor. I wish I could claim ownership of it, but it's been around for ages.

The author, William J. O'neil (the founder of Investors Business Daily), outlines the method in his book, 24 Essential Lessons for Investment Success.

I don't believe that Mr. O'Neil gave it a name, but my mentor called it The Counting Method. This method is only applied to Indices (Dow, NASDAQ, S&P, etc.) and cannot be accurately applied to individual stocks.

The Counting Method

This will be a general overview. It's listed in greater detail in Mr. O'neil's book, and goes over examples from previous Bear Markets. The picture is of the Dow Jones Industrial Average in 2003, at the end of a Bear Market.

1. In a confirmed Bear Market, look for a day when the index closes higher, but the previous day closed down. Again, if you have an up day and the previous day was down this is Day 1.
2. The lowest point of Day 1(intraday low) will be your support line.
3. Continue counting. Days 2 and 3 must stay above the support line of Day 1. It doesn't matter if days 2 or 3 close up or down. As long as they stay above the support line of Day 1, the method is still valid.
4. On the 4^th, 5^th, 6^th, or 7^th day you look for a follow through day. A follow through day is defined as a day when prices close higher than the previous day by 1% or more and volume has to be higher than the day before.

The follow through day usually occurs in between the 4^th and 7^th day, but isn't necessary. A follow through day can be on the 10^th day, but is a weaker confirmation than if it occurred on the 4^th day. If any of the days close below the support line of Day 1 you stop counting, the test has failed, and you start again when you get another Day 1 signal.

Additional Signs of a Stock
Market Bottom

In addition to a completion of the counting method, here are a few other practical things I look for:

• A Double Bottom in prices: when prices trend down, trend back up, trend back down, and then back up again, forming a "W".
• A declining number of stocks hitting 12-month lows: You can get these figures from the Investors Business Daily.
• A crossing of the 30 and 200-day exponential moving averages: I usually begin to watch for this crossing when the 200-day moving average begins to flatten out.

There are several other economic as well as technical indicators that one can use to spot a stock market bottom. These are just the ones that I use.

Don't take my word for it though. Do your own research. Search the Web and also go back over previous Bear Markets and see if you can spot a few of these patterns. See if they are at or around the end of previous Bear Markets.

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