Stock market bottom must be played with strict adherance to money management discipline. Investors can begin investing when preponderance of evidence (ie, more than 50% of all major leading indicators) suggests a stock market bottom is near. For example, when 51% arrived, invest 20% of your money; when 61% arrive invest another 20%. But plainly, investors should at least keep 10 to 20% cash (even when over 90% of all evidence suggests a bottom).
These appear to be major signs of stock market nearing a bottom:
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from seeking alpha: http://seekingalpha.com/article/109814-is-it-time-to-buy-what-history-shows
Goldman Sachs’ research department (yes, I know, who would listen to them after all that’s happened between a $200 oil forecast and the credit crisis and all?) released some historical precedents on how the market anticipates a recovery. In their defense, predicting the near-term future is darn near impossible, but these are historical facts. According to the bank:
The S&P 500 tends to bottom:
One quarter before the GDP bottoms
3 months before the ISM manufacturing survey bottoms
7 months before the peak unemployment rate
4 months before the largest decline in non-farm payrolls and
4 months before the bottom in consumer confidence surveys
If the market truly did hit rock bottom in November, we can expect a genuine economic recovery somewhere between March and June of 2009.
Believable? I wouldn’t bet on it, but it’s certainly possible. So, here’s what to do.
------------------ Market valuation (Long term indicator): A proper market valuation is accomplished by considering both earnings and earnings growth using a formal Discounted Cash Flow Model. Some of the organizations who perform proper market valuations are:
- Morningstar[6] uses a market valuation graph giving the ratio of price to fair value for the median stock in each coverage universe over time. A ratio below 1.00 indicates that the stock's price is lower than the estimate of its fair value.
- Valueline's VLMAP (market appreciation potential) attempts to project a stock's appreciation over the next 3-5 years[7]. Its use has been studied by Peter Bernstein and Dan Seiver, who uses it in his PAD system report[8]. When the Valueline indicator rises above 100, it is taken to be a buy signal. This method of measurement gave buy signals during the bottoms of October 2002 and March 2003, and the panic low immediately following the 9/11 terrorist attacks. However its record as a sell indicator (at a market top) is thought by many to be questionable[9].
- A common but less accurate method of market valuation is to utilize the company's profit and earnings P/E ratio[10]. It does not take potential growth into account.
- Investor sentiment (Long term indicator): When an extremely large percentage of investors and financial advisors express a bearish (negative) sentiment, it is a strong signal that a market bottom may be near. However the predictive capabilities of this kind of investor sentiment (see also market sentiment) are thought to be highest when investor sentiment reaches extreme values. Indicators that measure investor sentiment may include:
- Investor Intelligence Sentiment Index[11], [12]: If the Bull-Bear spread (% of Bulls - % of Bears) is close to a historical low, it may signal a bottom. On July 22, 2008 it stood at -20.20%, a remarkably low value for past three year period.
- American Association of Individual Investors (AAII) sentiment indicator[13]: Many feel that the majority of the decline has already occurred once this indicator gives a reading of minus 15% or below.
- Mark Hulbert's Stock Newsletter Sentiment Index (HSNSI)[14]: During the March 2008 bottom this indicator gave a reading of minus 29.4%[15]. As of June 30, 2008, it stood at minus 35.9, which was its lowest value in a decade.
- Other sentiment indicators include the Nova-Ursa ratio [16][17][18], and Short Interest/Total Market Float[19][20]
- Market oversold indicators:
- Relative strength index (RSI)is a momentum indicator that compares recent gains to recent losses. It is measured in values between 0 and 100. When the RSI is below 30, the market or stock is considered to be significantly oversold and therefore undervalued. For example here is an RSI chart for the NASDAQ Composite: [1]
- Greatly Undervalued securities: Prices that are below several multiples (2 to 4) of the standard deviation from the 50-day moving average[21]. (See also Bollinger Bands.) For example here is the chart for NASDAQ Composite MA with 2% deviation [2]:
- 'Standard and Poor's (S&P) oscillator': This is a proprietary tool offerred by Standard and Poor's, a renowned investiment research company and one can access the S&P oscillator through a paid subscription with S&P. Standard and Poor's [22][23], This oscillator is thought to be based on a formula[24] originally proposed by George Angell. For a given bar, it is given by ((High - Open) + (Close - Low)) / (100*2 * (High - Low)) minus 50%; market lows are supposed to be marked by minus 4% to minus 9% (i.e. 4 to 9% below average).
- Market capitulation: In a severe down trending market there may be a certain threshold after which large numbers of investors can no longer tolerate the financial losses incurred as a result of the current downturn. [25]. This majority group of investors then capitulates (gives up) and sells in panic or finds that their pre-set sell stops have been triggered thereby automatically liquidating their shares of a given stock. This dramatic increase in the number of sellers causes a further increase in the speed and severity of the stock's price decline. Margin calls and mutual fund and hedge fund redemptions significantly contribute to capitualtions[26]. In other words market capitulation occurs when there is a sudden steep decline in price caused by high volume selling[27], for example note the high volume selling in this chart of the NASDAQ composite index (QQQQ) when it experienced a bottom(s)[3]. The peak in volume may precede an actual bottom.
- Other signs of a market bottom:
- Decline in the number of new price lows [28]. Chart for Nasdaq & NYSE Composite New Lows [4]
- Moving average convergance divergence (MACD) is used to assess longer term trends and the MACD histogram is used for shorter term trends. When the MACD line crosses over to a positive range (top half of the chart) it is a sign that the uptrend has resumed. For example the MACD of the QQQQ at a market bottom might look something like this chart.[5]
- Very high volatility as measured by the volatility index VIX or VXO[29]. A VXO reading above 30 that creates a sharp one or two day peak on a chart is often indicative of a market bottomYahoo Plot.
- Chart patterns: A bottom is often seen as a long term price pattern within a chart. Some of the more common chart patterns used to evaluate a potential bottom reversal of a stock or the stock market in general are:
- Inverted Head and shoulders, double bottom (a W-shaped formation), triple bottom, or cup and handle patterns.
- Japanese Candlestick patterns: Abandoned baby bull, Morning star bull or Morning Doji star pattern[30].
See further my article on "Business Cycle" published in May 2008 about market timing:
• Rising interest rates pull the dollar higher.
• Gold peaks.
• The CRB Index peaks.
• Interest rates peak; bonds bottom.
• Stocks bottom.
• Falling interest rates pull the dollar lower.
• Gold bottoms.
• The CRB Index bottoms.
• Interest rates turn up; bonds peak.
• Stocks peak.
• Rising interest rates pull the dollar higher.
This is what was said by [曹仁超] on 2008 10 16
"CRB指數（代表十九種原材料）跌幅已達39％，可以媲美2000至01年（跌幅37％）或1997／98年（跌幅28％）。家吓銅 價仍較2001年低潮時高出三倍；油價同1998年低位10.35美元距離仲好遠。根據哈佛大學經濟學家Martin Feldstein（佢同時係美國商業周期成員）研究，通常商品價格見底後一年經濟先復甦。換言之，即使CRB指數最近已見底，我地最少仍面對一年衰退 期。高盛證券估計，明年鉛價將回落17％及銅價回落12％。UBS估計，鎳價仲有32％及白金50％下跌空間。摩根士丹利估計，明年鉛價將回落20％及鈀 金45％。如佢地嘅預測準確，即距離衰退結束期仲遠。股市通常响衰退結束前三至六個月先見底，依家估底係咪太早?!"
See also my article on VIX published 9 May 2008.
Lastly, [曹仁超] said on 2008 10 16
"第一個底由拋空者平倉造成（例如2002年10月美股），日後唔再低過呢個底才確認牛市出現（例如2003年4月）；反之，未來日子如創新 低，便代表熊市繼續，反彈只係另一隻熊腳。到底上周五係底定係熊腳？等股市自己話畀大家知。如你一味想摸底，咁又點持盈保泰？我老曹冇水晶球，所以亦唔知 幾時見底；只知一浪低於一浪要出貨（Top Down），一浪高於一浪才入貨（Bottom Up）。
預測唔係可靠嘅投資工具（如你預測，遲早出錯），只有嚴守紀律，唔摸頂及唔估底；只有當頭起時入貨，當頭跌時出貨，先係致勝方法。"
On 15 Nov 2008, he said
牛市開始時必出現以下三點其中一點：一、喺五十個交易天內，道指反彈最少30%；二、喺一百五十五個交易天內，道指最少上升 13%；三、Value Line Geometric指數最少上升30%。
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