Investing--IBD: "Let The Market Tell You When It's Hit Bottom"
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Investor's Corner
Friday, November 17, 2000
>>>Let The Market Tell You When It's Hit Bottom
By Christina Wise
Investor's Business Daily
Spotting a market bottom is more science than art. You just need to know the facts.
The headlines may change from one bear market to another. But the major indexes act in a remarkably similar fashion – in large part because they reflect the hopes and fears of individual investors. Human nature doesn't change.
At some point in a long sell-off, stocks will try to rally. The first day or two tells you little about the prospect of a successful turnaround.
While you're waiting for the major indexes to confirm their bottom, take a look at the market's psychological profile. Is it in the right frame of mind to rally?
To answer that question, check indicators of investor sentiment such as put/call ratios or bullish/bearish surveys. They serve as good secondary gauges of whether a bear market has gone into hibernation.
Consider the put/call volume ratio. It compares the daily number of put options and call options. People who buy call options believe the price of a stock will rise. Traders who buy put options are betting the price will sink.
A daily graph of the ratio of puts vs. calls is found above the Nasdaq graph on the General Market Page, today on A28 in the print edition. The put/call ratio serves as a useful contrarian indicator. The reason? Option players historically have been wrong at major market turning points.
Pay special attention when the put/call volume ratio spikes above 1.0. That means most options traders think the market will sink further, so they buy more bearish puts than bullish calls.
When the market wrings out the last bit of optimism, it clears the decks for a new rally. The last sellers have made their move. Buyers can now return unopposed.
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On Oct. 8, 1998, the Nasdaq found its bottom after a three-month slump. The same day, the put/call ratio hit 1.11 (Point 1 in accompanying image), its highest point in nearly four years. The Nasdaq then rocketed up 56% in less than four months.
But this gauge doesn't always work so precisely, which is why you should let the market itself decide whether a new rally is at hand.
A strong sign occurs when one of the major indexes follows through with a gain much greater than 1% on heavier volume than the day before. The session should be clearly powerful. Usually this happens on the fourth to seventh day of an attempted rally. Follow-throughs after the 10th day signal a weaker rally.
As the market has become more volatile and dominated by huge mutual funds, premature follow-throughs have cropped up. While there are more false positives these days, no bull market has started without this vital buy signal.
Ultimately, you trade in a market of stocks. They have the final word. If quality stocks break out of well-formed price bases and head higher, a new bull market has arrived.<<< |
