Determining a Bottom Using Technical Analysis
By Kit Cohan, Optionetics.com
01/30/2001 5:00:00 PM
Bottoming is a process, more than just an exact point in time. A bottom forms when the balance between buyers and sellers reaches a kind of equilibrium; when drops in a stock's price no longer bring out droves of nervous sellers who drive the price down further on high volume. They form when the market decides that most of the bad news is on the table. In the past 9 months, we've had a lot of bad news in the form of earnings misses, company's guiding their numbers downward, and some unpleasant economic reports such as today's gloomy Consumer Confidence report. Warnings and misses are still being reported; but now that the Federal Reserve has finally cut rates (with more cuts on the near-term horizon), the market has lost some of its nervousness. The market is anxiously awaiting the outcome of the current Federal Reserve meeting, and the general consensus is for a 50 basis point cut. Since a 50 point cut is widely expected, anything less is not likely to be met with open arms.
As long as the market is still severely punishing earnings misses for market-leading stocks that are already well off their highs, then the bottom has yet to begin to form. But we do appear to be seeing some light at the end of this tunnel. Did you notice how when both Intel (INTC) and Dell Computers (DELL) announced earnings misses recently that their stock prices did not fly down to the underworld? Does this mean the bottom is right here, right now? Be aware that forming a bottom does not mean a rapid rise back to the top, it just means that stocks are finding it easier to make a bit of progress on the upside-not that they are all phoenixes flying skyward from the ashes.
Being able to rebound from the sort of damage we saw in last year's markets means that being an excellent stock picker is a more valuable skill than ever; therefore, sharpening your skills in the area of technical analysis is a must.
To start, keep an eye on the charts of the top members of the Nasdaq Composite ($COMPQ) and the Nasdaq 100 ($NDX) indices by taking notes on what the standard technical analysis techniques tell you about these stocks and major indices. Some of the charts of the major members of these indices show more than just one nasty drop in price over the last 9 months. Last August, both INTC and DELL were trading at levels roughly double their current valuation. Both had more than one gap down day in response to reports of serious slowing in the PC markets or actual reports of earnings misses in the fall of 2000. Since that time these stocks have lolled around their lows. Lately they've stopped reacting severely to bad news and have actually been showing signs of life. For example, Dell Computer (DELL) reported an earnings miss last Monday, but the stock closed barely down for the day. Intel (INTC) found itself in the same boat earlier this month, but again the stock did not sell off severely. This is classic bottoming behavior-a stock no longer going down when bad news in announced. Indeed both of these stocks have recently shown some upside progress.
When you're trying to get a feel for the state of the major indices, take a look at the charts of the main members of these indices to see if they are showing this kind of behavior. You'll see it first in the stocks before it becomes apparent in the indices. This doesn't mean that another sell-off is out of the question; it just means it is getting harder to scare weak holders out of their stocks at this particular point in time.
However, just because a stock or index appears to have finished going down, does not mean it is going to head right back up with no backing and filling of the chart. "Backing and filling" is a technical analysis term that basically means chopping back and forth, like a tug of war. Buyers and sellers are pulling the price back and forth, and neither side is making too big of an impact. This churning forms a support level in the chart, an area that by definition is where buyers have shown they will step up to the plate when sellers appear at that price. Eventually those who are selling at the support level will exhaust their supply and the buyers will gain the upper hand. Upward price progress will finally occur though there will still be plenty of back and forth action in the process.
The best looking bottoms are those that qualify for buns of steel designation: those with firm, tight bases. Sloppy, wide-ranging bases will neither make for a world-class Olympic runner or a reliable bull run. Another thing to be concerned with when looking for a bottom in the markets is if there are enough charts showing tight bases. Without these "rested and ready" stocks, the general market is likely to have trouble sustaining any rally. Strong, competition-ready bottoms are not formed with a weekend juice fast, but with consistent effort applied over a length of time that requires patience and commitment. Beware of short-term bottoms that have not done all the work needed to exhaust all the sellers and get that firm, solid base formed.
The final step of the bottoming process is when stocks actually start going up with good news. The actions of the Federal Reserve should help move that process along, but again, this requires a bit of patience. Don't think you have to establish all your options positions in a market frenzy engendered by a Federal Reserve announcement. The beauty of trading limited risk options spreads is that the wild swings of such announcements are not your specific targets. You are looking for positions that mature over time, and not just in the few minutes of frenzy in the trading pits. |
