Did you know that there are ways to spot a bottom in a stock?
Before the stock rises, they often give subtle hints that a bottom has formed. The general public often do not know how to spot bottoms.
But the trained technical analyst and the great investor knows how to differentiate between a stock that is good for bottom fishing and one that is a falling knife.
While it is not an easy thing to spot a bottom in a stock, I think it is doable.
After all, stocks that bottoms do exhibit certain characteristics. And it is in this article that I would like to show you what these characteristics area.
History often repeats itself and perhaps in the future you might be able to spot a stock that is bottoming yourself.
The primary reason we want to spot bottoms in a stock is of course to buy it at a cheap price before it rises.
Some great profits can be made when you identify a bottom early. Traders who swing trade can also buy a stock that has formed a short term bottom. They hold it for a few days and sell it for a quick profit.
It can be pretty lonely at the bottom when nobody is really interested in the stock, but if you are in early, the risk to reward is enormous.
First of all, in order to understand how to spot bottoms, you need to know the 4 stages that every stock goes through. Very briefly, the 4 stages are:
You will make money by buying stocks that have just bottomed and are about to start a Stage 2 uptrend. Here are some signs to look for to spot a bottom in stocks:
We will cover each one in more detail below. Hopefully these few characteristics will enable you to spot the next stock that tries to bottom.
Breaking trendlines is a great way to spot a change in the trend. A stock that is in a downtrend will often break a trendline when it is about to bottom and move up.
Breaking a downtrendline changes the psychology of market players. While not all stocks that break their downtrendline will move up and start a new uptrend, many stocks often exhibit this behavior when they are starting a new uptrend.
You can easily construct a downtrendline by connecting the highs of the rallies.
I think drawing downtrend lines is itself a skill that needs to be honed. If you are starting out you may not even know how to draw one.
Many newbies will just connect anything that they think will make a trend line. But I suggest that you try to connect as many rally highs as possible.
Also, you can look at how other more experienced people draw their trend lines. In that way you will soon learn how to be able to draw your own trend lines.
In the chart above, you can see how AAPL broke above its weekly downtrendline. When it broke above the trendline, it gives traders an indication that things are getting better.
It is a hint that this stock might be bottoming. Sure enough, the stock climb up from there.
Trendlines can be used on daily chart as well. ALLE broke above its daily trendline and formed a bottom. The stock rally and rise from there. Trendlines are very simple tools but they are extremely powerful to spot a bottoming in stocks.
The above chart is a new addition to this article. I think many more will be added if I have the time. I will try to update my articles when I have the time.
This will give you more and more examples so you can study them and learn from them. I myself also will learn from them as well.
The chart above is the daily chart of Agilent Technologies. It is interesting because there are 2 downtrend lines that give hints that it is bottoming.
The first one which is the black line is a shorter and steeper one. When the stock gap above this downtrend line, it tells investors that a short term bottom might have formed.
I think newbies might not even know how to draw this trend line. But notice how it tries to connect the rally in the price. So when the stock crosses over to the other side of the trend line, it is an early indication that it wants to change trend.
And of course in this case, it did change trend.
Then we have a second downtrend line which is larger and bigger and longer. This trend line is a gauge of the stock's trend for a longer period.
When the stock was below this blue trend line, one could consider it to be mid term not in a good trend. But when it cross back above this blue trend line, it told investors that perhaps the mid to longer term trend of this stock is changing to bullish.
So there you have it, sometimes a stock can break two downtrend lines. A shorter one that shows a short term change in trend and a longer one that shows a longer term change of trend.
And when the stock breaks above two of those trend lines, it gives you more confidence that the stock has bottomed.
Chart patterns like the double bottom, triple bottoms, cup with handle and reverse head and shoulders often appear when a stock is bottoming. Whenever a stock exhibits these kind of patterns, we need to take note because they usually tell us the stock might be finding a bottom.
The S&P 500 above formed a double bottom pattern in January to March. Double bottoms that happen in indexes can often be very very reliable. Look how the market rally up.
The weekly chart of Apple showed that it formed a triple bottom. The triple bottom tells us that the stock tried to move lower 3 times but failed to do so. The bears were not able to make the stock go lower despite 3 times. The bulls were stronger and supported the stock everytime it fell. Therefore, Apple rallied and formed a bottom. It is hitting new highs now.
The cup with handle pattern is a very useful and reliable bottoming pattern. It is popularized by William O' Neil in his book How to Make Money In Stocks. Today, this pattern is often watched very carefully by investors and traders. When they see this pattern, traders will look at whether the stock can break above the handle. They will often invest or buy the stock as it rises above the handle.
ABT above shows how this reliable pattern marked a bottom in the stock. The stock broke above the handle and flew higher.
A reverse head and shoulder is also a very potent bottoming pattern. The stock will form a left shoulder then move lower to form a head and then form a higher low which creates a reverse head and shoulder pattern. ADBE above formed this pattern from November to January and look how the stock fly higher from there.
Reverse head and shoulders also work very well in weekly charts. The chart above shows the FTSE 100 which formed a reverse head and shoulders pattern. The funny thing was the BREXIT vote happen in June 2016 which is where the right shoulder formed.
When the surprise results came out everybody thought the FTSE market was going to fall drastically. World markets crashed lower but quickly regain the losses. Turns out the crash formed the right shoulders which eventually made the FTSE move higher. Traders knew better because they saw the reverse head and shoulders pattern.
A stock that is in a daily downtrend can look devastating. But many stocks that are in a bear market tend to end the downtrend when they reach the weekly and monthly long term support.
In the chart above, you can see HSIC having a downtrend. The stock then reached the weekly support and the stock then started to formed a rounded bottom. From there the stock started a new uptrend.
IBM was in a very long downtrend. The monthly chart of IBM showed how this stock dropped from 2014 to 2016. The stock then reach the long term monthly support. It formed a bottoming tail and notice that is where it met the monthly 200 MA as well. The strong support as well as the psychological 200 MA support help keep IBM from dropping further. The stock formed a bottom and then started a new uptrend.
Bottoming tails are excellent candlestick reversal patterns. They work very well in daily charts but they also work superbly well in weekly charts. When there is a big market crash and the S&P 500 makes a bottoming tail, it often gives us a very reliable signal that a reversal is at hand.
The chart above shows the S&P 500's weekly chart. Do you notice the many weekly bottoming tails that appear after the markets crash? They did a very good job of telling us when a bottom is happening.
The chart above shows the weekly chart of IR. You can see the stock formed a double bottom pattern and the right bottom has many bottoming tails there. This told us that the stock was rejecting going lower. Eventually the stock found a bottom and made a new powerful uptrend.
Bullish candlestick patterns in daily charts can setup very nice swing trading opportunities. But a bullish candlestick pattern in weekly charts can show a potential bottom in a stock. This is usually more for V shape bottoms where the stock drops and have a quick bottoming process instead of a long rounded bottom. This is where the bullish candlestick pattern comes in.
In the chart above, JBHT had a drop and then it formed a weekly bullish harami. The bullish candlestick pattern marked the bottom for the stock. Studying Japanese candlestick patterns can be very beneficial to spot reversals in the weekly charts so do spend some time studying these patterns.
Oversold indicators such as the stochastics can be very helpful to spot stocks that are bottoming. When you use the indicators in the weekly charts, it can even be more beneficial to spot long term bottoms.
In the chart above, JNJ had a bear market in late 2016. However, the stock was actually dropping to weekly long term support. The stochastics were oversold and not only that, they were forming a bullish divergence which indicated bullish strength in the stock. The stock eventually bottomed and started a fresh new uptrend.
The 50 day moving average is a closely watched moving average by the investing community. The other one is the 200 day moving average.
While the 200 day moving average will hint of a long term health of the stock, the 50 day moving average shows the picture of the mid term health of a stock.
Many times, a stock may have a correction and drop below its 50 day moving average. When it is ready to reverse back up, it goes back above the 50 MA.
If you see a stock finally crossing back above the 50 day moving average, this can be a hint that the stock is bottoming and ready to start a new uptrend.
In the chart above we can see how UNH had a period of declining prices.
The stock then gap above the 50 day moving average. The blue line is the 50 MA while the red line is the 20 MA and the 200 MA is the yellow line.
UNH had been below the 50 day moving average for quite some time. When it traded back above this MA, it told us that a change in trend happened.
Notice how the stock broke back above its downtrend line as well.
When you have the stock breaking back above the 50 day moving average and also breaking back above a downtrend line, this is a very strong signal that the stock is about to change trend.
As you can see, UNH started to move back up and made a new uptrend after it went back above the 50 day moving average.
When it comes to this point there is one caveat...
Watch what rich investors do not what they say.
People may say anything they want...
Try not to listen to what famous investors say. But rather be on the lookout at what they do.
For example, if you hear a rich and famous investor putting $5 billion into the stock, then you should really pay attention to it and perhaps put some money inside as well.
The reason is simple. Anyone who says something may not believe what they say the next day or worse they may not really mean it. But anyone who is putting a huge some of money into a stock or the market is voting with their money.
And that is what will make a huge difference.
Try to sift out the A grade investors from the rest. People who are billionaires and have made a huge amount of money in the stock market with a huge track record are more likely to be correct than the rest.
Recently, we heard about how Bill Ackman made a killing of about $2.6 Billion when the stock market collapsed due to the Coronavirus.
Then he put about $1.5 Billion of the proceeds into buying shares of companies like Berkshire Hathaway and Hilton.
You can read more about this in the Forbes article here Billionaire Bill Ackman Made 100-Fold Return On Coronavirus Hedge That Yielded $2.6 Billion.
According to the article above, Ackman closed his hedges on Monday March 23 2020 and then proceeded to buy stocks in about a day. That is about when the stock market bottomed and the next day it shot up furiously.
The March bottom may or may not be the exact bottom, only history will tell us. But if it is really the bottom, then it does tell us that the smart money do have an edge over the rest of us.
When they buy, it could mean that a bottom is very near.
There is no one perfect way to spot a bottom. The above ways when you add them all together can be very powerful to spot a bottom in stocks. You can use these techniques and indicators to spot a bottom in stocks, indexes and even commodities. When you use them in weekly charts they can often tell you when a stock or index is bottoming and about to start a long term uptrend.
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