Invest/Trade with Disciplines

How to Identify Bottoms

Some say investing is about time, not timing. This depends on the time horizon one is looking at. It would certainly make a huge difference whether you jump in at the top or bottom. It is very desirable if one can buy the bottom and sell the top, but there is no known method for doing that exactly. Nevertheless, it is good enough if one can buy NEAR the bottom and SELL near the top. The question is how one can identify bottoms and tops. Here, I'd like to share some methods based on my own research and observations. Right now, the market has just had a significant drop, so I would focus on how to identify bottoms.

How to Identify Bottoms by Counting the # of Retracement Staircase Steps

Counting Downturn Steps Using a 3-Month Daily Chart

First, a retracement is a reversal in a price movement trend. I have observed that a major downturn would take 6 - 8 steps to reach a bottom. For example, the following chart shows the COVID-19 induced downturns with the Dow Jones, Nasdaq and S&P 500 indexes. Note that it is more desirable to use a 3-month daily chart to count the downturn retracements, which resemble a staircase from top to bottom. In these cases, it took 7 steps for the Dow Jones index and 6 steps for the Nasdaq and S&P 500 indexes, respectively, to get to the bottom prior to a quick rebound. Of course, in general, we would not know exactly how may steps a downturn would actually take. However, it is prudent to start jumping in when at least six steps have been observed, which is better than: (1) jumped at much earlier steps, and (2) totally missed the bottom. An educated guess is mostly better than completely blind guesses.

How to Identify Bottoms by Using Candlestick Chart Patterns

A Candlestick Chart's Dual Purposes

First, candlestick charts don't mean much or anything if looked at standalone. However, they could be very useful when the trend approaches the end and is already very clear. Here, I have some examples showing how candlestick charts can be used for both counting down # of new lows in a downturn and for identifying trend reversals. They are self explanatory, but if you are not familiar with candlestick chart terms, I suggest that you look them up online on your own.

The following chart shows the DIA (Dow Jones ETF) downturn induced by the COVID-19. Once again, we used a 3-month daily chart for showing the trend. In this case, it made 11 new lows prior to a quick rebound. Nevertheless, jumping in anywhere between steps 8 and 11, inclusive, would have been prudent.

How to Identify Bottoms by Using Candlestick Chart Patterns

A Candlestick Chart Showing a 5-Day Buy Window at the Bottom

This example shows the QQQ ETF for Nasdaq index. It is seen that it took 8 steps to reach the bottom, with the bottom very obviously noticeable. Thus, one can buy more aggressively within that 5-day window prior to the quick rebound.

How to Identify Bottoms by Using Candlestick Chart Patterns

More Candlestick Chart Patterns

The following chart shows the price movements with an IPO stock with symbol SDGR. I labeled it with more candlestick patterns such as spinning top, engulfing, and dark cloud cover. Note how well the spinning top patterns have indicated two breakouts. Also notice that this is a very nice weekly doubler.