I received an interesting question Tuesday… A reader tracked me down and asked me to define a term that is quite common in our financial markets.
“What is a market bottom? Is that when one should buy stocks, expecting a rise to follow?”
It’s a great fundamental question… and today we’re going to answer it and, more importantly, how to spot it. Understanding bottoms can provide investors with opportunities to go long on equities, and recognize the best way to trade around stocks you want to own at a price you want to pay.
What is a Market Bottom
A “market bottom” refers to the lowest point reached by a financial market or asset during a specific time period. By definition, this is the opposite of a “market top,” which is the highest point in the market cycle.
We use this term to discuss movements in equity, commodity, currency and other markets. If we look at this price chart of the last four decades, we can see that market bottoms happened during the first Gulf War, after the Dotcom Crash, and after the Great Financial Crisis. Markets also bottomed out in March 2020 after the COVID-19 crisis drove the S&P 500 down 33% in a month.
A market bottom is important because it signals that the downward trend is coming to an end. That could fuel significant upside due to a reversal or mean reversion. Investors and traders often look for signs of a market bottom to identify potential buying opportunities, anticipating that prices may start to rise from that point.
What Drives a Market Bottom?
Various factors can contribute to a market bottom, and for most investors, they’re usually discovered in hindsight. These factors could include economic indicators, stronger corporate earnings, and shifts in investor sentiment.
I prefer to look at a few other elements. For example, I pay very close attention to the actions of the Federal Reserve. After the Dotcom crash, for example, the Federal Reserve began to cut interest rates and buy assets on its balance sheet.
This process of quantitative easing has been a major factor in market reversals over the last two decades. QE was essential to the market finding a bottom in March 2009, December 2018 and March 2020. The Fed has pumped significant amounts of capital into the financial markets by purchasing bonds and mortgage backed securities across multiple rounds of easing. This liquidity is essential to the stability of the markets. But it creates dramatic incentives for capital to flow into risk assets — including stocks that possess extreme valuations or a lack of profitability.
Of course, it’s not just the Fed that engages in QE. Last October, the markets witnessed a period of easing by the People’s Bank of China, the Bank of Japan, and the Bank of England. The latter sought to contain a crisis in its bond markets after liquidity challenges hammered the nation’s pension system.
That period coincided with what Michael Howell at Capital Wars has referred to as the bottom of a liquidity cycle in the markets. The chart below shows the bottom of a long-term liquidity cycle, according to CrossBorder Capital.
Other Ways to Spot a Bottom
It’s very difficult to spot the bottom of the market as it’s happening. A lot of investors typically reach a period of “extreme fear” and aren’t eager to buy in an extreme crisis. So, it’s important to watch other factors, like those linked to fundamentals or technical analysis.
I always recommend that investors look for short-term market bottoms by paying close attention to the daily reading of the Money Flow Index and the Relative Strength Index. When both reach oversold levels (MFI under 20, RSI under 30), investors should look for short covering and dip buying among institutions and algorithmic traders.
We can see in the chart below that the S&P 500-tracking SPY ETF hits a short-term bottom and reverts after the RSI and MFI both hit oversold territory at the same time.
There is one more important, contrarian indicator that investors can follow… It’s what we follow at Executive Payouts Unlimited every day. We’re talking about the buying patterns of executives in their own stocks. The following chart is a measure of insider buying to selling in dollar terms.
At the top of the chart sits the strongest insider buying (blue line) over the last 15 years. Those strongest levels coincided with major market bottoms in 2009, 2011, 2015, 2018, 2020 and 2022.
Insider buying is a terrific signal because it combines the collective wisdom of leadership at major public companies that believe their individual stocks will climb. When insider buying picks up — as it did in October 2023 — we want to be actively trading or buying stocks over the long term.
The best way to get started is joining Executive Payouts Unlimited. There, you’ll get insight into the best way to take advantage of market momentum and insider buying activity.
*This is for informational and educational purposes only. There is an inherent risk in trading, so trade at your own risk.
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