Spotting the top or bottom of a market isn’t easy. Prediction is a tricky game, and those claiming to see the end or beginning of a bull market are usually full of … well … bull. If it was, everyone would be rich (or poor, if you really think about it). So can anyone really predict a market top or bottom?
It’s the eternal trading and investing question: Are we nearing the top of the market or is the bottom of the market in sight? And there are a million sub-questions that go along with predicting a top or bottom: Are indices a reliable indicator of where the market is going? Do the ‘experts’ really know what they’re talking about?
There are busloads of self-professed market experts who are quick to call a market top or bottom with no regard for the actual trends.
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These are hilariously described by Ritholz Wealth Management’s CEO, Barry Ritholz, in an article published by Bloomberg. Ritholz gives offers ‘experts’ 10 steps to calling a market top—even if you have no idea what you’re talking about.
The short story is this: Don’t blindly trust the experts; trust the objective indicators. The longer story is a bit more involved …
Where is the Market Top and Market Bottom, Anyway?
A market bottom is where stocks, commodities, bonds, and the like reside when they have no more room to fall, and the only thing they can do is rise. A market top is, of course, the opposite.
Simple enough, right?
If you watch the market closely, you will probably be able to spot when a bottom is on the way and make the best of it by buying low and selling high. If a market top is on the way and you’ve paid attention to the indicators, you’ll be better positioned to avoid some major losses.
So, here’s what you need to watch for:
- Time. Tops and bottoms don’t happen overnight; they take months, which is why you should watch market trends for a period of six to nine months, or more. With bottoms, recession is the starting point: historical data suggests that a market bottom tends to occur about six months into a recession. This means two quarters of negative economic growth. Yet, a recession alone is not enough: some recessions last longer than others, and the emergence from recession takes a long time to spot, so don’t pin your hopes on recession alone. With market tops, you will need to see at least nine consecutive months of growth in the market. Remember the “at least” part. Markets fluctuate, so this growth may not be constant, but there has to be an upward trend that’s at least nine months long.
- Trading volumes. When the bottom of a market nears, trading volumes start thinning on downward price movements and rising on upward movements. Also, watch how market averages trade: when a bottom is approaching, a double-bottom pattern is likely to appear: first the main averages will hit a low accompanied by heavy trading volumes, then rebound and then drop to the same low but with much lighter trading volumes. That’s a pretty good sign of a bottom.
- 52-Week Highs: With market tops, you’ll need to follow the number of 52-week highs and the performance of indices. One indicator of an approaching market top is a decline in the number of 52-week highs despite—and this is important—an overall rise in the index that follows the stocks. Also, compare the indices’ performance against the NYSE. If the exchange is starting to decline, forget about what the Dow Jones or S&P does: if the wider market is declining, look for the top.
If Headlines Are Shouting at You, Turn Down the Volume
Be wary of loud headlines when you’re trying to predict the market’s top or bottom. You should also be wary of the predictions of big-name investors.
Remember Robert Zuccaro’s book “Dow 30,000 by 2008: Why It’s Different This Time”? Well, not only did the Dow not hit 30,000 by 2008, but it began the worst financial crisis since the Great Depression.
Or, Nobel-prize-winning economist Paul Krugman’s 1988 prediction that the internet would have no real impact on the economy …
When they’re not flat out wrong, news reporters are as a rule too late—or too early—in their predictions of a top or bottom. This is probably true, at least in part, because economic indicators reflecting a top or a bottom also often follow the top or bottom itself.
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However, you can use the frequency of positive or negative economic news headlines as an additional indicator. During a bottom, the amount of negative economic news is the greatest, for example, and you can use this to confirm your suspicions or hopes that the market has hit a bottom and now is the time to buy.
With a top approaching, news would be positive, with some experts, whether real or self-professed, talking about a top approaching. Check the indices: the moment they touch a lower low than the last one, it’s time to prepare for a top. That’s because an uptrend moves in waves: prices move higher and higher, but sometimes they slide a bit. Whenever the latest slide is bigger than the one before it, the uptrend is over.
And still, be careful: there is no 100% guarantee that the downtrend you are seeing will lead to a bottom. The same is true for any uptrend that may be taking place right now. Follow all the indicators and tread carefully or you could end up at the bottom when you should be at the top.
So, as you can see, there no single reliable indicator for a market bottom or top that you can use to make money. There is a variety of indicators, all equally important, as they help you to make informed decisions.
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