Traders Toolbox: Bottoming behavior
Markets which have been in a persistent downtrend often exhibit a common pattern as the end of the decline is approached. The pattern is to post a sharp rally followed by one final decline to new lows.
Sharp rallies formed recently in both pork bellies and gold. Following the rallies, both markets plummeted to new lows. However, once new lows were made, the declines stalled. The failure to sustain the break on the move to new lows indicated the selling was effectively exhausted and potential bottoms had formed. A similar pattern marked the low in soybeans prior to the 1983 bull market.
The logic behind this type of bottoming action is that the persistence of the downtrend has finally forced the bulls out of the market. As the last longs are liquidated, the burden of keep- ing the downmove going falls totally on the shoulders of the bears to keep pressure on. Any faltering of the bears to keep the pressure on can lead to a sharp short-covering rally as the sellers "all" turn buyers.
Any hint of bullish news accompanying the short covering rally will tend to entice the emotional bulls back into the market. Then, as the bullishness diminishes, the sellers try to reassert them- selves. Often a push to new lows occurs and the stops of the early bulls are triggered. The stops provide additional short-term sell- ing pressure. When this subsides and the bears find no more selling entering the market, they head for cover in a more orderly fashion.
A relatively gentle upmove starts as the market searches for the levels which will entice sellers back into the market. From there, the burden of proof falls on the market to determine if the bulls are now the strong hands or if the bears can regain their control.
Like your analysis. The DOW is forming that very pattern right now and it will be interesting to see if the patern holds. Look at the 50 day MA of the DOW and you'll notice a rebound when the daily touches the MA. I wonder if the daily value hit the MA in the examples that you used?
I'd just like to throw my .02 in here...
Price patterns, including bottoming patterns can not be confirmed without corresponding volume changes.
Adam, if you'd please describe the volume changes that accompany this pattern, I think the community will benefit much more from it.
-Steve
Hi Edy,
I'm not certain I agree that the DOW is doing this now. On all three of these charts, the pullback surpasses the previous low, which hasn't happened here. I think on the short term chart we have broken out of a rising triangle, but conviction is low based on trade volume.
I think we're putting in a top in this short term rally. however, that doesn't mean I'm ready to start shorting the market as the signs just aren't solid enough one way or the other. For me, this is a good time to sit out and weight for more clear signals
Hi Steve,
It appears that Apple is on a sharp uptrend only to retrace to new lows then on a move to new highs.
I like to see bad news accompanying bottoms. Yes there may be good news once the price starts to head up, but bad news is often the providor of liquidty, and as Steven said, volume.
Does this pattern occur at tops too?
Amanda,
Patterns repeat all the time in the market both in the daily, weekly and monthly charts.
All the best,
Adam