First let's review on weekly SPX chart what happened between October 2007 and March 2009. After topping the market took a year and a half to bottom and SPX lost about 60% during that time. Bear market completed in four distinct phases. During each drop market lost between 10 and 40% while corrective rallies added from 5 to 20%.
Now, the main point of this series is to first show how extremely difficult it might be to spot a bear market bottom correctly. And second, to provide some insights into what tools we might use to catch a new bull market in as early stage as possible. We'll look at every intermediate bottom between October 2007 and March 2009 and search for bear market bottom clues.
The first bottom after initial drop took place in March 2008. Several accumulation days very close to the bottom suggest a new rally might be underway. However, a rally started with wedging, followed by distribution day (DD) immediately. Now, one DD during rally out of intermediate bottom is almost a must and not a critical warning sign on its own. More important is what follows it. A three day pullback was obviously bought as market sported an 11th day follow through day (FTD). Such a late FTD almost always means that rally will be short lived. Following FTD was a 6 week choppy rally with several DDs on the way up and not much momentum in general. Market reversed in June with a technical double top that sent prices to new lows.
The second bottom took place in July 2008. This rally was much weaker than the previous. A failed 7th day FTD is the first sign that rally may not last for long. Price then gyrated in tight range before breaking out, but this breakout turned out to be a bull trap. Without obvious warning signs price just slowly collapsed into new lows.
After an epic plunge during early fall 2008 the first reactive rebound happened in October. Again, at first glance this rally looks quite strong. But the main problem is that reactive rebounds out of extremely oversold conditions are almost always fakeouts as the rally is fueled mostly by short covering. Not surprisingly rally quickly fizzles out into a real intermediate bottom in November 2008.
Now, after 20+ percent drops late in the bear market cycle is when traders should become alert as the probability of final bottom increase dramatically. The rally out of November low is obviously not strong enough to reverse the overall trend. Rally is choppy in general without FTD and momentum and in fact it looks pretty much like the rally out of July 2008 bottom with a fake late rally right before another reversal.
The final bear market bottom occured in March 2009. The most important properties that separate this bottom from all the previous are the following:
- Rally started with a strong accumulation day off the bottom and a perfect 4th day FTD.
- Every minor pullback immediately got heavily bought.
- There was no choppiness as the price progressed in steady uptrend during the first few weeks.
- Price got extended quickly, leaving latecomers very few chances to jump on board.
As we know now the March 2009 bottom started a two year rally. With the benefit in hindsight spotting the exact bottom might look easy: just search for FTD and buy. But it's far from that. The 2007-09 bear was in fact pretty well-mannered. The first good-looking bottom was actually the final bottom. As we shall see during 2000-2003 bear market analysis this is not always the case. Often perfect FTDs will fail and sometimes market will bottom in a choppy manner when everybody are in doubt about the rally. But that's the way the market works in we traders have to conform to it.
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