double bottom

As regular readers may have discerned, I have a complicated view of the value of technical analysis, which is the attempt to derive useful investment information from studying the volume and price trends of individual securities and/or entire markets.

In the US of the 1920s, technical analysis was king.  That’s because there were no real standards for reporting of financial results by companies (some of which switched accounting standards the way most people do shirts to show themselves to the best advantage) at that time.  Nor were there legal bars to prevent syndicates of wealthy investors from creating artificial enthusiasm by manipulating individual names up and down in bucket shop fashion.  Basically, technical analysis was all there was.  In my view, subsequent legislation mandating minimum auditing and disclosure standards, and outlawing syndicate activity, have rendered much technical work obsolete.

By the way, I also find much of technical analysis to be useless/incomprehensible.  Take head-and-shoulders movements as an example   …or the Dow Theory.  But my main objection remains that technical analysis is a century-old tool that has been superceded by fundamental analysis of audited and SEC reported financial results.  It’s like riding a bicycle in a NASCAR race.

Nevertheless, even fundamental analysts fall back on technicals in times of panic, which is, after all, completely about sentiment with no room in fear-gripped minds for fundamentals.  And there are a few indicators that I think are very helpful in gauging sentiment.

One of these is a double (sometimes triple) bottom.

what a double bottom is

The idea is to figure out the index level where selling that is driving down a market/stock either exhausts itself or meets potentially strong resistance from buyers.

bottom occurs when downward movement stops and reverses itself.  Often this happens on higher than normal volume.  Sometimes the final down period is marked by a steeper than normal decline.  The level of the low may also be closely related to a prior significant low.  At times, however, none of these confirming signals are present.  The important thing is that the marke/stock stops falling and begins rising again.

Four to six weeks later–not any sooner, but occasionally even later than six weeks–the market/stock stops rising and declines again to the vicinity of the prior low.  If the market/stock then reverses course and begins rising a second time, it is said to have tested and confirmed the prior low.  In most cases, this double bottom signals the end to the down phase.

Sometimes, the market repeats this process and forms a triple bottom.

 

From a psychological point of view, the fact that the market/stock falls to a significant low but repeatedly fails to break through that low creates and strengthens the belief that this is a point where significant resistance to further decline will occur.  The more the low is successfully tested, the stronger this conviction grows.

relevance for now?

The S&P 500 made a low of 1867 on August 25th.  This is very close to the closing low of 1862 (intraday:  1820) on October 15, 2014–and another low (1816) on April 11, 2014.  The index reversed course on all these occasions, this time reaching 2020 on September 17th.  The S&P then declined to 1882 on September 28th.  The market then reversed course again and has been rising since.

So far this looks like a classic double bottom–the first low, the four-week interval, the confirmation of the first low, all linked to prior significant lows.  We’ll only know for sure as we see trading unfold over the next few weeks.

In the present case, the formation of a firm bottom for the market would also be evidence in favor of the idea that investors are willing to separate clearly the (weak) commodities-related sectors from the (strong) rest of the market and are not prone to let the former infect the latter.

 

 

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: