Bottoming Process Continued

On June 11^th I published a post “Bottoming Process” and noted a few of the common technical chart patterns along with a few of the poorer performing Russell 2000 stocks up to that date to be compared to. The primary point of the post was to be aware what components the indexes are comprised of and be aware of whether or not they were suggesting bottoming patterns in accordance to the model. Since the indexes are lagging, burrowing under to the individual stock will get one closer to the actual price action and behavior under the surface.

What I wanted to start this post with is comparing 6 of these charts then and now as a follow up. The premise at the time was that unless these charts began to put in floors and stabilize then the likelihood the market was putting in a bottom was the less probable scenario. Worth keeping in mind as well is that simply because these have floored is not enough, stocks behaving well should be monitored in addition to note topping behavior and a next wave of potential selling.

  

On occasion a market will sell off and put in a sharp V-Shaped bottom, but the more probable scenario is going to be action like that which has been occurring since the June 04 pivot low. Action reminiscent of trying to find one's footing on a sheet of ice as limbs flail akimbo until there is traction and stability. Something that stood out to me when analyzing the NASDAQ chart today is time and factors of it, particular mine. Through observation and empirical evidence I've decided upon a time frame of 5 days in which a stock has to prove itself to me or else I will stop myself out. In keeping with this theme I wondered why in turn I was not analyzing market action based upon this same time frame.

Eventually a market will reach a low that will be “the low” and when that is we can not determine with 100% precision, especially at that moment. But what we can use is time. The longer a low holds, the more probable that becomes the low of the move. So I broke down chunks of 5, 10 and 20 days price action from that low and a key higher low that followed thereafter. The underlying hypothesis for me and one I intend to use from this point forward is that: if it is a low it should be not be breached for a five to ten day period and thereafter any key higher low pivot should follow to confirm. This is just one piece of information however, the second is the pure statistics of market action.

Over the past 84 years there have been 294 pullbacks of 5% or more which averages out to 3.5 per year and of these at least one will be in the magnitude of 10%. A move of 15% occurs 14% of the time and 8.5% of the time a move of over 20% will occur. If a move is going to 15% it obviously has to punch clearly through 10 and this information helps formulate a belief about current market structure and time. Once a market hits 10%, a not uncommon pullback, the chance that it goes much further decreases, therefor the probability there may be a bottom forming increases. So by combining the magnitude of the move in addition to the the length of time a key pivot low goes unbroken can assist in getting on the correct side of the market move much earlier.

Another aspect of time to be aware of is the horizon. A move of 4-6% is a modest pullback and the horizon for the return to uptrend will be shorter than if there is a much more corrosive move of 10-15%. A move of this size will not bounce back swiftly so expectations of markets breaking to new highs rapidly should be muted. These types of moves need a longer span to unwind before commencing the next uptrend.