Finding the bottom in the markets is one of the most sought after technique in all investing. Personal investors are always predicting the bottom before it occurs and are usually late to the party after a true bottom has formed.

Luckily for us, IBD has developed a method that will pin down the bottom over 80% of the time.

Required Reading

Before you can begin spotting bottoms, you need to know how to read accumulation and distribution (buying and selling by professional traders).

This is a very easy thing to do. All you need to do is look for days where the volume is higher than the day before. If the price moves up over .25% then it is classified as accumulation, if it moves lower over .25% then it is distribution.

Here is a chart without anything marked. Try and point out the accumulation and distribution for yourself.

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Now, here is the same chart with the accumulation marked with green arrows:

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Lastly, here is the chart with the distribution days marked with red arrows:

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Spotting the Bottom

Now, this technique will help you spot a confirmed rally, which could ultimately be a major market bottom. Keep that in mind when using it to analyzing the market.

As the various indices fall during a bear market, they always stage a rally that can be very profitable to a trader who can tell the true rallies from the little blips on the way down.

For the start of a rally, you need to identify a day where the market finishes off lows after a decline the day before. Here, the volume is irrelevant, although higher volume is preferable. 

For the rally to be official, you are looking for a follow-through day to occur between 4 and 7 days from the original rally point. If the follow-through day happens between the 8th and 10th day, the rally is more likely to be mild.

The follow-through day should occur with accumulation volume and should be a major advance of 1% – 2%.

Example

Lets take a look at the recent rally in the S&P 500 to illustrate this point.

Here you can see the 1st day of the rally attempt marked by the arrow. Stocks pulled off lows to finish in the middle of the day’s range. We have a big day of accumulation two days after and then get the rally confirmation on the fourth day as the S&P 500 jumped up 4% on high volume.

Notes

The one thing to keep in mind is that this identifies rallies in bear markets as well as true market bottoms. Not everything you identify as a rally will turn into a true bottom, but only time will tell.

To trade rallies effectively, you should also learn to spot tops. I will be doing a post in the next week or so that will teach you to identify tops in the market.