How To Identify Stock Market Bottoms: Use This Key Signal

While it’s impossible to know when the stock market is going to bottom, investors can use a chart signal known as a follow-through to begin buying stocks.

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Here’s what to look for: Following a prolonged market downtrend, look for the first up day from an index low. That’s the start of a rally attempt. The index can be the Nasdaq composite or S&P 500. The Dow Jones Industrial Average is rarely used for this signal.

In some cases, a down session can mark the first day of a rally attempt if the index cuts sharp losses and closes near the day’s highs. A close in the upper half of the day’s trading range is acceptable in these cases.

The most important element is a big percentage gain — something over 1% — in higher volume than the previous session on the fourth day or later of the rally attempt.

In the more than five decades since he began tracking this signal, IBD founder William J. O’Neil says he’s never seen a bull market that didn’t begin with a follow-through. Keep in mind that not every follow-through works. There have been false signals. If the index undercuts its follow-through day low, the signal is likely to fail.

That’s a lot of detail, so let’s walk through an example.

On Oct. 5, the Nasdaq rallied 1.25%, signaling Day 1 of a new rally attempt (1). Six sessions later — on Oct. 14 — the Nasdaq staged a follow-through by rising 1.7% (2) in higher volume than the previous session (3). The move — coming on the eighth day of the rally attempt — was the time to start buying stocks. The Nasdaq continued rising for several weeks before it hit another weak period.

Buying After A Stock Market Follow-Through

The follow-through day essentially tells investors to start buying quality stocks again, as they break out past buy points.

It should put your portfolio and mindset in sync with the stock market action. Sometimes, buying opportunities are scant on a follow-through day, especially after sustained downtrends.

But don’t panic if you miss the first couple of breakouts. If the stock market uptrend is real, there will be plenty of time to buy stocks and make money.

Following the Oct. 14 follow-through, Advanced Micro Devices (AMD), Coinbase (COIN), Nvidia (NVDA) and Tesla (TSLA) broke out past correct buy points, leading to big gains over the next few weeks.

On Oct. 18, AMD stock broke out past a double bottom’s 114.59 buy point, according to IBD MarketSmith chart analysis. Shares rallied as much as 34% past the entry to a Nov. 30 peak.

Coinbase broke out past a 280.71 double-bottom entry on Oct. 15. By Nov. 9, Coinbase stock advanced more than 31% from the buy point.

Nvidia topped a 230.53 entry in a choppy cup base on Oct. 25. Nvidia shares surged more than 50% to its all-time high on Nov. 22.

EV giant and longtime IBD Leaderboard stock Tesla moved past a 900.50 cup-base entry on Oct. 22. Tesla shares ascended more than 38% by Nov. 4.

Be sure to follow Scott Lehtonen on Twitter at @IBD_SLehtonen for more on growth stocks and the Dow Jones Industrial Average.