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"Markets which have been in a persistent downtrend often exhibit a common pattern as the end of the decline is approached. The pattern is to post a sharp rally followed by one final decline to new lows.
Let's use this example of sharp, past rallies that were formed in both pork bellies and gold. Following the rallies, both markets plummeted to new lows. However, once new lows were made, the declines stalled. The failure to sustain the break on the move to new lows indicated the selling was effectively exhausted and potential bottoms had formed. A similar pattern marked the low in soybeans prior to the 1983 bull market..."
Revisit the Trader's Toolbox Post: "Bottoming Behavior" here.
Jennifer,
This bottom pattern isn't much described elsewhere, but is a very reliable one. This is the "central dome" in a cup, and it signals a shift in the relative strength from negative to positive, as the buy-side mobilizes after a lengthy downtrend and such confirms the support levels.
The time perspective is just as important as the levels in this, since buyers with the shorter horizon mobilizes more readily than those with a longer horizon. This tend to create a steeper upturn than decline on the dome, which essentially results in an RSI>50 for the complete dome - and confirms the change in dominant pressure between buyers and sellers. If the RSI for this formation is not above 50, then the actors with a longer horizon haven't mobilized. Then major support may still be broken, and just a change in a longer-term declining trend could could be the case.
When the investment horizons among the actors are more or less evenly distributed, this formation (the "dome") becomes a very good signal for an arriving pivot point. It's usually located to the right of the central vertical line dividing the cup, but not always so, as this also depends on the news-picture reaching the markets. And remember: A cup can be inverted as well.
Happy trading! 🙂
Thanks, Jen -- If this paradigm is being posted to suggest the general stock market (main indexes) is finishing up this correction, I think it might be premature. Indicators I watch are not yet flashing positive divergences and the key support pivots (for example 1303 on SPX) have ben violated and now have a weekly close below. Slow Stocastics are still pointed down on the daily charts. The volatility gauges have yet to show real
fear which I think speaks to complacency and is somewhat ominous. That indexes closed very close to lows today and importantly, on the week, suggests lower prices ahead. Of course there's always the Bernak & the PPT in the wings to, as usual, ride to the rescue. But sticking to price action and the charts, I think its fair to say we need the smoke to clear and more evidence before declaring the bottom is in.
thank you, jennifer for your patience in reviewing these techniques for us. it is interesting to apply rules and patterns to the chart which expresses the emotions of people trading. my question: do the bottoming behaviors also apply to topping markets?
thanks ec