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Technical Analysis Deep Dive: The October 13th SPY Bottom

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On Wall Street, picking bottoms can be a dangerous endeavor. Why? Because by nature, one who picks bottoms is going against the trend. Nevertheless, investors who can correctly time their buys on severely beaten-down assets can reap major rewards. Benefits include:

More Reasonable Valuations: Corrections can make stocks and markets cheaper from a price-to-earnings (P/E) perspective.

Enormous Mean Reversion Potential: Beaten down stocks can often act like a rubber band being stretched far in one direction – when they snap back in the opposite direction, they can snap back with gusto.

Investor Psychology: There are many ways to “skin the cat” on Wall Street. While some investors may prefer to latch onto existing trends, others may like to buy into weakness.

Learning to Identify Bottoms

Regardless of your investing style, learning to identify potential bottoms in the stock market is a skill that can pay signficant dividends. After all, three in four stocks tend to follow the general market’s direction. In October 2022, the S&P 500 Index ETF ((SPY - Free Report) ) flashed some classic bottoming signals, including:

Bullish RSI Divergence: The Relative Strength Index, or RSI, is a technical indicator used to measure the strength and momentum of a price trend. Bullish divergences in the RSI occur when the price of an asset makes a lower low while the indicator notches a higher low – a subtle indication that, despite the price drop, bullish momentum is picking up.

The black box in the picture below shows the SPY’s bottom late last year. Point #1 shows where the RSI hit lows, while point #2 identifies where SPY hit lower lows. The bullish RSI divergence was a subtle yet valuable clue that bulls were gaining momentum.

Zacks Investment Research
Image Source: Zacks Investment Research

Bullish, Wide-Range Reversal Candle & Blowout Volume: While the bullish RSI divergence was a step in the right direction, the bottoming day (October 13th) divulged additional clues for savvy technicians. First, SPY shook out weak hands by undercutting the previous low and reversing higher. Next, the price reversed violently to finish the session higher by 2.64%. Note how the range was the widest price range in months – this is typical for a market bottoming day. Finally, volume rocketed to 79% above the 50-day average – signifying heavy accumulation.

Zacks Investment Research
Image Source: Zacks Investment Research

Market Climbs “Wall of Worry”: On the morning of October 13th, inflation reached its highest level in 40 years. However, after early weakness, bulls took control. Remember, its not the news that matters, but rather the reaction. When bad news is good news, good news becomes even better news. Since then, inflation has cooled and stocks have roared higher.

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