How to identify a market bottom? Let's talk how to identify the stock market bottom. S&P 500 is the famous stock index that is considered to the barometer of the US stock market. If it is going up, it means the stock market is doing well and if it is going down, it means the stock market is not doing well.
S&P 500 is comprised of 500 stocks that represents the different sectors of the economy. It is a value weighted index unlike the Dow Jones Industrial Average (DJIA) that is a price based index. So, when we talk of the US stock market, we should consider S&P 500 Index.
What we need to do is use the MACD or the Stochastic oscillator and wait for a divergence pattern to appear. Divergence pattern appears when the price action and the indicator are moving in the opposite direction. For example, the price action is sloping up while the oscillator is sloping down or the price action is sloping down and the oscillator is sloping up. This is considered to be divergence and when it appears, it means that the market is about to make a turn.
When, the price action is sloping down and the oscillator is sloping up, it is considered to be a bullish divergence pattern. Bullish divergence means the market is about to make a turn and an uptrend is about to start. In other words, the stock market has reached its bottom.
Now, when this bullish divergence pattern is identified, you need to confirm it with a trend reversal candlestick pattern like the bullish engulfing pattern. A bullish engulfing pattern is considered to be a pretty strong trend reversal pattern.
A bullish engulfing pattern is formed when in a downtrend, a bearish dark candle is followed by a bullish while candle that completely engulfs the bearish candle. This is a two stick candlestick pattern that takes two days to form.
When you spot this pattern, it confirms the bullish divergence pattern. What this means is that there is a strong probability of a trend reversal and the market reaching the bottom soon. You can use other trend reversal candlestick patterns too to confirm the divergence pattern. In fact, this method is used by pro traders to identify the top and bottom of any market whether it is the stock market, forex market or the commodities market.