Learn four tools that will help you spot stock market bottoms. They will tell you when it is time to start buying stocks again and when conditions are favorable for swing trading stocks on the long side.
As swing traders, we want to avoid the big downside drops and get back in once there is some confirmation that a new uptrend is starting. As investors, we want to know when the drop is finished so we can buy long-term positions at great prices.
There are actually highly reliable signals that alert us when an uptrend is potentially starting following a decline; in other words, these signals alert us when the stock market has bottomed.
Once those signals have been generated by the market we can start buying stocks again for swing trades (with valid trade setups).
A few notes before we begin:
- By “stock market” I mean the major indexes. Typically I look at the S&P 500 (SPX on TradingView) and/or the Nasdaq 100.
- By “swing trading” I mean taking trades that have a calculated stop loss and exit point for taking profits. These trades typically last a few days to several months.
- I swing trade with a specific style that requires a rising market, and then I buy stocks that are moving aggressively higher overall. This is called momentum swing trading. The Continuation Patterns article, along with the links within it, describes a good chunk of the method.
- By market correction/decline, I mean a greater than 10% price decline in the major indexes. A decline that typically takes us out of all positions and has us waiting for a turn higher before getting back. Small declines in the index typically don’t stop us out of positions and are quickly recovered anyway, so these types of signals aren’t needed (although you can still look for the signs of strength discussed, such as rising ADL and a good number of stocks in short-term uptrends).
How to Know When the Stock Market Has Bottomed
I don’t know when a bottom will occur in advance. I see lots of people trying to predict when a bottom will occur, but this isn’t required. Instead, we can wait for signals that tell us the bottom is already in. These signals typically occur within several days of the stock market bottom. Needing to predict the exact bottom is ego, not trading. Once the stock market turns higher, there is loads of money to be made. Knowing the exact bottom in advance is inconsequential.
There are two signals that have a highly reliable track record for signaling that a stock market has bottomed or is near a bottom.
- Lowry 90% upside day (or two 80% upside days in a row).
- and/or a William O’Neil follow-through day.
We really only need a follow-through day, but it is nice to see a 90% upside day (or two 80% upside days back-to-back) followed by a follow-through day.
These are not my signals. They were developed by others, I have just incorporated them into my method. I will provide how I use them, and provide resources for additional information.
Lowry Upside Days
A 90% upside day is when 90% of the volume on a given day occurs in stocks that moved higher during the session. This must be based on closing data (full day, not intraday data). Back to back 80%+ upside days are equivalent to one 90% upside day.
You can calculate this number by taking “up volume” divided by “total volume”. On TradingView I use USI:UVOL/USI:TVOL. On StockCharts $NYUPV:$NYTV.
You can also manually calculate the values using WSJ daily data: divide Adv. volume by Total volume (the bigger numbers, without * beside them. The ones with * beside them are block trades. We want the total volume, not just block trades).
90% upside days often occur while stock prices are still falling or right near the bottom. It is an early warning sign that the stock market is within 7 days or less (typically) of a stock market bottom.
We don’t act on a 90% upside day. It just lets us know that the market may be near a bottom. We can then start scanning to find strong stocks we want to buy IF we get the other signals. We don’t place any swing trades yet, though.
We only care about 90% upside days as the price is falling, and very early in the uptrend. Once the price has already started to rise for several days, they don’t matter anymore. The other signals discussed take over.
You can read more about Lowry upside (and downside) days in the free Lowry whitepapers – the paper relating to this topic is Identifying Bear Market Bottoms and New Bull Markets – A Study of 90% Days.
A follow-through day is simply a strong volume and price advance 4 to 7 days into an attempted rally. Notice, the price actually has to start rising, for more than three days, in order to generate this signal.
- A major index—I use the S&P 500 mostly—must advance 1.5% or more in a day, four to seven days into an attempted rally (1.25% is the bare minimum and a pretty weak signal).
- The 1.5%+ advance must come on higher volume than the prior day.
- Typically follow-through days are strong, like 2%+ to the upside. With lots of big movement days occurring all the time, a 2%+ follow-through day will likely become the norm.
Here are the requirements of an “attempted rally”.
- An attempted rally is when the price moves higher off a low point and then makes a higher close (day 1).
- The price must not undercut the low of day 1. If it does, everything starts over.
- Following day 1, assuming the price doesn’t undercut day 1, then we wait for a strong price and volume advance between days 4 and 7. Allow a few extra days if needed, but no more than 10 days.
Once we have a follow-through day—strong price and volume advance 4 to 10 days (within 7 ideally) into a rally—then we know a bottom is likely in. That doesn’t mean the price will surge higher, or that the price can’t re-test the low point, but it is strong evidence that buyers have stepped in and overall we are likely to see higher prices over the next few months.
If you are an investor (long-term buy and hold), at this point you can start buying those great stocks you have been eyeing.
If you are a swing trader, then maybe pick one or two of your very best trade ideas, in the strongest stocks you can find, and allocate a portion of your capital to them. As mentioned, the indexes have turned but that doesn’t mean they can’t decline or chop around for a while. It is not time to plow 100% of your capital into stocks, but you can start allocating maybe 20 to 40% of your capital to high-quality trade ideas (for me, that is typically 2 or 3 trades, using Fixed Dollar, With a Twist, Position Sizing.
All trades, of the few taken at this point, must have a valid setup based on the stock strategy you are using. If you can’t find a trade with a valid setup (cup and handle or continuation pattern) then stay out until you have a valid setup.
This is early in the trend. There is money to be made, but as the uptrend unfolds there is MUCH more to be made. So we don’t need to rush in. Grab one or two good stocks if they set up properly, but don’t dive in 100% just yet.
On small typical corrections, like 3% to 7%, in the S&P 500 we may not get follow-through days to signal the emergence of a new uptrend. This is because a small correction isn’t a big deal. We don’t need to see that big surge in volume come in, because the price didn’t decline much and we probably weren’t even stopped out of all our positions.
That said, you can still look to see if the market is healthy by using the below indicators to determine if it is wise to keep taking trades or if you want to hold off until conditions improve a bit. On small typical corrections, I am usually still scanning and looking for trade setups to buy unless we have signals of a possible top or decline in the indexes (an article for another day).
Follow-through days were introduced to me in a book called How to Make Money in Stocks written by William O’Neil. I highly recommend reading it.
Additional Indicators for When to Start Aggressively Swing Trading Again
If we get the 90% upside days and a follow-through day (most important) then the stock market indexes have likely turned higher. The indexes are a reflection of what many stocks are doing, so as the indexes turn higher, you can bet most stocks are as well. The strongest stocks out there turned higher much earlier, are already in uptrends, and are starting to set up high-momentum cup and handle and continuation pattern trades.
We may be holding one or two trades at this time (less than 40% of our capital) as setups are typically limited at this point, and we are very early into an uptrend.
As the uptrend unfolds we will start to see more stocks provide trade setups based on the cup and handle and continuation pattern strategies.
We can also look for additional confirmation from the following indicators that the stock market is indeed becoming favorable for swing trading on the long side (buying stocks).
Once the following two signals occur, I will typically have all my swing trading capital allocated to stocks assuming I can find 5 to 7 great swing trades. This usually isn’t a problem if we have had the follow-through day, greater than 50% of stocks are above their 50-day moving average, and the NYSE advance-decline line making swing highs.
Percentage of Stocks Above 50-Day Moving Average
This is a simple metric that tells us how many stocks (percentage of total) on the NYSE are above their 50-day moving average. It is a crude metric of whether lots of stocks are in short-term uptrends or not. The NYSE lists stocks of varying sizes and from different industries, so it is a good metric of whether most stocks are in an uptrend or not.
On TradingView, open your SPY or SPX chart and then click compare: type S5FI (under index). Right-click on it and select Move to >New Pane Below if you want it below your chart. On StockCharts the symbol is $NYA50R.
Our odds of winning trades increases with more stocks in uptrends. If only a few stocks are in uptrends, unless your stock selection is absolutely perfect you’ll likely lose money.
Conditions are typically ideal for swing trading on the long side when more than 50% of stocks are in short-term uptrends. Yet, after the follow-through day you can typically add another trading position as the indexes and the percentage of stocks above their 50-day average keep rising. Once it is over 50%, I have no problem being fully invested.
I also look to the next indicator for confirmation.
Monitor Swing Highs in the NYSE Advance-Decline Line
The NYSE Advance-Decline Line (ADL) is a running index of how many stocks rise and fall each day on the NYSE stock exchange. It is a broad measure of how most stocks are performing, since the NYSE lists thousands of stocks.
When most stocks are rising over time, the ADL will trend higher, creating higher swing highs and lows. On TradingView the indicator name is ADL. On StockCharts it is symbol !ADLINENYA
Before I start swing trading aggressively I want to see the NYSE ADL making at least one higher swing high. This shows many stocks are moving higher off their bottoms. We don’t need to use a major swing high. Movement above the most recent high point is fine. There will certainly still be other peaks above it. Those will be overcome later.
This signal will often occur around the time of the follow-through day, but not always. Once a follow-through day occurs, we can check to make sure that the NYSE ADL has also made a higher swing high.
This is another measure that helps give us the “all-clear”. If we have a follow-through day, and the NYSE ADL hasn’t made a higher swing high (and is still moving lower), that tells us that participation in the rally is still low. While the S&P 500 (a select basket of large companies) may be moving higher, the majority of stocks may not yet be moving up aggressively. I may still take one or two trades in really strong stocks (assuming we have had a follow-through day), but until the NYSE ADL starts moving up, I won’t be loading up on trades.
An uptrending NYSE ADL is even better.
We don’t need to be the first people in at the bottom. With these indicators, we will be getting in plenty early. But by waiting for these signals, we avoid getting caught in a bunch of false rallies.
Finding Stock Market Bottoms, Swing Trading, and Tying It All Together
None of these signals in and of themselves trigger us into trades. All they tell us is that it is ok to start considering taking quality trade setups in strong stocks. If you haven’t been scanning, the 90% upside days and follow-through days tell you to start!
These signals are not 100% accurate. We will still have losing trades.
Yet by following these protocols you won’t be buying as price keep falling on you. Also, if stocks do fall after a follow-through day, our loss is limited to a very small amount of our account if our stop loss is hit (because we have only used a small portion of our funds).
A 90% upside day, or a two 80% upside days (back-to-back) typically occur near the end of a decline or early in a rally. Often, the signals occur a bit too early, which is problematic because during a selloff the price can fall a lot even in a week. Once we see a 90% upside day, we get out game-face on. We know a turn higher is near, but we still need to wait for more confirmation.
Regardless of whether we see a 90% upside day or not, we must have a follow-through day before we even consider buying swing trading stocks. Once the follow-through is confirmed, that is typically when I buy investments (I just buy index ETFs) for my retirement accounts.
For swing trading, once the follow-through day has occurred, you can start scanning for great trade setups in strong stocks. If there aren’t any trade setups like the ones discussed in the cup and handle and continuation patterns articles, then don’t trade yet. After a follow-through day, I may take one or two trades at a time…this is less than 40% of my account (2 trades).
Once I start also seeing a higher swing high on the NYSE ADL and the percentage of stocks above their 50-day moving average is increasing, then I know conditions are likely favorable. More setups are likely to start occurring. When more than 50% of stocks (or close) are above their 50-day and all the other indicators are a thumbs-up, then I am willing to allocate all my swing trading funds to trades…but of course only if I find enough valid trades to use all my capital (typically about 5 to 7 trades at a time).
My actual stock trading strategies go hand-in-hand with all of this. Once the index starts looking good and healthy, I start looking for trade setups. Those trade setups require a breakout (in the individual stock) to the upside. Unless the index keeps rising, those stocks likely won’t trigger my buy stop-limit order. If the index starts dropping again, nothing happens. My orders don’t fill and I go back to waiting and watching for setups. If the market keeps rising, my buy orders will likely trigger and I am riding strong stocks higher as the stock market continues to push higher.
Here is a video I made back in March of 2020 as the stock market was selling off due to COVID-19 fears. I have been able to find all these tools on TradingView, so I now use that.
Adding All These Indicators to Your TradingView Chart
Here’s how to add all these indicators to your chart on tradingview:
Do this all an SPY / SPX/ S&P 500 /or ES futures chart.
In the main ticker box where it says SPX, or whatever index ticker you are using, type: S5FI. Make sure to click ALL so it searches all products. This will change your chart to this symbol. > Right click on it > Move to > New Panel Below. This will make it look like an indicator. Click on the settings for it > Style > next to the color, pick Line chart instead of candles.
Repeat the above process for the next one. Copy this into the symbol box for the main chart: USI:UVOL/USI:TVOL > Right click on a data point > Move to > New Panel Below. Click on the Settings for it > Style> next to the color pick Columns.
In your main ticker box, put the symbol back to SPY or SPX or whatever major index you are using.
Add volume as an indicator.
ADL is an indicator. Add indicator>ADL
Rate of Change is an indicator. Add indicator>ROC (rate of change). Click settings, under Input: 1, close. This one isn’t discussed in this article, but it is important for seeing when big drops may be starting. I discuss in detail in the Market Analysis section of my Complete Method Stock Swing Trading Course.
SAVE THE CHART LAYOUT IN THE UPPER RIGHT. All these indicators will take up some real estate, and we don’t need to be looking at them all the time. Double left-click on your chart to temporarily hide them. Then double left click to bring them back when you need them.
Cory Mitchell, CMT
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.