Bulkowski’s The Nature of Bottoms

Written and copyright © 2009 by Thomas N. Bulkowski. All rights reserved.

When price bottoms, what does it look like? Is it a rounded turn, V-shaped, or have multiple valleys before price begins climbing again? This article takes a look at some examples to answer that question.

Bottoms Over Time: Crash of 1987

The chart shows the Dow Industrials (^DJI) on the monthly scale. The main chart shows the Dow during the crash of 1987. Price made a large drop over two days in October, shown here as a large black bar at A. Price bounced during the next two months to form a higher valley at B.

Notice that the decline was steep (at A) and the industrials did not slide horizontally for long. Rather, it began a new trend higher.

Also notice the approach, how price trends higher leading to A and the angle it makes after A. They angles nearly the same, aren't they?

WWII

Look at the small chart to the left. I show the Dow during World War II (1942-1943). Price made a V-shaped bottom, trending downward in a straight-line run and then recovering in a mirror image of the decline. The angles of the drop and rise look similar, about 45 degrees.

Go Go 60s

The years from 1962 to 1963 shows a different bottoming pattern. This pattern is similar to the bottom during 1987. The decline to the bottom at I is a steep, straight-line run down followed by a higher valley at J. This time, though, price moves up at a slower velocity than it did on the way down to I.

2002 Bear Market

The next inset shows the price action during the bear market in 2002 to 2003. Price forms a multiple bottom low, resembling a head-and-shoulders bottom, with the head at K and the right shoulder at L, and the left shoulder is the spike to the left of K. It is not a classic head-and-shoulders bottom because the two shoulders are not a symmetrical distance about the head.

Notice that the bottom at L is above the bottom at K. The angle of the decline and the angle of the rise are similar, about 45 degrees. In fact, a quick glance at the charts so far shows price rising at about 45 degrees after each large decline. Is that a clue to how price recovers after a bottom?

2008 Bear Market

Finally, we come to the current price chart. Price drops in a rounded turn, easing over and then tumbling. The speed of the decline is what makes this pattern distinctive. It resembles the 1962 and 1987 declines. Will it also bounce like those patterns?

The Ugly Double Bottom Secret

Now let’s look at how you can determine when the bear market is over. Returning to the 1987 chart, price touches down at A and bounces to make a higher valley at B. This pattern is called an ugly double bottom.

In a traditional double bottom, price touches down at two valleys that are near the same price. In an ugly double bottom, the second valley is higher than the first. It is an ugly version of a traditional double bottom.

When price turns from trending down to trending up -- a trend change -- it always makes a higher bottom (eventually). I show that higher bottom at point B. To be sure that the trend has changed, wait for a close above the high between A and B. That occurs at H

The inset in blue shows a clearer picture. Valley D is the first bottom followed by a higher low at E. Price has to close above F to validate the reversal. That occurs when price closes above the green line at G.

Looking at the other charts, point C is near where price bottoms in the higher valley, but I do not show the complete down move on this chart. Points J and L are the higher valleys.

Where is the Higher Low?

The 2009 bottom will have to form a higher low, then confirm it by closing above the peak between the two bottoms. The chart shows the first bottom has completed followed by a bounce upward.

Also notice that I am using the monthly chart. Although the ugly double bottom pattern occurs on all time scales, the monthly chart shows that the change from trending down to up takes months to form.

Looking at the Dow chart from 1936 onward (not shown), I see that the steeper the decline into the first bottom, the less likely it is that the index will form a multiple valley bottom like the recent transition from bear to bull market in 2002 to 2003. Rather, I believe the turn will look like 1987 where we had a steep drop followed by a higher valley and recovery thereafter.

To sum this up, look at the monthly charts for a higher bottom. When that occurs and price closes above the peak between the two valleys, then we have completed the transition from bear to bull market. And that is how the bottom will form.

-- Thomas Bulkowski

Written and copyright © 2009 by Thomas N. Bulkowski. All rights reserved. "One lawyer with a briefcase can steal more than 100 men with guns." -- Vito "The Godfather" Corleone