Bulkowski’s Review: 2000-2002 Bear Market

Written by and copyright © 2005-2008 by Thomas N. Bulkowski. All rights reserved.

For 18 years I waited for a bear market. When I wrote the first edition of Encyclopedia of Chart Patterns, I did not cover bear markets because I could not locate any data. That changed in 2000. All of the indices started trending lower. This page examines what happened.

I define a bear market as when an index or average (I prefer the S & P 500 Index) declines by more than 20%. Similarly, a bull market occurs when the index or average rises by at least 20%. Based on this definition, you will not know you are in a bull or bear market until well after they have begun. That is not a problem because bull and bear are just labels. Following the current market or stock trend is more important than a label.

From a technical analysis standpoint, the bull market ended this way: The Dow Industrials formed a broadening top that eventually broke out downward. The S & P 500 Index formed a diamond top but it had an upward breakout. However, the index failed to make a new yearly high and it started down, too, following the Dow lower by about two months. The Nasdaq formed an inverted and extended V-shaped top which preceded a double top. The composite confirmed the double top and down the market went.

At the bottom, when bear turned to bull, the three markets studied below showed similar patterns and all turned upward in October 2002. A head-and-shoulders bottom chart pattern predominated. None were prefect examples of that chart pattern but perfection is rare in the markets. Nevertheless, the head-and-shoulders signaled the turn and the markets responded by soaring.

The above chart shows the Dow Jones Industrial Average before and after the bear market of 2000 to 2002. The first thing I notice is the weekly price range shows large swings. This is probably due to the small number of stocks (30) involved in the average calculation.

A broadening top chart pattern appears during 1999 and the Dow reaches a high at B. That high marks the end of the bull market despite the average moving horizontally for the next 1.5 years.

The partial rise at point A predicts a downward breakout. That does occur, but it takes over a year. Between the breakout and the end of the broadening top, a descending triangle has an upward breakout. This is bullish and a descending triangle with an upward breakout is one of the chart patterns I look for and trade.

The rise after the triangle breakout did not last long and the index tumbled, leading to the start of a large broadening bottom. The index broke out downward at C, but that lasted just another week before the index made a large upward rounding turn, an inverted and ascending scallop (shown but not highlighted between C and LS). The bottom of the scallop ended at the start of a head-and-shoulders bottom. The head-and-shoulders is not symmetrical, meaning that the left shoulder (LS) is closer to the head than is the right shoulder (RS). The head of the head-and-shoulders bottom marked the end of the bear market. The industrials after the right shoulder low climbed in a straight-line run.

The Standard and Poor's 500 Index shown above has a large diamond top chart pattern. The peak in this diamond marks the end of the bull market in the S & P 500. The breakout from the diamond is upward but the index fails to make a new yearly high. The index tumbles, forming a descending broadening wedge. An inverted and descending scallop lifts investor’s hopes but then dashes them when the index rounds downward. It bottoms at A, bounces and forms a slightly lower low at B, and a slightly higher low at C. The three valley pattern is a triple bottom. Point B marks the end of the bear market for the S & P 500.

A higher low (C versus B) is one of the ingredients of a trend change, but it is not a guarantee of success. Look at points 2 and 3. The higher low (3) and higher high are bullish but the index falters and dives. The 1, 2, 3 pattern looks like a head-and-shoulders bottom and indeed it is. It confirms as a valid chart pattern when the index crosses the green neckline. But in this case, the rise did not last long and the market tumbled, continuing the bear market.

The last chart shows the Nasdaq composite on the weekly scale. An Adam & Adam double top chart pattern (points A B) signals a bearish turn for the composite. The market drops, forming two large descending scallops just before the composite bottoms. Points F, D and E might be called a head-and-shoulders bottom, but with the unsymmetrical shoulders in both time and price, I would not pay attention to it. Rather, points D and E form an ugly double bottom which calls the end of the bear market (the low at D, is the turning point in the high-tech market from bear to bull).