Market crashes are scary. At some point in the cycle of the global economy, market conditions will have one or several catalysts to trigger a major market crash. News, social media, or your so called "gurus" have the tendency to elicit fear in the investing public causing most to sell. This selling triggers a domino effect of panic which is represented as steep downtrends in the price chart. As frightening as it can be, these panic selling periods have been historically proven to be the best time to enter the market to make some serious profit.
As technical analysts, we look at the charts and use historical support & resistances, volume and market sentiment to gauge a possible low risk entry within the selloff. It is not our goal to bottom pick. Our underlying motive is to be at the buying side when market conditions show signs of reversal. The question to ask now is, how do you spot this reversal point?
Analyzing Volume
It is important to understand that stock prices move up and down because of the prevailing supply and demand of major financial institutions and other key players of the market. When buying volume is greater than selling, prices go up. When selling volume is greater than buying, prices go down. The reasons for the strength and weakness of demand can be caused by a multitude of factors. It is no longer our goal to determine the exact reasons. Our main goal is to look at volume and calibrate the trade plan based on the prevailing information that the chart provides.
When buying volume starts to pick up, you should be at the buying side of the market. When selling volume starts to increase, you should start locking in on your profit or remain in a cash position (whichever your trade strategy is).
Signs of a Reversal
The chart usually shows some notable signs of a reversal on the later phases of a market selloff. Price candles, volume and patterns emerge that show fresh buyers and decreasing selling volume which generally leads to a shift in trend.
In interpreting the chart, price candles tell large part of the story. During the peak of the selling phase, red candles are long and form together in a sharp declining manner. Gap downs are common during market sell offs. This shows that majority just want to get out at any price they can. This is the classic nature of panic selling scenarios. As selling loses steam, candles will be shorter. A Doji or a Bullish Pinbar candle at a key support level are good signs that selling and buying are reaching an equilibrium. This may mean that several key players may have started to shift at the buying side already.
The Bullish Divergence
A bullish divergence is illustrated in the chart when a contradiction forms between the price and the RSI. This signal happens when the indicator (usually the RSI) is making HIGHER lows while the price action of the stock is establishing LOWER lows. This signifies weakening selling pressure that might transition to an uptrend rally.
As seen in the chart above, a Bullish Divergence is formed at the multi year support level. Price goes lower but the RSI shows that selling volume is decreasing which eventually shifts the price to an uptrend.
The Double Bottom
A Double Bottom pattern is a typical reversal pattern that occurs in a stock’s key area of support. After a stock bounces from a major downtrend, the price will likely retest the support area to validate the strength of the buying pressure. As more buyers come in, another bounce is triggered and eventually propels the stock price to break its initial resistance.
The chart above shows a typical Double Bottom formation. After a steep downtrend, the price makes an initial bounce at a key multi-year support area of the chart. After failed attempts at a breakout, it retests the support a second time with greater buying volume that eventually results to a breakout.
"The time to buy is when there's blood in the streets." Baron Rothschild
The stock market has shown time and time again that history tends to repeat itself. Having the awareness to spot a market crash and utilizing the necessary trade strategies to enter it will enable BIG profit for your trade/investment portfolio. So next time you see the market tumbling down, know that there is a pot of gold at the bottom.
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