Ingredients for a Stock Market Bottom

No way to sugarcoat it.

This week in the market sucked.

All US Major Market ETFs were down more than 2%

DIA ( ▲ 0.55% )  SPY ( ▲ 0.56% )  IWV ( ▲ 0.65% )  IWB ( ▲ 0.54% )  QQQ ( ▲ 0.74% )  VTI ( ▲ 0.47% )  OEF ( ▲ 0.48% )  MDY ( ▲ 0.71% )  SPSM ( ▲ 0.8% )  IWM ( ▲ 0.33% )  

If you missed last week’s post on risk management, it was timely, as many key levels got hit.

The S&P 500 finally broke out of its slap chop range, shifting from opportunistic to risk management mode.

Do I know the future? No.

Does anyone? Also no.

All we can do is take it day by day, manage risk, and watch for signs of a bottom or the start of something worse.

Let’s dig in.

Bottoms are messy.

You never really know it’s a bottom until after the fact.

But historically, two key themes show up again and again:

• Capitulation – Panic selling, extreme fear, and exhaustion.

• Price Action Follow-Through – A reversal that sticks.

1.) Capitulation – Everyone Giving Up

Warren Buffett’s famous quote, “Be fearful when others are greedy and greedy when others are fearful,” gets thrown around but most people don’t truly understand what it means.

WhenWhen sentiment hits extremes, the bearish case sounds smart, logical, and well-reasoned. But by then, most people have already sold.

That’s the paradox of market bottoms, the fear feels justified, but the worst is often priced in.

It’s scary in the moment, but that’s exactly how bottoms form.

If everyone has already sold, what’s there left to do?

Buy.

And that’s when markets turn.

Key Capitulation Data

Some of the best data for spotting capitulation includes:

• AAII Sentiment Survey – Tracks retail investor sentiment.

• New Highs & Lows Data – Shows whether stocks are breaking down or recovering.

The AAII Sentiment Survey, running since 1987, gives a forward-looking read on investor sentiment.

Extreme bearishness often signals we’re near a turning point.

The last two surveys showed the highest bearish sentiment and lowest bullish sentiment in over a year a potential sign of capitulation.

But sentiment extremes alone don’t mark a bottom, we need bulls to return for a real trend shift.

And that usually happens after price confirms the bottom.

You guys know I love my New Highs - New Lows data.

Just like sentiment surveys hitting extremes and rebounding, a deep drop in New Lows followed by a sharp recovery is often a sign that capitulation has played out.

This week, we saw readings we haven’t seen in over a year.

So, we’re getting capitulation signals from both AAII sentiment and New Highs - New Lows.

But it’s not capitulation that pays.

2.) Price Action Follow-Through

The capitulation signs are promising, but we all know what really matters.

Price, baby.

We need upside follow-through to confirm the move.

No confirmation, no bottom.

While waiting for that, we look for two key signals:

1 - Bullish Divergences

Sounds fancy, but it’s simple. Price keeps making lower lows, but breadth or momentum doesn’t.

That’s a sign sellers are running out of steam.

• Example: Earlier this year, RSP ( ▲ 0.94% ) made a lower low, but RSI (momentum) made a higher low.

• The downside acceleration stalled, setting up a bottom, but only after price followed through to the upside.

On a shorter time frame, we’re starting to see bullish divergences develop, but they need to follow through on the daily charts to mean anything.

We don’t get paid for spotting divergences.

We get paid when price confirms the divergences.

Right now, we’re still in a "sell the rip" tape but if this RSI divergence gets upside confirmation and price reclaims $580, that would be a promising sign that a bottoming process is underway.

2 - Failed Breakdowns – Flushing Out the Sellers

Just like sentiment capitulation, failed breakdowns are a flush-out.

Except this time, it’s the sellers getting trapped.

Price drops below a key level, attracts short sellers, then quickly reverses higher.

S&P 500 Example: This year, we’ve had multiple fakeouts below $580, only to recover quickly.

Right now, we have the potential for another one.

But, as always, we need price follow-through.

Key Levels to Watch: $580 & the 200-day moving average.

Holding support at the 200-day MA and reclaiming $580 would be significant.

It would shift the market out of a "sell the rip" environment and provide time for stabilization.

Bonus Analysis: Bullish Breadth Divergence

Looking at market breadth, we are also seeing a slight bullish divergence.

Even as price tested new lows, the percentage of stocks above their 20-day moving average did not break down further.

This adds to the evidence that fear may be overdone and instead of reacting emotionally, it may be time to start considering opportunities.

I’ve never been one for making wild predictions or overanalyzing the market.

Right now, I think it comes down to two things when looking for a bottom:

1. Capitulation – Have we seen enough panic selling?

2. Upside Price Follow-Through – Are buyers stepping in to confirm a shift?

At the end of the day, the market can’t reach new all-time highs without first reclaiming $580.

That’s the key level I’m watching.

We are getting close, but close isn’t the signal.

Confirmation is.

If we don’t see that follow-through, then it’s about continuing to manage risk against key levels and staying disciplined.

Check out my weekly show with my friends at Stocktwits!

I break down what’s needed for a market bottom, walk through all the Magnificent 7 stocks MSFT ( ▼ 0.9% )  NVDA ( ▲ 1.92% )  GOOGL ( ▲ 0.88% )  META ( ▼ 0.36% )  AAPL ( ▲ 1.59% )  TSLA ( ▼ 0.3% )  AMZN ( ▼ 0.72% )  MAGS ( ▲ 0.27% ) (which make up over a third of the S&P 500), and share my thoughts on chart requests from the chat.

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Cheers,

Larry Thompson, CMT CPA

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