How to Call a Market Bottom

Real bottoms don’t happen all that often, but when they do, if you call them correctly, you could make a small, or not-so-small, fortune. Bottoms are great because they represent fantastic buying opportunities with very little risk, as long as your bottom call is right.

But how do you call one? First of all, don’t rely on pure technical analysis. Chartists, even the best ones, are often wrong. The chart is not enough – you need to look at the fundamentals, too.

Cramer has never seen a software package that got it right. He’s never seen a stock bottom out based on an earnings report either. The thing about a bottom is that if too many people see it coming, it won’t happen. And bottoms rarely happen all at once. Usually, the market bottoms in thirds, sector by sector, over a period of days – not weeks. (OK, that’s not always the case, but it is how you should approach a bottom.)

Here are the three things Cramer uses as warning signs that a bottom is imminent: market sentiment so bad it makes the front page of the newspaper (the actual front page, not the business section front page), significant pullout by mutual funds, and some kind of catalyst, like the subprime lending crisis, one that’s not a catastrophe but has a widespread effect on the market.

Understand, to correctly spot a bottom, you need to be right when almost everybody else in the market is wrong. You also want to be looking for capitulation from the bulls who were holding out hope. When they give up, you get a massive “crescendo selloff.” You’ll see lots of volume and sinking prices as the last holdouts give up. You will not have a bottom until these investors have thrown in the towel. A crescendo bottom is one of the rare times when the market bottoms all at once, not in thirds, and you can really back up the truck and start buying.

Cramer's New Book