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How to Call a Market Bottom

A real bottom doesn’t happen all that often, but investors can make mad money if they know how to call one. It's a fantastic opportunity with very little risk, Cramer said, as long as the bottom call is right.

But how does an investor call one? Cramer's first piece of advice is to never rely on pure technical analysis. Chartists, even the best ones, are often wrong. The chart is not enough – the fundamentals need to be considered too.

Cramer has never seen a software package that got it right. He has 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, he said. And bottoms rarely happen all at once. Usually, the market bottoms in thirds, sector by sector, over a period of days – not weeks. This isn't always the case, but it is how Cramer recommends investors appraoch 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, an investor needs to be right when almost everybody else in the market is wrong. He also wants to be looking for capitulation from the bulls who were holding out hope. When they give up, there is a massive “crescendo sell-off,” Cramer said. There will be lots of volume and sinking prices as the last holdouts give up. Unless these bulls throw in the towel, there is no bottom. A crescendo bottom is one of the rare times when the market bottoms all at once, not in thirds, and an investor can really back up the truck and start buying.

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Cramer's New Book