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Fly Fishing the Stock Market: How to Search for, Catch, and Net the Market's Best Trades by Stephen Morris

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BOTTOM PATTERNS

This pattern is easy to recognize. Along with topping patterns, bottoming patterns form at market extremes, are usually associated with divergences of trend-following indicators, and occasionally accompany exhaustive moves.

The following is a list of the basic elements of bottom patterns:

  • Some event or technical feature has led to a severe price sell-off.
  • Prices drop through support, leading to a precipitous sell-off to new interim lows.
  • EMAs turn down, the fast dropping below the slow and the slow dropping below the 50-day EMA.
  • Momentum begins to weaken, represented by diminished volume and associated bullish divergences of the indicators (MACD, Force Index).
  • Following a feeble bounce, previous lows are retested, usually leading to lower lows.
  • Down thrust of prices continues to diminish, causing price bar shortening and a reversal of the moving averages. This is commonly combined with an MACD line and histogram bullish divergence as higher lows for this indicator are put in.

Figure 8.2 illustrates the technical formation of this pattern in the SPY, an electronically traded fund of the S&P 500 Index.

FIGURE 8.2 The market bottoms out.

SPY, daily, indicator set #8.   • A sharp sell-off (A–B).   • A low point reached with prices far below the moving averages (area B).   • A bounce to the value zone that doesn't hold (area C).   • Prices drop to a new low (area D) as the MACD lines and histogram put in a higher low.   • Prices recover to the 50-day EMA (area E) ...

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