How to Know When the Stock Market Bottoms Out

SmartAsset: How to Know When the Stock Market Bottoms Out

From global politics to the prospects of tech startups, many influences drive the stock market. So when investors grapple with market volatility, one question often emerges: Will the market rebound now or is it headed further downward? While there are no certainties in the market, history shows that specific indicators can help investors tell if the stock market will bottom out. The stock market bottom during a bear market is the lowest average price securities fall. Here’s how to know when the stock market bottom occurs and what to do.

A financial advisor could help guide your investments during market volatility or a bear market.

While the average investor might associate a stock market plunge with economic recession, it’s important to remember that a stock market bottom is established when stocks begin trending steadily upward again. Therefore, market performance has its own characteristics – sector factors, price, volume, and market happenings – that indicate a market bottoming out. Let’s take a closer look at what each can reveal:

Sector factors. Every stock you invest in belongs to a company, which has its place in a sector in the economy. Each sector consists of businesses that operate in the same economic arena; for example, financial, medical, and entertainment are different sectors that individuals and companies can invest in.

Usually, a stock’s performance correlates with the sector it belongs to, and each sector’s stock price correlates with the rest of the market. Abnormalities in sectors can indicate the bottoming out of that sector or a downturn in the market. For example, in March 2020, the COVID-19 crisis caused energy sector stocks to drop while the grocery sector soared.

Poor performance among a few scattered sectors may hurt some portfolios. However, if many sectors take historic dives, the stock market has a greater chance of bottoming out.

Price and volume. Stock price and volume across sectors also tell part of the story in the overall market. Typically, stock prices reach their bottom when sellers become rare and an abundance of buyers exists.

This scenario may seem counterintuitive, but it’s a picture of the market at its bottom rather than on its way to the bottom.

While panicked trading and decimated investment accounts might characterize a declining market, a bottomed-out market is different. It features the lowest price at which stocks are traded and the beginning of rising stock prices as swaths of buyers start competing over the limited amount of stocks for sale.

Pay attention to market happenings. Just as the market constantly changes, how investors feel fluctuates as well. Since investor sentiment drives trading activity, it’s a key influence on market performance. In other words, investors’ fears of a bear market can become a self-fulfilling prophecy if most investors decide to hold their positions and regard other stocks as overvalued.

To get a better idea of how investors feel, the American Association of Individual Investors (AAII) publishes a weekly report on how investors think about the stock market’s future. The AAII has conducted this survey since 1987, and looking at the data can provide indicators of how investors’ feelings correlate with when the stock market bottoms out.

How to Weather a Bear Market

A bear market is the name for when the stock market’s value drops by 20% or more. Bear markets are problematic for obvious reasons: they can ruin investment accounts and even jeopardize older Americans’ retirement plans, forcing them to work for more years.

Unfortunately, stock market volatility isn’t going anywhere. However, here are five common strategies to mitigate the financial damage and keep your investment accounts going strong:

Diversify. Whether you actively manage your investments or put your money into a stock index, diversifying your portfolio will help you endure stock market dips. Consumers consistently purchase the basics regardless of market conditions. Companies that make food, toothpaste, and other staples may not be as exciting as tech startups, but they’re reliable in a bear market.

Dollar-cost averaging. Dollar-cost averaging operates on the idea that buying stocks over time is better than making one big stock purchase. By putting money into your investments every month rather than once or twice a year, you give yourself more opportunities to buy low. Gradually buying into various stocks reduces your risk and keeps you from committing to one stock at a specific price and relying on that position to make gains. In a bear market, a steady, modest stream of funds allows you to take advantage of falling stock prices.

Assess risk. How much risk you’re comfortable taking is critical for your investing habits. If you can make your peace with riskier stocks, then losses on some of your more aggressive positions might not bother you. However, if you have low risk tolerance, investing in stocks with less risk and less reward might be a wiser choice. Bear markets happen to everyone, but what’s vital is using an investment strategy that matches your preferences and doesn’t cause you stress.

Hedge options. Hedging is a way to insure yourself against downward trends in the market. While it can seem like a complex strategy for expert investors, its premise is simple. There are financial instruments you can purchase if you think your investments won’t give you healthy returns over a specific timeframe.

For example, you can enter an agreement to buy or sell stock for a preset price at a specific time in the future. This strategy is one of many ways to engage in options trading, and it can help you diminish your losses in a bear market.

Work with a financial advisor. Whether your stocks are providing great returns or plunging to historic lows, it’s challenging to beat the market over the long haul. Financial advisors can help individuals optimize their investments and meet their financial goals. Their expertise gives them insights into how to minimize losses during a bear market and find opportunities for gains.

Investing is complex, and a field of professionals make their living just by working in it. If you’re feeling lost, taking advantage of their skills can help you weather a bear market.

Bottom Line

The stock market is never entirely predictable, and investing in a volatile market can be challenging. However, by paying attention to trends in sectors, overall trade volume, and investors’ attitudes, it can be easier to tell if the market is bottoming out. Additionally, surviving a bear market that is bottoming out is daunting for any investor. That’s why working with a financial professional can help you stay calm, adjust wisely and keep your long-term financial goals in mind.

Tips for Investing

One of the benefits of working with a financial advisor is having someone who can help you interpret market data and make smart decisions to match your financial goals. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Use SmartAsset’s no-cost asset allocation calculator to get a quick estimate of how best to adjust your investment portfolio in light of your timeline and risk profile.