Market X-Rays: All the Symptoms of Nearing a Bottom

Editor's note: This was originally published on RealMoney. It is being republished as a bonus for TheStreet.com readers.

From a technical, sentiment and institutional money flow standpoint, there appear to be some important changes occurring in the market. I started pointing these changes out in my column on Oct. 10 when I said:

"Depending on how the market closes today Oct. 10, I may start to look for some long-side opportunities in the indices I have highlighted. The key will be for a big down opening this morning, and then we close higher at the end of the day. ... If that happens, it may be a good time to start small positions in these areas with protective sell stops directly beneath those lows."

That situation happened that very day, and I began to take positions in the index ETFs. I followed up in my column last Friday, noting that sentiment indicators were hitting historic extremes.

Technically the stock market has all the symptoms of being near a short-term bottom. If so, the next question will be whether it is a major bottom that holds for a number of years, an intermediate-term bottom that holds for six months, or a short-term bottom that holds for a few weeks. The first step is to determine whether a bottom has truly been reached.

Mr. Market that has managed to defy all the usual rules over the past few months, so I am not ruling anything out, but looking at my indicators and historical precedents, the situation is looking brighter than it has for some time.

I'm sure readers are still asking how I can be more optimistic when the news is so terrible. In fact, last week's economic news was the worst that I have ever seen, even topping the pessimistic outlook from September.

We have sentiment readings like consumer confidence, which was so severe it fell from 70.3 to 57.5 -- the worst decline ever in both speed and magnitude. Retail was also hitting a wall along with industrial productivity, which is suffering the worst decline since 1974.

If you have been studying the market for any length of time, though, you know that markets tend to bottom when economic conditions are at their absolute worst, and it's hard to imagine them getting much worse than they are right now. With the government and the Federal Reserve ready and willing to take whatever measures necessary to flood the economy with money and support to avoid a major depression, the current situation could continue to improve.

The credit markets are also beginning to loosen and we have support from the oil markets with oil trading near $70 a barrel. That is not something that is likely to hold for the long term, but it sure helps our current situation.

Let's take a look at some X-rays of the market.

Institutions -- Buying, Selling
Click here for larger image.
Source: StockTiming.com
The first notable change over the last few days in the institutional buying/selling chart, which tracks the spread between how much buying and selling institutions are doing on a given day. This relationship is the "control factor" institutions have in what happens in the market and on the VIX.

Over the past few days there has been a dramatic change in institutional activity. The spread between buying and selling narrowed significantly, and selling dropped tremendously. Normally, we would get a trading range from this action, but there is a possibility that an attempt for a strong drive higher over the next few days could push stocks higher.

You can see from the chart that the selling (in red) had reached extremes over the past few weeks but is now starting to drop dramatically. The important key here is that the blue line, which represents institutional buying, has begun to trend sharply higher.

My indicators on the major indices have given off a solid short-term buy signal. My intermediate indicators are still negative, but current conditions continue to signal a high probability of further upside. The key now will be for the market to confirm that our indicators are correct. This is often the mistake that many market analysts make -- they trade strictly off of fundamentals, or economic conditions, or technical indicators, and they leave out the confirmation of market action. Until that happens, nothing is confirmed.

All of the indices are forming a technical pattern called a symmetrical triangle. This formation is normally positive in an uptrend and signals higher prices ahead. However, any downtrend triangle is usually bearish. That is why we must make sure that the market confirms our other indicators before we can be sure that the short to intermediate term is in the process of changing.

S&P 500
Click here for larger image.
Source: TC2000

PowerShares QQQ Trust (QQQQ)
Click here for larger image.
Source: TC2000
Besides my sentiment indicators, you can see from the charts of the S&P 500 and PowerShares QQQ Trust ( QQQQ) that my stochastic indicators turned positive yesterday, and the MACD is ascending very quickly and also looks like it is about ready to turn positive. The confirmation will come from an upside breakout from the triangle.

A downside breakout in any of these indices would immediately prompt me to move back to cash.

iShares Russell 2000 ETF (IWM)
Click here for larger image.
Source: TC2000
The Russell 2000 index has not yet given a short-term buy signal, but it certainly looks like it is close to producing it. Again, make sure you have the confirmation of an upside breakout before you increase your enthusiasm.

Remember to keep close protective stops on all positions in case today's selling accelerates.


Finally, I want to follow up on my buy recommendations on inverse ETFs in my column way back on Jan. 11 of this year.

With the current short-term buy signals that my indicators that are giving off, the opposite is occurring in the inverse exchange-traded funds that I recommended in January. With my indicators turning negative on Short Dow30 ProShares ( DOG), Short S&P500 ProShares ( SH) and Short QQQ ProShares ( PSQ) and current gains of about 30% in these funds since I recommended then, I would personally start taking most of the profits with a close trailing stop on the remainder of your positions.

This was originally published on RealMoney on Oct. 21, 2008. For more information about subscribing to RealMoney, please click here.

At time of publication, Manning had no positions in the stocks mentioned, although holdings can change at any time.

Mark Manning, AAMS, is an Accredited Asset Management Specialist and Registered Investment Advisor with Butler, Wick & Co., where he specializes in wealth management. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Manning appreciates your feedback; click here to send him an email.

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