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Spotting Bottoms in Stocks
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If someone asked me what I do for a living, what's my modus operandi, I would have to tell them that I spot bottoms in stocks. That's my specialty. That's what I am best at. I'm good at buying a stock when it is down and nobody much cares for it. Most investors are momentum driven. They want to try to catch a stock while it is having a huge move. They like to buy up, pay up, find a stock that's moving like Secretariat and catch the last five furlongs. That's not for me. Not enough reward, too much risk, especially given what I know about how a company's stock can diverge substantially from the worth of the underlying company. That's why I am not a chaser; I'm a classic bottom fisher. I try to buy situations where stocks have gone down to some level that to me is just plain wrong, that is totally and unequivocally out of synch with the underlying company the stock represents. I try to buy stocks with such a limited downside that I feel they are gifts if they go any lower, not accidents waiting to happen. Given that we accept that the fundamentals and the stocks that are supposed to track these fundamentals don't act in synch, obviously the most lucrative time to buy the divergence is when the company's otherwise sound fundamentals are temporarily impaired and the stock takes a header well beyond what is warranted. That's when the company's long-term virtues are totally out of whack with the equity.

It stands to reason then that the same goes for the market as a whole. There are moments of sheer lunacy involving the S&P 500, the benchmark index that we all follow, or in the NASDAQ or even the Dow Jones averages, where these gold standards of investing go awry because of panicky sellers. They can be completely and totally wrong versus how the underlying companies or the economy is really doing. That happens at bottoms. The positive realities separate themselves from the panicked fantasies of bizarre, uneconomical, and irrational closing prices, and you have to pounce when they do.

Understand that bottom fishing is not a "technique" per se, as in "buy a stock down 10 percent from its fifty-two-week high or "buy the market on a big dip." That's way too ephemeral for me. Nor is it a formula, as in "wait until a stock trades through its growth rate" or "don't pull the trigger until a stock trades at a 25 percent discount to the market, or at 10 times earnings." That's too hard and fast for reality. Lots of really crummy stocks of really crummy companies are going to trade down 25 percent and then go down another 75 percent. That's a fishing net that catches some salmon as well as a lot of killer orcas, murderers of your financial well-being. My bottom fishing is a collection of perceived working patterns that have held up over a substantial period of time for both individual stocks and the market as a whole. Just like the sport that I compare it to, bottom fishing requires incredible patience and a sense that just when you are about to give up is the moment that greatness strikes. You can't rush bottoms. It is no more scientific than fishing—there's a definite feel to it. The biggest mistake people make in finding bottoms is that they find too many of them and find them too often. The bottoms I am talking about are rare, rare and dramatic. True long-lasting bottoms just don't occur every day, or every month, or even every quarter. They occur just often enough to make the patient rich and to reward the out-of-favor buyer.

Nor are there successful software packages or Web sites that produce lists of surefire bottoms, even though many people pitch these products in that vernacular. Don't be taken by shameless charlatans; things aren't that easy out there. hoid those packages that show you well-defined channels or successful entry points. They are all bogus and will cause you to double down or sell at the worst possible moments. My kind of bottom calling is also different from the unoriginal and often corrupted world of Wall Street research, where hedge funds or mutual funds lean on analysts at sell-side firms, telling them to call bottoms in some of their flagging stocks or else they will take their commission dollars elsewhere. Don't think this stuff has happened? Then you were never on the other end of the line when I berated analysts to climb out of their foxholes and make a stand to defend a Cisco or an Intel when I owned them. I used to do it all of the time; thank heavens I am out of that contest. Nor do I spot bottoms by watching and listening to the much hyped "earnings" reports during earnings season. Despite all of those "upside" and "downside" surprises, none of the bottoms I have studied were ever caused by those reports. These are almost all artificial anyway, a product of the companies' whispering to analysts what numbers to use so they can beat those lowball projections by a penny or two and take in unsuspecting new shareholders, or buyers. That was supposed to have stopped with the corporate reform—the Sarbanes-Oxley Act—but it still goes on. So you can forget about that mumbo jumbo for finding bottoms after a long slide; it doesn't compute.

Nor am I talking about capturing momentary trading bottoms, either. I am not trying to persuade you to try to scalp flow off institu­tional buy and sell orders, as I did at my hedge fund. You need to generate monster commissions before you will get "the call" that a seller who has mercilessly knocked a stock down while exiting has at last finished his nefarious work and the temporarily depressed stock is ready to bounce. That kind of ephemeral bottom doesn't make you big money and is completely inaccessible to you anyway. It just generates a lot of short-term profits for the hedge fund operators and a new set of commissions for the brokerage houses on top of the ones gained from working the stock down.

Not one big bottom that I have found was ever called by a Wall Street analyst with a buy recommendation, either. The "hold to buy" parlance never coincided or was predictive of the bottoms I am trying to catch. These people make you money, for the most part, by luck. Almost all of the major analysts at the large firms got hired for banking prowess—bringing in the next underwriting deals—not for stock picking. If you have to use one, be sure he doesn't do banking first, so you at least know that you are the client and not the investment banker down the hall. In a study of literally thousands of big bottoms in the stock market or in individual stocks I couldn't find a single big bottom that was snared by these folks. In fact, it is the opposite. I found their downgrades to be more predictive of important bottoms than their upgrades because of their inability to see the bottoms coming. So there's nothing in this chapter that relies upon my hedge fund specialty, my good calls from brokers for all the business I did, nor my close contacts with dozens of analysts from around the country. In fact, sadly, the closer you get to the vortex of information that I swirled in at my old office, the more likely that a bottom will be drowned out by the accompanying noise that often causes it.

My bottoms are what I call "megabottoms." These are the kinds of bottoms that you brag about getting for years, the kind that occur after vicious and often wildly exaggerated declines. The kind that happen when a stock seems permanently damaged even as the company underneath is suffering no more than a scant hiccup. My work on the topic is the result of examining and studying thousands of true bot­toms that I have called—and some that I have missed—in both the stock market and in individual stocks. When you invest in these kinds of bottoms, you don't have to be nearly as worried about all of the other things that I caution and counsel about in this book. You can stay a bull for a while, you have a longer time to wait until you become a pig. You don't have to fear imminent overvaluation because you have caught a stock at its most severe undervaluation and the pendulum just doesn't swing that fast in this game. Your reward so outweighs your risk that you can come as close to relaxing and living off a stock as you ever will in this business. You have gigantic leeway to let your gain run. That's the best kind of gain and one that can make up for a lot of losers.

I divide the patterns into two kinds of bottoms, investment bottoms and trading bottoms. Trading bottoms don't last but are so juicy, and, in these days of low commissions and instant trading, so obtainable, that I don't want you to miss them. Investment bottoms, how­ever, are long lasting and you can get in some fantastic prices for discretionary savings or retirement. Some coincide with overall bottoms of the stock market itself.

I love to talk about individual stocks more than anything else in the world. I would like to think I can spot a stock that is finished going down better than anyone. But with that talent comes a recognition that no matter how good you are at divining the moves of individual stocks, the vast majority of bottoms occur simultaneously with market bottoms. That's because there is so much money "indexed," or bet on the S&P 500, that if you can pick a bottom in that index, you can pick a bottom in most stocks. There are always exceptions. The gold stocks don't trade with the index; they represent an industry that tends to do well when the index does badly. Same with the oil stocks; they are a counterindex. If you can nail the index at its bottom, though, suffice it to say that you have a lot of bases covered. That's why we will review market bottoms first. At market bottoms you could have five hundred to six hundred new lows to choose from, and even the worst ones bounce if you catch the move right.

In the past twenty years we have seen four market bottoms of consequence: the 1987 crash bottom, the 1990 Iraq-Kuwait bottom, the 1998 Long-Term Capital bottom, and the 2002-2003 post-dot-corn, pre-second-Iraq-war bottom. All four of those bottoms were exquisite moments to buy because if you nailed them, if you kept some cash on the sidelines for them and applied it correctly, or if you went all into equities at these moments, you beat the vast majority of managers and made fortunes for yourself or your investors. There were many other false bottoms during this study period, but none of them measured up in terms of opportunities worth.committing that excess capital aggressively into the market. What mattered, in each case, was that indi­cators reached extremes that told you it was safe to land your capital. I chose that analogy because I like to look at the market the way a pilot examines an instrument panel when there is so much fog that he can't land on visibility alone. I like to consider the indicators as a checklist that, when enough criteria are met, signals that it is okay to bring down the airplane, or to commit capital to the market. That's why I present them in checklist form so you can use them during the periods when most market gurus and mavens are saying it is safe. You can know better.

I have studied these bottoms intensively, both as a participant and as a historian. They each had one-of-a-kind characteristics, but not enough to make the study of them useless and nonpredictive. They had so many readily observable commonalities that these bottoms are, in retrospect, discernable and investable, and, most important, worth waiting for.

Every bottom is caused by different events. In the 1987 bottom, which occurred the day after the crash of 1987, a series of mergers and acquisitions took place as corporate America recognized that the monstrous 22 percent sell-off didn't foreshadow any economic downturn and was more a matter of computerized program trading run amuck. (We haven't had a decline like that since then because of sensible moves put in by the New York Stock Exchange to control the velocity of declines.) The 1990 bottom occurred after Iraq's invasion of Kuwait, which led to a dramatic decline in the price of oil after an ini­tial spike. The 1998 decline got staunched, ostensibly because of a cut in interest rates by the Fed. The 2002-2003 double bottom (October 2002 and February 2003) occurred with the run-up to and start of the Iraqi war.

It's because of the disparity of events and their unusual nature— the next bottom will most likely not be triggered by another Iraq war—that most people tend to think that market bottoms are too aberrational to call. That lack of history repeating itself has led to an investment philosophy that says, basically, "We don't know when a bottom is going to be reached, so you should just stay long all of the time and not worry about it.'' There is a certain logic to this notion: The academic work of Jeremy Siegel, the nation's foremost stock historian, shows that high-quality equities have outperformed every other asset class over a twenty-year period, so you could say, what does it matter if you spot a bottom when you already own stocks for a much larger cycle? Indeed, for retirement investment, I am in the camp that says bottom calling is not an important exercise. I routinely invest one-twelfth of my allowable retirement funds each month, accelerating that process only if we have a significant decline, one that I define as 20 percent, in the market. That staged investment, coupled with the occasional plunge during a big decline, however, has produced far above average results.

More important, though, discretionary money, money meant to augment your paycheck, should always be at hand so you can take ad­vantage of bottoms. I almost always keep a minimum of 10 percent up to a maximum of 25 percent of my discretionary money in cash, to profit from when I see the signs of a bottom developing.

With that, let's examine what all four of these market bottoms had in common, what had to happen in each case before the stock market could stop going down. All of this information is readily accessible, by the way, through reading a combination of USA Today, the New York Times, Investor's Business Daily, and the Wall Street Journal. If that's too time-consuming, I constantly update this stuff during the trying periods in TheStreet.com.

1. Market sentiment. The first dashboard instrument we have to check to determine whether we have a bottom at hand is market sentiment. Sentiment's a tough thing to gauge. There are tons of anec­dotal indicators and services that produce "bottom calls," but I find them dubious because they tend to be without long-term significance. We are, in the end, measuring pain, and when the pain gets to the maximum, we are going to get a bottom, which was the case in all four of our megabottoms of the last twenty years.

That said, here's my sentiment/psychology checklist of what must occur before we can be sure that a bottom might be at hand. Until you see every one of these indicators, you would be nuts to commit any excess capital to the market. It would be akin to running outside of a bomb shelter during the London Blitz without waiting for the sirens.

First: The pain makes the front page of the New York Times. This indicator, one of the absolute favorites of Mrs. Cramer, has literally never been wrong. Such a simple thing, but is worth considering why it works so well. First, the supposition here is that during the periods of incredible pain there are always people who show up in the business sections of your newspaper, in the business magazine press, and, of course, on business TV, saying that a bottom is at hand. For the most part, those who say these things are pushing an agenda. They typically have liked the market for some time and didn't get out, or they are al­ways liking the market because it is good, at least short-term, for their business, whatever that business might be. Maybe they run a mutual fund and that fund can't short. It's therefore "always" a good time to invest in that firm. Maybe they run a brokerage business that makes its money in commissions and the worst thing that can happen is to say, "I wouldn't buy now." Given that most of the profits from equities come from writing buy tickets, chiefly of underwriting, where the sales fee is much bigger than anything that could be gotten on the sell side, the notion of trusting any of these people is simply preposterous. Nor does it help to read in the business section of the New York Times or the green "Money" section of USA Today, the two most important papers when it comes to calling a bottom, that there is a lot of blood on the streets or that the pain is getting too great. Those are classic canards, too. In my research on bottoms I found dozens of articles about pain and losses in these sections that were written before some of the biggest parts of declines occurred. But all bearish bets are off when the New York Times or USA Today puts the market's pain in a prominent place on the front page of their papers. Amazingly, at every bottom, stories about how horrid the market is have become a staple. If the market-woes stories aren't on the front page, then simply wait; the bottom hasn't been reached yet. There hasn't been enough pain outside the little financial world to create a bottom. It is simply incredible how right this indicator always is. It's so right that every time I have come up against a terrible bear market phase, and there have been a ton of them in the last twenty-five years, I find myself arguing with my wife about the possibility of a bottom, and she will casually ask me whether the Times has put the markets' woes on page one. When the answer is no, stay on hold; you aren't there yet. You will miss some transient bottoms for sure, but all megabottoms meet this characteristic before rallying sharply and, largely, for good.

For twenty years, Investors Intelligence, a nationwide service, has questioned newsletter writers about whether they are bullish or bearish. While you might expect that a good time to invest is when the managers are bullish, that's actually the worst time to invest. Anyone who answers the poll by saying he is bullish is admitting that he likes the market. If he likes the market, he is by definition already in and invested. It therefore stands to reason that if everybody's bullish, then everyone's spent his cash and bought his stock. Which is why the single most important sentiment indicator I follow after the front-page New York Times indicator is when a majority of money managers polled dislike the market. When the bull-bear ratio shows a definitive majority of bears or even a plurality of bears with less than 40 percent bulls, you are in the safety sentiment zone. Mind you, a reading alone of less than 40 percent bulls doesn't per se mean a bottom. But remember this is a checklist, and this is one of the most important indicators to hold out for to be sure you are not getting a false reading. If you jump the gun and commit your reserves because you think the market's bottomed and you aren't there yet on this ratio, you will always be wrong. That level of certainty is rarely available in any other kind of gauge. For those unfamiliar with this indicator, it can be found among all of the indicators in the Investor's Business Daily and is available every Thursday morning in the paper. Never buck it; doing so has cost me tens of millions of dollars. Why should you lose money after I have proven that the losses always occur when you anticipate the bull- bear percentages too soon.

It is somewhat unfortunate that so many of my sentiment indicators take advantage of the wrong-way nature of so many market participants, but remember, when you are calling bottoms you have to believe that all hope is extinguished, and so therefore everyone who has to sell has already sold. That's why I regard the third and one of the "meanest" indicators to be one of the best: mutual fund withdrawals. No important bottom is without these. No bottom is sustainable without mutual fund flows occurring steadily for at least two months. There can always be periods of one or two or even three weeks where you might get outflows related either to tax concerns or to unusual events that scare people. But consistent, repeated outflows of several months in duration accompany all the big bottoms. These numbers, available on Fridays through an organization call AMG, are almost always in the papers Saturday or Monday, so, again, we are not talking about esoteric hard-to-find data. If you haven't seen big outflows, again, you aren't there yet.

Perhaps the most esoteric of my sentiment indicators, and the only one that isn't readily accessible in your local paper, is the fourth indicator: the VIX. The VIX, or volatility index, is a measure of stress in the system. It is a compilation of worry as defined by various ratios of puts and calls (I'll explain these terms in the final chapter) that gauge either complacency or panic. Panic signals the freak-out selling that always accompanies market bottoms. A reading above 40 in the VIX— a measure of pure panic in the marketplace—indicates a market bottom. In fact, anything above 35 can trigger a possible bottom, but +40 is a requirement that all four of our significant bottoms have met. Any reading below 30 indicates that the bottom can't be trusted. One note of caution: The first reading above 35 isn't going to be the last. If you have the luxury, my work says the third week of +40 readings is the safest time to buy.

When I first heard the word "oscillator," I said to myself, Now here's some Genuine Wall Street Gibberish, some indicator that tells you whether stocks are "oversold" or not. How can some indicator that tabulates how eager people are to unload stocks by measuring how many sales occur on downticks and at distressed levels really help you identify a bottom? But as someone who daily measures the over- bought-oversold condition through the columns of TheStreet.com's Helene Meisler, someone who I believe is the world's number one technician, I have come to respect this instrument to the point that I never buck it, ever, when calling a bottom. It is my fifth bottom indicator.

Most of the time markets are in equilibrium. Buyers buy at reasonable levels relative to the last sale and sellers sell at reasonable levels relative to the last sale. But at times market players en masse are so exuberant that they push up prices constantly with their buying. They don't wait for supply and demand to be in balance and they chase stocks up, causing higher prices.

Similarly, there are moments when sellers want out so badly that they will not wait for buyers to step up to the plate. They seek out the buyers wherever they can find them, chiefly well below prevailing levels. Oscillators measure these pressures. (There are a number of different oscillator gauges. The Standard & Poor's company updates one every night that is available for $ 1,000, but I prefer the one that Helene Meisler calculates herself that can be found on Realmoney.com.)

Equilibrium buying occurs when an oscillator registers in the middle, which is defined by Of2. A +2 reading or a —2 reading signifies nothing. Only extremes matter. At every negative extreme, defined as —5 or lower, we have gotten a terrific opportunity to buy stocks. All four of the bottoms I have researched gave us extreme readings of —7 before they bottomed. The oscillator indicator, unlike the VIX, is something that produces almost instant results. The bottom is "in" when you get that reading along with all of the others that I have de­scribed here.

If you get all of these—a — 7 reading on the oscillator, a +35 reading or more on the VIX for three weeks, sustained mutual fund with­drawals, a reading of 40 bulls or fewer in the Investors Intelligence survey, and a front-page story in the New York Times or USA Today detailing the pain the market is causing the man in the street—you will have satisfied the sentiment indicator for a megabottom.

It sounds so simple, but in reality, using these indicators is an exercise in extreme patience. I can't tell you how many times people have called me during the last four years and said, "It's so painful, we must be near a bottom." And I have to go over the checklist and disabuse them about when we really are. Usually they say, "That's okay, I can hold out," but I will let you in on a secret—nobody, not even the Trading Goddess, can take the amount of pain that has to occur in a swing from euphoria to a swing of despair. That's why if you are feeling the tightening around your throat or the knots in your stomach and we are nowhere near negative on the oscillator or near superbearish on the Investors Intelligence, I recommend that you trim your holdings back, perhaps dramatically. That's what I usually advise people who call in to my radio program.

2. Capitulation. The next set of indicators that we must see before we can call an investible bottom gauge capitulation. In every one of the megabottoms, we had what I describe as a "crescendo sell-off" before we had an "exquisite moment." In a crescendo sell-off we have massive capitulation. Players who had been hoping to stay with the market finally give up and can't take the pain anymore.

Spotting a crescendo bottom isn't as easy as it sounds. But there are some overt signs that can be seen in the daily paper. A crescendo bottom is a bottom where a great many sellers converge at once to take stocks down to unusual levels versus the fundamentals. The accompanying detail that has marked all crescendo sell-offs is a dramatic imbalance in the amount of new highs to new lows. At all of the bottoms that I have found to be investible, you have between four hun­dred and seven hundred new lows and only a handful of new highs. That kind of capitulation is a must-have before you can be sure that the majority of selling is over. When you have only a couple of hundred new lows, not enough damage has been done to reach a buyable crescendo.

A second characteristic of a crescendo bottom comes from the bizarre forced-selling method that the brokers apply at all major brokerage houses. Throughout all sell-offs, marginal players and speculators attempt to call bottoms on a repeated basis. Their meager efforts are often a sign that we are not anywhere near the bottom. That is why we have to monitor their selling closely to see when it comes to an end and they are washed out of the picture. Fortunately, their telltale selling comes almost entirely between 1:30 and 2:30 in the afternoon. That's because brokers everywhere are on the hook for trades done by their clients in violation of margin rules. The rules state that unless the customer borrowing from the firm puts up more equity when positions go against him to the point where his collateral no longer meets the requirements, the positions must be cashed out. The brokers badger these customers all morning, but the brokerage house finally stops fooling around and after the Federal Wire system closes at 1:00 p.m. the margin clerks swing into action and brutally sell out the common stock of overly margined players. The selling lasts until about 2:30. You will see during prolonged downturns that the selling during this margin-clerk hour is by far the most brutal of the day. If you have to buy a stock during a downturn, you would always be wisest to wait until the forced-selling period is over.

But for spotting bottoms, it is more important to recognize when the hour of trading doesn't bring further pressure on the market. If there is no strong sell-off by 2:30, then that's a sign that margin debt has shrunk to acceptable levels and speculation has been wrenched from the system. You never get a bottom before that speculation has been flushed out. You can always wait until the SEC releases the monthly margin debt numbers, but I have found that before every radical decline in margin buying has occurred, you can spot that decline simply by focusing on the 1:30 to 2:30 p.m. margin-clerk selling. Mind you, this indicator only works on down days. You need to see no selling to speak of during that hour after a series of declines, or even weeks of decline, before you know that the market has bottomed out.

Until about a decade ago, we had no one pool of capital large enough and reckless enough that its own busting could be a form of capitulation. But that changed with the 1998 bottom, when Long-Term Capital, a gigantic hedge fund, made a series of monster bets that went wrong, resulting in that company going belly-up. Its forced liquidation, which took place over the final days of September and early October, produced the only tradeable bottom that wasn't caused by widespread capitulation on the part of a multitude of speculators. I point this out only because the 1998 bottom did not produce a wave of margin selling at the retail level, just at the hedge-fund level. Fortu­nately, that hedge fund's decline was well chronicled and therefore could be gauged even easier than the margin selling that helped create all of the other bottoms I have studied. During big declines you will find me hard at work between 1:30 and 2:30 checking the levels of forced selling and looking for imbalances that indicate the margined folk are being led to the slaughterhouse. Once they are out of the picture for good, bottoms can be found much more easily. In 2000 there was so much margin debt that we didn't clear things up until October 2002, when the forced margin selling was so palpable that it amazed you. And then it ended. Within a few weeks, you got your bottom.

A third characteristic of a crescendo bottom is a dramatic spike in volume on the exchanges. There can be day after day of lethargic selling that produce no bottoms. You get a crescendo only when the volume is loud enough to indicate that many sellers are cleaned up.

This method of spotting a crescendo always eluded me until I became a part of one during a mini sell-off in the mid-90s. That was when Frontline chose to do a special about speculation and I agreed to let a film crew come in and film me at my hedge fund. Because the market had been quite terrible for almost two months and we had been buying in anticipation of a crescendo bottom, we had reached our maximum allowable buying power. During the morning when the film crew came in, the market looked colossally ugly, and we sensed still one more day of pain. Because of that we went to Goldman Sachs, one of our best brokers, and said we wanted to unload one- tenth of our merchandise, or $30 million in stock, before the market opened. We wanted the security of some cash; we were selling scared. The firm sized up our offerings and bid us down a point for each stock. We were quite relieved, and we sold them the stock. Within a half hour after the opening, Goldman came back and bid about a quarter point higher for more of the same merchandise. Volume exploded all over the Street by ten o'clock, with much higher levels of trading than we had experienced in months. We took that to mean that our own panic sale had been joined by many others. Suddenly buyers came out of the woodwork because an acceptable level had been found. The hourly volume spike made it evident that at last buyers were alive and sellers had been able to unload substantial chunks rather than dribs and drabs all the way down. Again, that cleared the decks of institutional sellers in the same way that the margin clerks clear the decks of the individual sellers. Of course, we have our bottom selling memorialized in a documentary; let it serve as a reminder to you not to sell into the big volume after a long decline. That's the time to buy, not sell. A minicrescendo had occurred, and we were part of it.

Another telltale sign of capitulation involves the flow of under- writings. Brokerage houses live by the selling of merchandise through underwritings. It is second in profitability to merger and acquisition work and the lifeblood of many of the larger sales houses. Because it is so important, firms will push these deals through the door no matter what, until there are simply no more buyers left. At that point, at last, they stop, because if they can't sell the deals, they get stuck with the merchandise. They won't bring a new set of deals until they have worked off the old merchandise. You don't commit capital until the most recent underwritings have worked. That means the excess inventory has at last been worked off in the system and the all-clear has been sounded; there's too much cash idle again at last. That's why underwritings are such perfect tests of when a bottom might be coming.

Remember the order of the stock market's underwriting cycle because it always anticipates the stock market's cycle as a whole. When you get an overheated underwriting market with wild openings (where stocks go up and up on the day they first come to market) and tons of offerings each week, that's a sign of a developing top (more on that later). So get ready to sell a lot of stock. Soon you get deals opening up unchanged, with little or no premium; that's a sign the market's getting sated and you should be in a minimum of equities. When deals just fail from the moment they come out, that's a sign of a weak market, one the underwriters will still pummel with greed. Don't be tempted to buy yet; many will be. That's a false bottom. It's only after deal after deal breaks down that the pipeline of new equity at last dries up. That's when the speculative juices are being wrung out of the market and liquidity is building up. During the period when no equity is being issued you will see a radical change in the supply and demand of equities. Well into a downturn companies will continue to buy back equity as a matter of course, but issuance dries up when the brokers get totally stung by deals. So supply and demand get way out of whack as money naturally comes into the market, through 401 (k)s and other retirement accounts, and there's a continuing and natural decline in the overall numbers of shares available to buy.

You can't catch a bottom as soon as the underwriting dries up because there are still so many excess shares kicking around in marginal accounts that don't want to hold them. But one or two months after the flood of new deals ceases—never longer—you begin to see a few terrific IPOs that come public and the stocks don't go down. That's the sign that you are now past the crescendo and should be in there buying stocks. You must wait until the whole cycle plays out, though. Moving in before the new set of deals goes to a premium is suicidal. These brokers know what they are doing. They aren't taking chances at that stage; they know that the market is at last fine to operate on from the long side.

A final indicator that you might be in a crescendo bottom comes from something so odd that it is only seen at market bottoms. That's the "stop trading, order imbalance" sign. This signal is tricky because you need to be at a machine to see it happen. It is, in fact, the only indicator of a crescendo that cannot be spotted simply by reading the papers. It is rare, although all four megabottoms had multiple days— but not weeks—of this behavior while the capitulation was occurring.

We often get order imbalances on individual equities when we have bad news on individual companies, such as some sort of executive resignation or earnings blowup or chicanery that causes a stock to open at a deep discount to its former price. But there are moments when we get "stop trading, order imbalance" across the whole stock market, with lots of stocks opening down huge simultaneously on no news. We had precisely this kind of behavior on the day after the 1987 stock market crash—the single best buying day in the recent history of the market—and we had it again in 1990 and in September and October of 1998 and again in October of 2002. Repeated order imbalances sans news are sure signs that the capitulation has reached absurd levels and you have to make your move to buy.

I love order imbalances after big declines in stocks; they clear out all of the panicky sellers—just the people you don't want in your foxhole—all at once. That's perfect; the safest time to buy.

3. Catalyst. The ultimate goal when you spot crescendo selling and you match it with the sentiment indicators is to consider what event could occur that would trigger what I call an "exquisite moment" where you have to buy because the opportunity is so great. In 1991, at the end of a seven-month bear market, and in 2003, at the end of a three-year bear market, we got the same exact catalyst: the start of a war with Iraq. In both cases we had a pretty high degree of confidence about when the event would occur. In both cases, as is often the case with what I call the "Big Bad Event Syndrome," where a news event that so dwarfs others is about to occur, the stock market factored in all of the negatives and none of the positives.

In 1998, the catalyst that triggered the upsurge was a "surprise" federal funds cut. I write "surprise" because the Federal Reserve let some of its buddies that talk to the press have a head's-up that the rate cut was going to occur. That was the signal to jolt stocks upward.

In 1987, the catalyst was again the Fed, which when it saw all of the delayed openings in stocks, said that it would provide all the liquidity needed to make sure the markets were orderly.

Again, after each sell-off a different trigger will cause the averages to reverse. The trick is to recognize ahead of time whether enough of the precursors are in place so that you are prepared when the catalyst comes to change the direction. The trick is not to know or try to predict the catalyst itself; that's rarely known. But the setup for the exquisite moment can be predicted much more easily than the actual trigger that pushes the market higher. The catalysts are always different, but in each case we had priced in all the negatives and none of the positives. That's why the setups are the key and are reproducible repeatedly even though the catalyst remains something mysterious. Think of it ultimately as a forest fire waiting to happen. The sellers' inventory, the liquid that keeps the forest damp, has run dry. Then you know that the tinder is ready, and the exquisite moment is about to strlke. You don't need to know when or where the spark will come from to know things are ready to ignite.

I called the exquisite moment on TV for the 2003 rally, right at the exact bottom, give or take 100 Dow points. People thought I was a genius—this was right before the war began—when in actuality all my indicators were flashing the brightest green. I am not saying it was easy; I am just saying the signs were consistent and you, too, could have spotted them if you knew what to look for. There's no magic or alchemy, just patterns readily available to all who have studied the market these last three decades.

For some people—I call them the "permabears"—these certain indicators and the exquisite moments they have begotten are still not enough to commit capital. I would point out to these permabears that the conditions are never perfect enough for us to know the exact bottom. But if we correctly identify these situations, even if we are wrong and we don't get an exquisite moment to buy, we are still not injured for trying. In every case where all these conditions occurred and we didn't get a bottom within four weeks, we still experienced no decline in capital. That's all you can ask for.

How do you know if you have missed the bottom or are too late to take advantage of it? There are dozens of subindices out there that bottom after the market as a whole has bottomed, but only one index has been coincident with or has led the market bottom in every case: the BKX, the Bank Index. If you see a 10 percent move up in the Bank Index you are already well into the upswing, and it might pay to wan for a couple of profit-taking days to transpire before you commit cap­ital. I always keep the BKX at the upper left hand top of my columns, right under the S&P, because of its canary-in-the-coalmine ability to detect that a big move is about to get under way. Unfortunately, a rally in the BKX has also produced several false tells, so be sure all the other indicators are working for you before you bite. The BKX predicts a lot of declines, too many to be useful, but it has always been right at confirming real bottoms as they have happened or right before them.

One other consideration: Sometimes the bottoms are so vicious and elusive that you need to test the waters first so you don't get too exposed to the market before it really bottoms and collapses again. For that, may I suggest something that has kept losses to a minimum when I am market bottom fishing? Start your buys on the morning of the bottom not with your favorites, but with some stocks that might have additional support from day traders and institutions. Buy the stocks that have been upgraded that morning. If the market does falter, the artificial buying that comes with every upgrade will at least cushion the downside for the stocks you are using to test. Don't leave it to chance or buy a stock that has no institutional support that day. You may end up in an equity that gets slammed if the market reverses down sharply, and you will be too shell-shocked to attempt the next bottom—and bottoms, real bottoms, are too precious not to try for. You can use that method to test every single bottom and never have to pay so much as a ticket for admission. It's a terrific way to feel for a bottom with minimum pain.

Believe it or not, bottoms on individual stocks are a lot harder to call than market bottoms. That's because divining the behavior of a single entity is much more difficult than trying to fathom thousands of equities that, in many ways, do trade together.

How hard is it? About fifteen years ago I was building a massive position in Control Data, now Ceridian, in an attempt to call a multi- year bottom. The stock had declined from about $150 to $15, and I thought we were nearing a bottom. So I began to build a position using what I call a "wide scale." That means that down every point I would buy another tranche of equity, and when I thought it reached absurd levels, I would make my buys even larger, pyramid style. During this period I was trading with my wife, and she used "strict" scales, meaning that she refused to deviate and try to call a bottom at a particular level in part because a bottom had eluded Control Data for more than a decade. When the stock got to 10 we had about 200,000 shares, bidding for 50,000 every point down. It then quickly dropped to 9.I got on a plane to go see the company in Minneapolis. I spent a day with management and I came back confident because the CEO at the time was truly bullish on the outlook. When I got back I wanted to double down at 8, that's how positive management had been, but Karen was convinced that we hadn't reached max pain level. Karen said we were sticking by our scale of 50,000 every point. Sure enough, the stock traded through 8, where we bought 50,000, and then through 7, where we bought another 50,000. Amazingly, the stock kept dropping. I kept calling management, they kept telling me, Chin up, not to worry; it was all going to be okay. Those were the days where we were trading out of our garden shed in Bucks County, and my wife would constantly tell me to call the company and go through the drill again and again to be sure I was right.

Then one Friday, when the market was particularly ugly and Control Data was trading at slightly above $6 and we were bidding for our usual 50,000 shares, Karen said that she saw signs of capitulation. The sellers were coming in faster and harder now and were asking for bids from the different brokerage firms. She said she was on the verge of the double down.

To me, she seemed nuts. We hadn't known each other long enough for me to acquire those German nerves of steel of hers yet. I was shaking, shaking so hard we just stood there while the sellers were out whacking everything. Shouldn't we step aside, I asked? Shouldn't we break our scale, or walk away? That's how hard the selling was.

She looked at me as though I had no idea what I was doing and then picked up the phone to our trading wire to be sure that the $6 bid was in and nobody pulled it while the sellers were busy panicking.

A few minutes later, the phone rang. Karen got it and said, "Jim, it's for you, some guy named Larry." I gulped. Could it be Larry Perlman, the CEO of Control Data, calling little old me in Bucks County, the guy who had 350,000 shares of his stock, which represented more than a quarter of my fund?

Sure enough, it was. Larry wanted to know what the heck was wrong with his stock. All was going so well, so exceptionally well, that he couldn't figure out what was causing the selling. He was at wits' end. I told him I wish I knew, that it was one tough row to hoe, and I hung up, totally rattled.

Karen asked me why I had turned so white. I said that I just got a call from a shaky CEO who wanted to know who the heck was selling his stock down and why, given how good things were. What was out there destroying the stock? I told her if he's worried, maybe I'm nuts to be so confident. I thought we should join the sellers.

Nonsense, she said, just the opposite. Only in the comic strips do lightbulbs go off over people's heads, but I swear I saw some light go on somewhere near her cranium. She picked up the phone to Jimmy, our position trader on the account, and said, "Bid six and a quarter outloud for one hundred thousand shares and keep reloading at the same price until you are filled three hundred and fifty thousand times."

She was doubling down, right then, right there.

I told her she had to be a whack job, that's how out of her mind she was. We just got a call from the CEO, I said, who has no idea what the heck's going wrong and your instinct is to double down?

Of course, she said. The definition of the bottom is when the two biggest bulls, her husband and the CEO, panic at the same time, when only the CEO knows more about the company than her husband. That's when you stand there, she said.

It got more painful initially. After we got filled on 350,000 shares at 6.25, she went "up," not down, and said bid 6.5 for another 100,000. Filled again. Darned seller reloading. Bid again, she said. Now we had about half of our fund in Control Data.

Sure enough, we weren't filled the second time. The seller had dried up. The buyers came in. Take a look at a multiyear chart of that security. It never looked back from that moment, and we feasted off our Control Data position for many years to come.

Yes, bottoms can be called on individual stocks, but usually because the people who love the stock finally throw their hands up and the cooler heads step in and profit from the capitulation. At the bottom even the CEOs are confused. Accept the chaos!

Stock bottoms may be elusive, but like market bottoms, there are some telltale signs you can use to spot them. You just have to remember what you are loohng for: the pricing in of the negatives without any of the positives being included.

One of the reasons spotting bottoms in equities is so elusive versus the averages is that the averages rarely go to zero—I can't recall even any sector indices that went to zero, and that includes the DOT, TheStreet.com's Internet index, during the worst of the dot-corn bust. Given that debt causes the stocks of good businesses to go to zero, I would heavily recommend that you not try to spot many bottoms among the more heavily indebted companies out there. That said, let me give you my checklist of what to look for to detect a bottom in an individual stock.

First, a stock needs to lose most if not all of its sponsorship to form a true bottom. Even in the tough market of 2004, with just a handful of winners, it is amazing to see that in each winner's case, it didn't bottom and then begin to move up until it lost most if not all of its sponsorship. Amazon, Yahoo!, and eBay, together among the best-acting stocks in the market, each received multiple downgrades and were even the recipients of sell recommendations at the bottom. That's a classic tell, when a stock loses whatever support it has left on Wall Street. It's predictable and bankable because of the method analysts use to pick stocks. Typically they build a model of earnings, and when they can find stocks that they think are cheap on earnings relative to the growth rate, they want to pull the trigger and buy. Unfortunately, business is rarely as predictable as these analysts might have you think. When a company makes the estimates, the analysts reiterate their buys. When a company exceeds the estimates they go from hold to buy. But when a company, no matter how temporarily, misses the numbers, they by nature have to downgrade the stock. Since all of the analysts use these earnings models instead of trying to value companies for their intrinsic worth, they all tend to downgrade at the same time for the same reasons. You get a bottom when even the most patient or brain dead of those using these methods downgrades the stocks, typically because management is embarrassed that such bad stocks remain on the recommended list. After the investigations Eliot Spitzer has made, this process has become even easier because in the old days the stocks went from buys to holds. Now the analysts take them to sells because they didn't have enough sells on during the crash to please the authorities; in fact, they had almost none! At the bottom in 2002-2003, almost every great stock that had been hit by the temporary slowdown of the economy had sells on it. Broadcom, shortly before it doubled, had four sells on it! What a terrific indicator! Same with Lucent and Nortel and Corning before their giant moves.

The bad news about spotting the sells is that it might take several quarters for the turn to occur, because these analysts won't get back on the horse until it has a couple of good quarters. They've been too burned to be anything but twice shy. The good news is that when everyone has downgraded a stock, and it has a decent balance sheet, your downside is extremely limited. The most dangerous thing that can occur is that you might end up sitting out of whatever rally you might be trying to play. They can't "hurt" you with any more downgrades; they've already occurred!

A second "tell" of a bottom occurs when bad news hits and the stock ceases to go down. This indicator is a simple one, and it is common in every single bottom. That's because bottoms get formed only when all of the sellers have finished, so there is no one left who cares about the new negatives to want to dump the stocks. Again, remember, this works only with a good balance sheet, because with a bad one, the bad news could lead to some sort of impairment that removes the equity from your hands and puts it in the hands of the bond or note holders. I love situations like one that occurred in EMC in 2003 when it reported a so-so quarter, guided estimates lower, and said business is just okay. The stock went up on the news. No one was left to be shaken out. That's a classic bottom, one definitely worth waiting for. EMC had fallen 40 percent before it found its sea legs.

A third indicator is consistent, large insider buying. Insiders sell for a myriad of reasons: taxes, estate planning, divorce, prudence. They buy for only one reason: to make money. Beware here, though. The managements know that they can draw attention to their companies with token buying or with widespread but small buying by all board members. This kind of forced buying shouldn't fool you. Don't bite when you see small dollar amounts of buying by individuals at the top. They could be "painting the tape" with their buys. You need to see buys in the millions of dollars to be sure that someone isn't trying to trick you into the stock, or con some reporter. Buy only when you see multiple buys, too. There's always one board member with a lot of cash around. But multiple and repeat buyers of significant amounts shows you the insiders mean business. It's a great tell and often signals the absolute bottom in an enterprise's stock.

A fourth indicator of a bottom occurs when a stock is rumored upon negatively and nothing happens. At all times there are plenty of hedge funds that need merchandise to go lower so they can bring in their shorts, either successfully or unsuccessfully. At all times there are also unscrupulous people who are willing to say anything about a company to anybody—particularly the press—to knock the price down, knowing that it will be repeated by willing brokers who want the short sellers' business. For most of you this process seems completely insidious. You think it is outrageous that short sellers plant rumors and tell tall tales to knock stock prices down. Not for me. I am always looking for all-clear signs to beat the system. I regard it as the ultimate tell of a stock going from weak to strong hands when I hear a negative rumor about the company—broadcast widely either through a network or a national newspaper, a Web site or magazine— and the stock, which most likely would have been totaled by the rumor at a higher price, does nothing. I especially like it when a hefty dollop of puts has been purchased beforehand. That's a terrific fire to the upside just waiting to happen. There's nothing like trapping a short seller with his own lying story and getting him to feel the pain himself of a stock that won't come down so he has to come in and sell the puts, which will automatically move the stock up. Particularly because the broker who bought the puts probably told others to expect something negative, and when the negative occurs and the stock doesn't go down, these tagalongs panic and cover the target company's stock.

So, I like to keep up on the negatives of stocks that have been breaking down to figure out when all the negative news is in. That usually means some positive news is about to come down the pike or the major damage is done and you are safe to speculate on a bottom.

The final kind of bottoms I look for are bottoms based on macro considerations. These are sector-rotation bottoms, and they are the key to making unusually large profits. Let's spend some time on them, especially because these are some of the most counterintuitive bottoms out there, yet they are begging to be had if you simply stand con­ventional wisdom on its head. These bottoms involve decisions by big money to make moves to get out of some stocks that have been very hot and into others that have been very cold, almost entirely because of macro decisions, like Fed tightening or loosening policies. Let's stick with them because they are consistent in each cycle.

Sector bottoms, picking individual stocks as part of a big sector bet, means going back to the model of earnings and Fed tightenings and loosenings that I described earlier. There is a simple theme to these rotations. When you believe that the tightenings are beginning to have an effect, you will see a sudden rush of money over a four- or five-day period into the Kelloggs, Gillettes, Avons, Procters, and Kim- berly~, the stuff that is in your kitchen and your medicine chest. I used to like to place these bets close to the midway point in the tightening portion of the cycle, but these days so many people anticipate the Fed's moves that I think you would be best to start buying right at the time of the first tightening. Usually you get the tightening after a prolonged period of inflation, which erodes the value of these key franchises. But when the Fed tightens, you get a freeze in the economy and the erosion stops. Also, when the Fed tightens, you get a fear that the cyclical companies will not make their numbers the following year, or that the future will be clouded for the companies that are heavily dependent upon the economy. That's why you have to jump into these situations in advance. One of the reasons why I was able to successfully navigate the severe downturn in tech stocks in 2000 was that I used this method to switch into a portfolio of food, soap, drug, and cosmetic companies, the type that don't slow down when the Fed ratchets rates up.

Of course, the opposite happens when the Fed does its first loosening. Traditionally you need to switch into a sector that does well with the economy, typically companies like the autos and the retailers. You rotate into the heavier cyclicals as the easings go on, until in the end you are stuck with the dirtiest of stocks out there, such as, steel, copper, and aluminum.

I point all of this out not to belabor something discussed earlier, but to point out that throughout these periods, brokers and TV pundits and mutual fund folk will be recommending the "cheap" food and drug stocks betting on a comeback, right in the middle of an economic expansion or when they have just started selling off. Think to yourself, false bottom! Same with the cyclicals. You like the cyclicals when they are most expensive, when their earnings have cratered, when they traditionally seem outrageously overvalued. But when their multiples are cheap, when you hear that Phelps Dodge trades at 6 times next year's earnings, run for the hills. It will never make that number. It might not even make half of that. That's the slowdown coming. Never be lulled into cyclical stocks when they are cheap; sell the safety stocks when they are ultra expensive. Their bottoms are both counterintuitively reached and formed by the Fed cycle, not by their intrinsic earnings power.

There are a couple of other kinds of bottoms to be aware of. Some bottoms occur when companies get so cheap as to be taken over by others, but again, I don't speculate on takeovers with bad fundamentals, unless all the risk is taken out of them and nobody likes them apropos of the bottoming process described above.

One other type of bottom is worth commenting on: the tax-loss bottom. Every year at the end of October, when most mutual funds end their fiscal year, the funds like to take their losses. There is a perception that you should wait until December to buy tax-loss names, but that's a canard because it is institutional selling that drives most stocks down, not individuals. The third and fourth weeks of October—hah, now you know why there are so many crashes during that period—represents the height of this kind of selling.

My experience is that if you are picking stocks off tax-loss selling, you should begin most of your buying in the last week of October, but leave some money for the occasional "legit" sell-off to demonstrate itself. Spend that money in the last week of November. I don't like buying stocks just because tax-loss selling is over. There are a million reasons why stocks go down, -but I know enough to take advantage of the seasonal pattern that constantly manifests itself.

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