Definition and examples of a stock bottom
How does a stock bottom work?
What does this mean for individual investors?
Definition and examples of a stock bottom
A stock bottom refers to the stage where the stock price declines and then rebounds in response to the volume of sellers versus buyers. The formation of a stock bottom on the chart appears like a bowl pattern, where the stock price drops and then rebounds. The lowest price traded during the formation of a stock bottom is called the “bottom price.”
Let’s take an example. Stock A has been declining for two consecutive months. Sellers are trying to sell their shares, but there is no demand – the number of sellers exceeds the number of buyers. During the third month, there is renewed demand for the stock. Now, buyers are actively purchasing stock A and pushing its price higher. The lowest price before stock A rebounds was $25; this is the bottom price.
How does a stock bottom work?
A stock bottom represents more than just a price decline or the lowest price traded for a security.
“Just because prices stop declining doesn’t mean a bottom has occurred. The bottom is the opposite of a downward trend,” said David Russell, Vice President of Market Intelligence at TradeStation Group, in an email to The Balance.
The formation of the bottom is affected by supply and demand. Specifically, it looks at the relationship between buyers and sellers.
“At any moment in time, there are always buyers and sellers,” said Russell. “The price is a balance between the two, and it changes when one side outweighs the other.”
When there are more sellers (supply) than buyers (demand), the stock price usually declines. When there are more buyers (demand) than sellers (supply), the stock price typically rises.
This is why low demand and low prices alone are not enough to form a bottom. “A simple exhaustion of sellers does not constitute a bottom,” said Russell. “Some stocks decline without rebounding, sit for a few months, and then continue to fall. A bottom requires the entry of new buyers.”
The formation of a bottom is completed with the entry of new investors who contribute to the rise in the stock price. As demand for the stock increases, its price rises.
“All the old shareholders who didn’t like it have already sold,” said Russell. “At the same time, a new group of investors who like the stock begins to come in.”
The bottom price often indicates a rebound for the stock, according to Russell.
“Stocks are usually at a bottom before good news officially arrives,” he said. “For example, the S&P 500 rose in March 2009 and March 2020. In both cases, it was over a month before the recession ended.”
This is why some economists may use stock bottoms to assess future business conditions.
What does this mean for individual investors?
“A stock bottom can be a major opportunity for investors, with benefits that far outweigh the risks,” said Russell. “It can sharply increase the chances of making a profit. However, it’s not easy.”
Sometimes this strategy is referred to as “bottom fishing,” where investors target stocks that are close to their lows, believing they are cheap deals. However, this strategy requires patience as the bottom formation can take multiple years.
Be cautious of time cost opportunities when waiting for stocks that have hit bottom to rise, as Russell pointed out.
“The biggest problem with targeting stocks that have hit bottom is that they rarely rise directly,” said Russell. “Most often, they pull back, and investors waste time and money. Investing is not always about finding value or cheap deals. It might be more beneficial to focus on real growth.”
Key takeaways:
- A stock bottom indicates a stage that begins when selling ends and buyers start to outnumber sellers. The lowest price traded during the bowl formation is the “bottom price.”
- It is not
It’s enough for stock prices to drop – forming a stock bottom requires the entry of new buyers to reverse the downward trend. - A double bottom occurs when the stock price drops to a certain level, then bounces back and drops to that level again before bouncing back again. Some investors use technical analysis tools like Bollinger bands to track double bottoms in real time.
- Tracking stock bottoms can be rewarding investment opportunities, but it requires patience and may lead to resource waste.
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Sources:
- The Balance
- Yahoo Finance
Source: https://www.thebalance.com/what-is-a-stock-bottom-5196177
Source: https://www.thebalancemoney.com/what-is-a-stock-bottom-5204687
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