How to Spot a Market Reversal

Before we get into screening individual stocks, let’s refresh our memories and understand what we are looking for in the major market indices: We are looking for a market reversal or as Jesse Livermore called it, the pivotal point.

“Whenever I have had the patience to wait for the market to arrive at what I call a “Pivotal Point” before I started to trade; I have always made money in my operations” – Jesse Livermore, 1940

Market direction or the ‘M’ in CANSLIM as I have highlighted it in the past is the most critical characteristic to consider when investing. Seventy five percent of all stocks follow the general market averages with these numbers becoming more skewed in times of extreme pessimism (like now – 90% of all stocks are following the carnage).

Bear markets are necessary to help deflate the overvalued price/ earnings ratios and overpriced shares in times of extreme exuberance. Bear markets create widespread negativity, overwhelming pessimism, fear, uncertainty and a total lack of confidence among investors. Cash exits the stock market as people panic like sheep and prices start to adjust back to reasonable levels, paving the way to new opportunities around the corner.

We are clearly looking for a new uptrend that sustains some life with a rally on above average volume. Bear markets will provide several head fakes as they typically fall in multiple waves of lower highs and lower lows. It usually takes the majority of stocks listed on the exchanges to sell off enough that a true base can form that will propel the next up-trend or bull market.

Study the charts below for the down-waves prior to the 1982 and 2002 bull markets. I selected these two years because they represent the strongest up-trends (bull markets) following a bear market over the past 30 years.

The first rally will feature one or more of the major market indices gaining at least 3% or more on higher volume than the previous day. It is then critical for at least one of these indices to follow-through with similar action four to ten days later (preferably four to seven days later – rules from original O’Neil books).

We won’t be able to tell if the market is building a rally after the first 3% up-swing so give it time and look for at least one, if not multiple follow-throughs from the four day on. The more, the better. Markets will give head-fakes about 1/5th of the time after a true follow-through so we will pay careful attention to the number of waves down during the current bear market. We have had three waves down but only one major wave down on the DOW (it could go lower – easily, before moving higher).

See charts below for the pivot point reversals and follow-throughs for the 1982 and 2002 bull markets.

We must understand that head-fakes and multiple pullbacks are clearly in the historical descriptions of former bear markets. I don’t quite know if the current markets have had sufficient pullbacks before launching a new up-trend (see the charts of the DOW and NASDAQ from yesterday’s post).

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What should we do?

The Dow is down 40% since its all-time high set on Thursday, October 9, 2007 and the NASDAQ is down 45% its 52-week high set on Wednesday, October 31, 2007. The NASDAQ’s all-time high was set on March 10th, 2000 at 5132.52; a 69%+ decline calculated using Friday’s close of 1,552.03.

So, what should we do?

That’s the question everyone seems to be asking.

A number of people have e-mailed me, sent me messages on Facebook or have asked me in person what I am doing or what they should do. It’s not a simple answer because everyone’s goal is different and the road each of us takes will vary. So, the best way for me to answer this question is to tell you what I am doing.

Let’s start at the automatic investments: 401(k) or IRA. Both my wife and I have these accounts and we will continue to fund them, especially with employer matches (why not – it’s free money). For example, my company matches 100% of the first 3% and then 50% of the next two percent. That’s a 5-to-4 ratio for the first 5% of my salary or in other words, I get an 80% return on the first 5% I add to my account without making a move (profit sharing is another perk that gets added to this account as well).

For example, a $100,000 salary would get $4,000 added by the employer for the first 5% or $5,000 invested into that 401(k). I suggest that anyone that doesn’t currently participate in a plan that offers a match is not making a great decision (in my opinion). Enroll and start making “automatic” deposits into the account; every year wasted is a year you lose out on an employer match and more importantly, the power of compounding. I don’t think this is the best option to grow wealth but it’s not bad when you get a match.

What about my individual stock investing account?

First, I always run to my personal library of “yellow highlighted” stock market books in times of extreme pessimism or extreme optimism. Why, because I can pick the brains of men and women who have gone through similar situations and learn from their experiences. In particular, I read Martin Zweig, Jesse Livermore, William O’Neil, Gerald Loeb and Victor Sperandeo (see reading list for details). I’ll also glance at pieces written by Warren Buffett and Peter Lynch for fundamental pointers.

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False Markets

I only have a few things to say: the up and down swings of the market over the past few days is an illusion. The prices are not completely true as short sellers have been eliminated from the equation (in the most important area). Do we trade in a free market system? I guess not. Until the short sellers return, the rest is baloney! I wonder if that 777 point drop would have been closer to 1,500 if short sellers were in the market.

Be careful when they do return (as restrictions are lifted).

Keep this in mind: the 777 point drop may have been the largest one day point drop but it was only #17 for total percentage points at 9%. The largest drop ever was 22%.

I am still long the dollar (and believe it or not, shares in Visa). What a mess!

We may have false markets but charts don’t lie!

8/24/08, $76.81: US Dollar Buy Signal

12/17/07, $77.43: US Dollar Snapshot

Shanghai is a Nasdaq Déjà vu

“All through time, people have basically acted and re-acted the same way in the market as a result of: greed, fear, ignorance, and hope – that is why the numerical formations and patterns recur on a constant basis” – Jesse Livermore

Jesse Livermore says it better than me and he is a big part of the reason why I study chart patterns so intensely. Stock charts organize human behavior in patterns that allow us to anticipate future moves based on past results. Based on this assumption, I wrote a post last October titled: Is Shanghai a Nasdaq Déjà vu

I compared the 1929 Dow Jones to the 2000 NASDAQ (as many have before me) and then the 2000 NASDAQ to the 2007 Shanghai Composite Index. The three looked so eerily similar that I knew I had to write an intense post with excellent graphics to back up the possibilities. The entire post is pasted below or can be found on the link above. This is what I had to say about the future developments of the Shanghai Composite Index based on my studies of 2000 and 1929:

This won’t happen overnight but human nature always repeats so expect a huge decline in the Shanghai Stock Exchange within the next several years.

“The price pattern reminds you that every movement of importance is but a repetition of similar price movements, that just as soon as you familiarize yourself with the actions of the past, you will be able to anticipate and act correctly and profitably upon forthcoming movements” – Jesse Livermore

Well, take a look at what has happened to the Shanghai markets since my post last October: The chart has dropped in almost an exact shape and slope as did the NASDAQ in 2001 and 2002. The index is now down more than 65% since my blog post and more than 70% since its peak.

The moral of this post (I’ll leave it to Livermore one last time):
“Wall Street never changes, the pockets change, the stocks change, but Wall Street never changes, because human nature never changes” – Jesse Livermore.

Take a look at the charts from 2007 and compare them to the charts above. Human nature!

*************October 3, 2007 Blog Post*************
The rise of NASDAQ in the late 1990’s has been compared to the rise of the Dow of the late 1920’s. Chart overlays are amazingly similar.

Image from

Well, the current two year rise of the Shanghai Stock Exchange Composite Index looks remarkably similar to the rise of the NASDAQ of the late 1990’s and the charts below explain better than I can!


The NASDAQ rose from 1,250 to 5,132 from March 1997 to March 2000: 310% gain!
The Shanghai Stock Exchange has moved from 998.23 in June 2005 to 5,552.30 today (10/2/07): 456% gain!


As you can see, the blue line of the late 1990’s NASDAQ has moved meticulously with the Shanghai Index of today.


Will the Shanghai Stock Exchange end up with the same result as the NASDAQ of the late 1990’s. As you can see, the NASDAQ went from 1,250 to 5,132 back down to 1,192 (all within a five year period).


This won’t happen overnight but human nature always repeats so expect a huge decline in the Shanghai Stock Exchange within the next several years.

1929, 1999, 2007, etc…

Is Shanghai a Nasdaq Déjà vu

Mark Cuban’s Take on CEO Pay

I read an article yesterday from Mark Cuban, My 2 Cents on CEO Pay, that I somewhat agreed with and thought deserved a post just before the weekend.

Do you agree, disagree or have a better idea on how to pay corporate CEO’s in America.

I tend to agree that CEO’s in the US have been screwing their own companies over the past few decades, if not longer. I am all for exceptional pay, bonuses and incentives if key benchmarks or financial goals are met but I don’t agree with rewarding poor performing CEO’s (especially when they walk away with half-a-billion dollar termination rewards after running the company into the ground; can we say Home Depot – or The Home Dumpo as I like to call it).

Incentive based pay is how I would run my company, from the most entry level employee to the top of the chain. Yes, I would offer base salaries but the majority of everyone’s pay would be incentive based. Enough of that; read Mark’s article and let me know what you think. Place all public perception aside about Mark’s character and focus on what he is writing.

My 2 Cents on CEO Pay
By Mark Cuban
April 15, 2008

“There is a game played by CEOs with the corporate issuance of lottery tickets. Otherwise known as stock. Stock can be issued in any number of ways, shapes or forms. Warrants, options, restricted or unrestricted stock. No matter what you call it, every CEO hired, is asking for equity knowing that their only goal is to hit the jackpot and create a pool of wealth that puts them in the “fuck you” wealth category. Thats enough money to buy or rent just about anything you can think of and put you in position to never have to work again. You just live off the cash in the bank.

Put another way, every hired CEO is looking to be in a position to look in the mirror , smile and tell themselves they have made it. They are living the American dream. The only way to do that is to grab as much equity equivalents as you can and do everything you can to get that stock price up as high as you can while periodically liquidating the stock and stuffing the cash in your bank account.

There is absolutely nothing wrong with doing so. Any CEO who doesnt take advantage of this golden ticket opportunity is an idiot. In fact, although I don’t have actual numbers, I would hazard a guess that more than 95pct of CEOs hired to run companies with a billion dollar plus public market caps probably do get themselves to the position of having more than 10mm dollars in equity very quickly. While those who manage to hold on to their jobs a while and not screw up too bad, can relatively quickly get past the 25mm dollar in equity mark and reach the 50mm dollar mark with in 10 years. Its actually pretty tough to screw up and not get there if you have any brains at all.

Why ?

Because you have the entire Mutual Fund, Hedge Fun and Brokerage industry doing everything they can to get you there. Think about it.

You can’t turn on CNBC or Fox Business without them cheerleading the market to go up. Every man, woman, child, fund, index or interested party who buys the stock is doing everything they can to get the stock of the company to go higher. They don’t really care how you run the company and they care less about the results of the company than they do about the performance of the stock. Heck, even if they did care, shareholders dont really own anything and have zero say in the company. If you really dig into it, its the ultimate in social networking. Everyone who owns the stock belongs to the fan page or group for the stock and they are telling everyone they can how wonderful the company is and why the stock will go up, all while praying it does so.

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