Market bottom strategy: Catch the bottom in a deep correction/bear market

Do you want to know if we can predict the bottom of a market with a deep correction or crash? Such as during the last Covid-crash in year 2020, during the US-China trade war in year 2018?

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However, one of the indicators are not available in MooMoo's platform. Not sure if MooMoo platform developer could add this indicator in after watching my video?

There are two indicators involved. The 1st one is Williams %R. Wiliams %R is a type of momentum indicator that moves between 0 and -100 and measures overbought and oversold levels. A reading above -20 is overbought. While a reading below -80 is oversold, where there is a potential for a price bounce.

In this video, I will be using Williams %R of over 52 period, using a weekly chart. Please note that for the video today, all the chart will be using weekly candle as I found that it is more reliable.

Let us back test Williams %R all the way to year 2000. I will mark it when the signal is at the oversold region. The return is estimated based on the distance from the oversold region, until the last period at the overbought region.

The most recent overbought region is on 16 Mar20, the covid crash. The correction was around 35%, and we entered bear market. Then, the market rallied for 102%!

(Please watch the video to get a better picture)
Next was 17-Dec-18, during the US-China trade war. The correction was 20%, just right to dip into the bear territory. After the Williams %R showed an oversold signal, the market rallied 38%.
The next one was on 11-Jan-16. The correction was 14%. After the oversold signal, the market rallied 53%.

Then, Black Monday 2011 on 26Sep11 dipped the market for 22%, another bear territory. After the oversold signal was shown, the market rallied 85%!

For the past 10 years, only 4 signals were shown, and it managed to predict the bottom accurately.

The next bear market was an infamous one: Sub-prime mortgage crisis in year 2009. The market crashed for 58%! While the William %R managed to anticipate the bottom on 23Feb09, previously it gave us 5 false signals, and the market dipped deeper. By the way, then the market rallied 97%.

Next is the dot-com bubble crash in year 2002-2003. The real bottom predicted by the signal was on 03Mar03. However, previously 6 false signals were observed! The market then rallied 87%.

Although the William %R alone manages to anticipate the bottoms accurately 4 out of the 6 deep corrections in the last 20 years, however, it also shows the major limitation of this indicator. The key limitation William %R is too responsive, meaning it gives many false signals. This is a typical weakness of a leading indicator.

Therefore, we need another indicator to streamline the Williams %R to anticipate the bottom is reaching. The indicator is normalized ATR. Let us understand what ATR is first.

ATR is Average True Range, and it is a market volatility indicator. High ATR means the market volatility is high. For example, in a less volatile market, Nasdaq composite index is generally move within 1%. However, since December 2021, the market is extremely volatile, where the Nasdaq composite index could move more than 2% per day frequently. This can be seen from the range of the daily candle. Before December 2021 (period before the yellow line), we could see that the candles are generally shorter. In contrast, there are many big candles can be seen after December- as indicated by the small red and green arrows.

Volatility after December is higher, and thus, ATR is higher too, as shown by the ATR indicator here:

The indicator that we are going to use, is called normalized ATR, which means it displays ATR as a percentage instead of absolute price. Normalized ATR creates a moving average of the volatility of a product going back X number of periods.

The ATR period used is 14, and we normalize with 52 period- as 1 year has 52 weeks.

Let us open the chart again:

Now, we are looking for the region where William %R is showing oversold signal, but the normalized ATR is above 80. When this happens, we call it signal converged.

Let us scroll through the chart (Please watch the video for a much better illustration)

For the past 10 years, the normalized ATR managed to converge with the William% R signal: the covid crash, the trade war, year 15-16 sold off and the black Monday 2011. Thus these 2 indicators managed to work together and predict the bottom accurately.

But, can it catch the bottom or reduce the false signal for sub-prime crisis and dot.com bubble crash?

During the sub-prime crisis, the converged signal showed that the bottom was on 06Oct08, where the price was higher than using the William% R alone. However, the numbers of false signal reduced from 5 to 2! If we manage our capital and cash flow properly, 3 rounds of dollar cost averaging are good enough for us to bring good profit, as the market rallied 50% from the converged signal.

How about the dot.com bubble? The converged signal managed to anticipate the bottom! Instead of 6 false signals if we used Williams %R alone, no false signal was observed if normalized ATR is also used! The market was then rallied 95%. For the past 20 years, both William %R and normalized ATR manages to catch 5 out of the 6 bottom accurately. Amazing right?

This is the summary table for what I have mentioned just now for your reference.

From this summary table, we can see that the combination of these 2 indicators manage to catch the bottom 5 out of the 7 deep corrections or bear market accurately!

Next, I will be sharing the limitation of this strategy:

1. Not for daily chart analysis. It will be a lot of false signals.

2. Not suitable for individual stock. The reason for these 2 indicators work so well together is because of US stock index is always going up. Thus, whenever the market is correcting, institute or big fish will sure buy the dip and push the stock higher. Thus, applying this strategy is not recommended for individual stock as the individual stock is largely depending on the fundamental and many other factors. However, since we know that most stocks are moving in the same direction with index, once we identify the signal from the index, we can then check the buy or sell signals of the individual stock.

3. Even when these 2 indicators converge to each other, it does not mean the exact bottom has reached. It may still going down a bit, or consolidate for a while before going up.

4. Never show hand and please manage the capital well. For example, buy the dip by controlling your cash ratio, and leverage down if the signal is false and the next bottom signal is shown again. For example, even though during the sub-prime mortgage crisis, we trapped by the first false signal. But, if we conserve our capital well, we can still buy the next dip when both signals converged again. Thereafter, we can just ride the trend. On the other hand, these 2 indicators help us to filter out a lot of noise without wasting a lot of our cash to buy the dip.

Hopefully you found this post useful, and MooMoo platform developer coul work on the normalized ATR indicator. Then, I shall prepare a tutorial video on setting it up using our MooMoo platform. Please remember to subscribe my channel and turn on the notification bell, so you won’t miss my tutorial video when I publish it. Thank you and see you in the next video.