What Is a Bottom in the Stock Market?
In investing, a bottom refers to the lowest price a security (or an entire market, as measured by a benchmark index) trades at over a particular period of time. This interval could be a day, a week, a year, or 10 years, but most discussions of the term focus on periods of a year or more. If you were looking at a line graph depicting a security’s price over time, the bottom would be the trough, or the lowest point on the line.
When it comes to stocks, which typically outperform other asset classes like bonds over the long term, the idea of a market bottom comes up frequently during pullbacks, corrections, bear markets, and other times when stock prices are slipping. When stocks are sliding downward across the board, everyone wants to know when the bottom will be, as historically, market bottoms are the best times to buy (and the worst times to sell) stocks.
Theoretically, if one could accurately time bottoms (and peaks), one would stand to make some steller returns. After all, the old adage “buy low, sell high” remains the first commandment of investing. Unfortunately, however, bottoms are usually identified in retrospect, and accurately timing one is far more easily said than done. That doesn’t, however, stop leagues of investors, both professional and amateur, from attempting to do so.
Why Is It So Hard to Time a Bottom?
Stocks go up in price when there are more buyers than sellers, and they go down in price when there are more sellers than buyers. So, theoretically, once everyone who was going to sell a stock has done so, only buyers should remain—the stock should have reached its bottom and be ready for a reversal. Unfortunately, in reality, buying and selling tend to happen in waves as new information—like earnings, federal interest rate hikes, and CPI figures—becomes available.
In fact, single days characterized by large rebounds in price are fairly common during bear markets. Each of these rebounds could mark a reversal and the beginning of a new bull market, but more often than not, these are just temporary green blips in a long, red slide. Even rebounds that last several days or weeks can turn out to be temporary, and lower bottoms may lie ahead.
In reality, the stock market is cyclical, but its cycles vary in length, and without a crystal ball, no one can tell whether a reversal will be temporary or mark the beginning of a new and long-lasting bull market.
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Market Bottom Example: The S&P 500 in 2020
The chart above shows the price of the S&P 500 index from mid-2017 to mid-2022. During the onset of the COVID-19 pandemic in early 2020, worldwide shutdowns led to widespread capitulation (panic selling), causing the index to drop rapidly to a bottom of about $2,200. This downturn was short-lived, however, and preceded a massive bull rally that took the index to a new high of around $4,700 before another bear market took hold.
Had an investor simply put their entire portfolio into an S&P 500 index fund in late March of 2020 when the market bottomed and sold at the bull rally’s peak in January of 2022, they could have realized a capital gain of around 210% in less than two years. This sounds like a no-brainer now, as hindsight is 20/20, but at the time, no one knew just how short-lived the COVID-19 selloff would be nor how long the subsequent bull market would last.
Do Stocks Usually Bottom at the Same Time?
During periods of market-wide decline, stocks, as a whole, fall in price. That being said, they don’t all fall at the same rate or by the same percentages, and they may not all bottom at the same time. Some industries, like energy, tend to perform better than most equities during the late stages of the economic cycle. Other industries, like technology, tend to be hit the hardest at these times.
Different sectors react to news differently and may peak and bottom at different times. When analysts discuss a market bottom in retrospect, they are usually referring to the bottom price of a benchmark stock index like the S&P 500, which represents the vast majority of the American equity market in an aggregate sense.
What Is a False Bottom?
A false bottom occurs when temporary relief lifts the price of a stock for a period of time, and investors assume a correction or bear market has come to an end. If this rise in price turns out to be temporary, and the stock or stocks in question fall back down in price below their previous low, then this first low would be considered a false bottom. False bottoms can occur relatively frequently during bear markets.
What Is a Double Bottom?
A double bottom is a “W” shaped pattern in the chart of a stock or index that theoretically occurs at the end of a period of decline. When this occurs, a stock drops to a low price, begins to rebound, then drops once again to a similar low. In technical analysis, many investors believe a double bottom can signal a real reversal.
How Can You Take Advantage of a Market Bottom Without Knowing Exactly When It Will occur?
One of the safest ways average investors can take advantage of a single stock (or the stock market at large) bottoming is to use dollar-cost averaging to lower their average price for each stock in their portfolio as these stocks go down in price.
Dollar-cost averaging refers to investing the same dollar amount in the same securities at a regular interval regardless of fluctuations in price. This means buying more of a stock when its price goes down and less of it when its price goes up. This strategy works best if each of the stocks in one’s portfolio has strong fundamentals.
If your goal is long-term growth, and your portfolio consists of strong businesses, bear markets can be great opportunities to set yourself up for larger gains whenever the market decides to turn itself around. Increasing the amount you dollar-cost average into your portfolio during downturns means you can scoop up more shares at lower prices, so that as long as you hold until the next bull rally, your gains will exceed those of someone who either sold their stocks or stopped investing out of fear when prices were falling.