Where will Nifty form a bottom ?

There is no doubt that we are in a bear market. What have we learnt from it ? "The only thing that we learn from history is that we never learn from history."

I hope you read my previous blogpost as to why 10,000 - 10,200 was a very important level on Nifty & with it being broken, one should have moved significantly to cash. This level was 200 weekly moving average which has been broken only once in last 17 years which was in 2008. So without any doubt we are into something like 2008 or far worse than that.Market has been literally butchered. Portfolio's are down 40-50% for many investors. And this is after a severe bear market in small caps for last 2 years

Psychologically there are 3 phases of a bear market:

Phase 1: During 1st bounce, we feel that worst is over and we can do bargain hunting 
Phase 2: Bloody hell. This is worse than I could have thought of !
Phase 3: I'm getting out of this market.

Phase 3 is where a bottom is formed !
Psychology plays a very important role in bear markets since as you deploy your capital, you may see your portfolio down by 20% the very next day !

Now the million dollar question is: where will the market bottom ?

As it is rightly said that, 'Tops and bottoms are made in hindsight'. So does this mean we would never know where the bottom would be ? Thats simply incorrect. We can certainly find patterns which have worked in past. Why ? Because even though history may not repeat itself, but it does rhyme. 

I have laid down few findings from previous bear markets (India as well as globally). 

Multiple bear market rallies
Bear markets generally never bottom in a single go. Nifty in 2008 saw 7 major rebounds. So don't go in all at the first temporary bottom. Market usually bounces back to get in more suckers to buy the rally & kills them with a brutal drop which follows. This is also the A-B-C pattern which I have mentioned in my previous blogpost. 
Bull market tops are made in minutes while bear market bottoms take days to form

Multiple rallies in a bear market

Nifty 8-12 p/e for bottoming out
Nifty in past has bottomed out between 8-12 p/e. With current EPS of around 525, that level comes to around 4200-6300

Technical patterns to signal that bottom is near

Fall in VIX: 
VIX is the volatility index or commonly known as fear index. Higher the VIX, higher the volatility. This is the sole reason we are seeing daily moves of more than 5% on the index. VIX always shoots up during bear markets & cools off during bull markets. So this is the first major signal of a bottom being nearby

Volatility Index

Reduction in trading range: Average daily trading range increases a lot during bear markets. Why ? Its because of VIX! Higher the VIX, higher the trading range, as VIX starts cooling off, watch out for reduction in trading range. Currently Nifty has an average trading range of 500 points. This trading range normalizes as bottom is being formed

These 2 are initial signals which you can look out for a confirmation of bottoming process.

Bottom confirmation using charts

Looking back at the bottoms which have been formed in history after a major bear market, below are few repetitive patterns identified. This is something which I've assimilated by reading various books & articles on internet pertaining to bear market. One should strictly use daily charts for this

• Wait for a long tail candle where the market closes above days low. This low is a new low in the bear market. The close is generally significantly above days low & is a rally attempt by the market. Lets call it day 1 low
• In the following days, market doesn't break the low made on day 1. It might test this bottom thereby making a double bottom, but doesn't break it
• Coming to the most important part. There will be a follow through day wherein market rises 2% or more. This follow through day should ideally happen after 3 days or more from Day 1 (this though is not a stringent condition, just signifies that the markets are respecting the bottom formed for a week or so)
• The follow through day bottom is an important level. Post the initial rally (wave 1) after the follow through day, market may come back to test this low (wave 2). Market may go below this low but closes above the low level & rallies back with another follow through day giving a confirmation of a bottom in place
• This follow through day may be a false attempt and market may go on to make new lows which signifies that the bottom is not in place

Have a look at charts below which exhibit these patterns for all major bottoms formed in past few decades. 

Dow Jones - 1987 bottom

Dow Jones - 2003 bottom

Dow Jones - 2009 bottom

Nifty - 1997 bottom

Nifty - 2003 bottom

Nifty - 2009 bottom

After looking at charts, do revisit the conditions which i've listed above. Bear market bottoms don't happen without a follow through day !

Fibonacci retracement

Though its futile to predict the accurate levels, we can try to identify some range. If we see 2008 bear market, Nifty retraced 78% of previous bull market rise. This range on Nifty will be between 4700 - 6400. In my earlier post I'd covered why 6300 is an important level on Nifty. Do check that here

Nifty - Fibonacci retracement 

So to summarize, one can look at bottom being formed anywhere between 4700 - 6400. (using Fibonacci retracement & historic p/e ratio).
But how will you get a confirmation that the bottom is in place ? Boss, you just read it sometime back ! 

Be on lookout for VIX cooling off & a 'Follow Through Day'