Most market money is not made picking price bottoms or tops, but taking a piece out of established trends. It’s an expensive lesson to learn if you think that a stock can’t go any lower. A sharp price drop is attractive but also an extremely risky investment.
Everyone loves bargains, but remember that you are also fighting momentum jumping in during the downslide.
The setup often has everyone convinced the down move will continue with there being little, if anyone at all left buying because they have already been burnt.
A market that has fallen hard is often due for some profit taking. One way to gauge when aggressive sellers may have gotten ahead of themselves is indicated with divergence.
Implied volatility typically increases as a stock falls with more fear. That uncertainty component jumps on a stock slide.
The divergence play exists when new price lows are made but no new highs are made in volatility. This is often a sign the sellers have exhausted themselves and the end of the down move is near.
DIVERGENCE Bottom = New Price Lows and NO NEW implied volatility highs
This technique can be used to identify a technical bottom from the fear factor stabilizing even at an extreme low.
Picking the bottom in a falling market is difficult at best but the divergence test is a disciplined technique for a turn.
