How to Identify a Market Turnaround

The indian bear market

A market crash that occurs because of an economic event happens suddenly and swiftly. The fall is steep and sharp, and most retail investors have no other option but to wear brown pants 🙂 Many are tempted to sell stocks, and some investors who own quality stocks and have surplus cash, do not invest because some idiot analysts keep saying that “averaging” is a bad idea.

Anatomy of a Market Crash

When the markets crash because of an event, the fall is swift and sharp and recovery takes some time, maybe a few months. Not everything recovers – penny and low quality stocks go into a long hibernation while quality stocks and companies that stand to benefit from the cause of the crash recover their ground and start moving up rather quickly.

The idea behind this post is to spot a market turnaround – a situation where it can be relatively safe to buy into the market.

The tools I use to spot a turnaround are:

MACD (26,12,9); Weekly

RSI (14); Weekly

MACD-Histogram; Weekly

Let’s now dig into history and check how markets recovered from a crash:

The 2008 Global Financial Crisis

The global financial meltdown started in January 2008 and it took 9 months for the Nifty to bottom out in October 2008.

For Nifty, the Weekly MACD Line (26,12,9) crossed above the Signal Line in December 2008 – and the cross over sustained. Thereafter the Nifty went on to recover its losses and make new highs. The RSI (14) crossed above 50 in March 2009.

At that time, the opportune time for an ultra-safe investor to buy Nifty was somewhere in December 2008 (at this point you know the MACD Line has crossed above the Signal Line but you aren’t sure it will sustain) or January 2009 when the crossover sustained for 2 weeks in a row. The RSI crossover above 50 (which implies that the Nifty is breaking out of a consolidation or bear phase) happened in March 2009, which confirms that the MACD got the move earlier on.

This was about the Nifty. The MACD and RSI of other stocks would have for sure started crossing over the aforesaid parameters much before October 2008, and those I regard as stocks to track and buy if convinced.

The 2015 Greece Default

Likewise, Greece defaulted on its debt in August 2015 sending financial markets into a tailspin. The market bottomed out by February 2016.

The Weekly MACD Line crossed over the Signal Line first October 2015 and later in April 2016. The first signal was false, and this is where the importance of the MACD Histogram (which is nothing but the difference between the MACD and Signal Lines) comes in. In October 2015, the MACD Line value was -71 while the Signal Line Value was -96. So, the MACD Histogram was just -25. Now compare the absolute value of the Histogram with the Nifty, which was about 8200 at that time.

25/8200 = just 0.30%. You’re ideally looking for a positive MACD Histogram with a value between 0.75% and 1% of the underlying (Nifty). By this logic, the crossover does not translate to a buy because:

(a) The Histogram is negative

(b) Its absolute value is below 0.75% and 1% of the underlying.

The MACD Histogram passed both the parameters only in April 2016 making Nifty a buy. The RSI too crossed over 50 in April 2016.

Note that this crossover signal should be followed by ultra safe investors to confirm a market turnaround. Regular traders can always watch the price action, NR7, other indicators, etc., to snake in and out of positions.

The COVID-19 Crash

In the COVID-19 crash of March 2020, the Weekly MACD Line crossed above the Signal Line in May 2020 and in June 2020, the MACD Histogram was positive at 127 points, which exceeded 1% of the Nifty value of about 10,000 at that time. This was a buy signal. The RSI too crossed 50 in June 2020 confirming the MACD reading.

The Screener for Spotting Market Turnarounds

Stock passes ANY of the below filters in cash segment:

Weekly Rsi ( 14 ) crossed above 50
Weekly MACD Line ( 26,12,9 ) crossed above Weekly MACD Signal ( 26,12,9 )

After the screener throws up a list of stocks:

  1. Check their MACD-Histogram and apply the logic discussed upstairs
  2. Remember that when market crashes, MACD is a more potent indicator than RSI
  3. Ignore penny stocks and check up on the fundamentals or business disruptions of the rest and act per your risk policy
  4. Note that this guide is only for investors who play safe. Risk takers have their own setups.

If you have questions, ask on Twitter @TheBullBull

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