What we'll cover
What a market bottom is and why it matters
How to interpret the Volatility Index and investor sentiment
Long-term and short-term investment strategies
It’s impossible to predict the exact movement of the stock market. But that doesn't mean there are no indicators to keep an eye on — some signs have proven to be good markers of potential market changes.
What is a market bottom?
A market bottom is the absolute lowest point in a market decline, or the turning point where selling stops and buying begins. You can think of the market bottom as representing the moment of peak pessimism from which the market will start to rebound. Instead of trying to pinpoint the bottom — which can't really be done until it's over — keep an eye out for when the market might be approaching a turning point.
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Why does a market bottom matter?
Understandably, many people want to know the best time to invest and aim for the maximum possible return. Some investors look for the bottom as a strategy to get in on the ground floor, so to speak. This might be helpful if you’re looking to invest a lump sum or have a windfall of cash on hand that you’d like to put into the market.
But if your investments are more long-term, like retirement or a college savings account, focusing on these market movements isn’t really necessary. It’s often better to take a set-it-and-forget-it approach to these investments.
Instead of trying to pinpoint the bottom — which can't really be done until it's over — keep an eye out for when the market might be approaching a turning point.
Signs of a market bottom
While there are many factors at play in market recovery, two of them are considered to be fairly reliable and are accessible to the public.
Volatility Index
Commonly referred to as the VIX or the “fear index,” the Volatility Index is an indicator that has some historical merit in its correlation with market bottoms. The VIX measures the price of optionson the S&P 500 and tends to spike during market uncertainty or decline. Put simply, demand for options increases as people look for ways to protect their portfolio from market volatility. This causes the cost for options to go up, and so does the VIX.
Typical prices on the VIX hover around 17. Past bear markets have had the VIX reach 45. But extreme market downturns, such as the 2008 financial crisis and the 2020 COVID crash, have had VIX prices above 80. A higher VIX is driven by increased volatility and uncertainty, but a VIX price in the 80’s range has historically indicated that a market bottom can be forming.
But that doesn’t guarantee that the market will turn around the next day. For example, in 2008, it took four months for the market to rebound after the VIX reached 80. It’s worth saying again: There are no guarantees when it comes to timing your investments.
Investor sentiment
The other factor you can look at when anticipating a market bottom is investor sentiment. People drive markets, and it’s important to pay attention to how much appetite investors have to buy or sell. The American Association of Individual Investors puts out survey results that represent investors’ thoughts on the market's direction. The sentiment of the surveyed investors is divided into two categories: bulls and bears. If you're bullish, you’d likely predict a higher market in six months, while bearswould typically expect stocks to be lower.
Bullish and bearish sentiment can be an indicator of an opposite market move. It might sound counterintuitive, but when many investors are predicting stocks to drop over the coming months, it can signal to others looking to buy that the time is right, bringing on increased activity in the market.
Calm your investment anxieties
With so much talk about inflation and market volatility, it can be stressful to think about when and how to invest. If you decide to use these market-bottom indicators to strategize, consider using a small percentage of your overall investments for more tactical moves. But remember: Investing early and consistently means more time and money in the market. Simplicity often trumps complexity when it comes to investing.
Approach your investments with humility and caution — if there were one easy way to navigate the market, everyone would be doing it. With a patient approach, you can take some of the stress and emotions out of timing these important financial decisions.
