Market Top and Market Bottom: How to Recognize Them, and Why It Takes Time

A market top is the highest price a market reaches before a lasting decline, and a market bottom the lowest price before a lasting rise. Between them lie the bull and bear phases of the market cycle. The difficulty is in the word "lasting": on the day it happens, a top looks like any other high, and only the decline that follows shows it was the top. The same holds for a bottom, so both are identified in hindsight.

What defines a top and a bottom

There is no official threshold, but one yardstick is widely used for stock indexes. According to the SEC's investor.gov glossary, a bear market generally occurs when a broad market index falls by 20% or more over at least a two-month period. The same glossary defines a bull market the other way around, a rise of 20% or more in a broad market index over at least a two-month period, so a gain of 20% from the low is a common marker of the end of a bear market. Market commentary usually calls a smaller decline, of 10% to 20%, a correction; that threshold is a convention with no official source. A top, then, is the peak of a move that turns into a bear market, and a bottom the trough from which a new bull market begins.

Before the bear market is confirmed, the same peak could have been an ordinary pullback. The rally that follows a low can also fail: a rise inside a bear market that gives way to new lows, called a bear market rally, makes a bottom look real before it fails. Our page on the bull trap covers that case.

Five tops and five bottoms of the S&P 500

Since 1987, the S&P 500 index has fallen 20% or more from a record close five times, measured from close to close. Each decline ran from a record close to the lowest close before the index recovered it.

For each top and each bottom, the next chart shows when the index first closed on the other side of its 200-day simple moving average, a common trend filter, and how far it had already moved from the top or the bottom at that close.

The 200-day average confirmed every top here, but only after the index had lost 5.7% to 12.0%, and every bottom only after it had gained 14.1% to 39.4%. The cross of the 50-day average below or above the 200-day one, the death cross and golden cross, came later still: 28 to 152 sessions after the tops and 74 to 149 sessions after the bottoms. In 2000, the death cross came on October 30, by which time the index had recovered part of its losses and stood only 8.4% below the top; the decline then continued for two more years. The 1987 bottom came about seven weeks after the Black Monday crash of October 19, at a close slightly below that day's.

A confirmation that whipsaws: 2022

The chart shows the S&P 500 ETF in 2022 with its 200-day average. The ETF made its highest close on January 3, 2022 and first closed below the average on January 21. It then crossed back and forth: above on January 24, below on January 25, above on January 28, below on February 11, above on February 15, below on February 17, above on March 18 and below on April 11, nine crossings in less than three months. It stayed below the average until a one-day cross on August 16. After the lowest close of the year on October 12, it first closed above the average on November 30, fell back below on December 5, and crossed twice more on December 13 and 14. A trader who used each cross as a signal would have changed sides fifteen times in the year.

Warning signs traders watch

None of these signs tells when a top or a bottom happens; each describes a market that has changed character. The first and the third are easiest to see together:

• Price structure. In a rising market, each high and low is above the previous one. A lower high followed by a break of the last higher low is a first sign of a top, and the reverse is a first sign of a bottom. The Wyckoff method describes the distribution and accumulation ranges that can form around these turns.
• Reversal patterns. Double tops and bottoms, head and shoulders and triple tops and bottoms are chart shapes that traders read as turns. We measure what followed them on our bench, below.
• Momentum divergence. A new high in price without a new high in an oscillator such as the RSI or the MACD is a bearish divergence; a new low without a new low in the oscillator is a bullish one.
• Volume. Some traders count days when a major index falls on heavier volume than the day before, often called distribution days, and read a cluster of them within a few weeks as selling by large holders near a top.
• Sentiment. Extreme optimism is read as a warning of a top, and extreme pessimism as a sign of a bottom. A climax can also take the form of a blow-off top.

Reversal patterns at tops and bottoms

The patterns below are classic shapes of tops and bottoms. The figures come from our bench, with the rules described in our methodology:

More chart reading guides are in technical analysis.