Street Sense: The fundamentals of stock market investing
How to Buy at Market Bottoms
The stock market is always a risk vs. reward proposition. Use these indicators to identify safer buying opportunities.

BY JERRY HELZNER

 An unprecedented drop in the stock market this summer created widespread fear. The selling continued to feed on itself and many investors finally panicked and sold their stocks.

Did many scared investors sell right at the bottom? Probably. Could they have made better decisions? Certainly.

In this article, I'll tell you which signs to look for that will tell you when a market decline is coming to an end. Know these signs. They'll help you buy bargain stocks when others are selling.

One of the best signals that a bottom is at hand is tremendous negativity surrounding the market. These negative feelings are often reflected in the cover stories of popular weekly magazines such as Time and Newsweek, or on television talk shows. But investor fears can also be expressed in ways that are actually measurable. These "sentiment indicators" are an excellent tool for timing changes in market trends and are readily available to you as an investor.

USING SENTIMENT INDICATORS

The basic sentiment indicators measure the confidence of investors at a specific moment in time. If the great majority of investors are fairly certain the market is going to drop further, their fears will be reflected in some key market statistics. Here are some indicators you can check daily or weekly:

ILLUSTRATION: JOHN PATRICK

The Chicago Board Options Exchange (CBOE) put/call ratio. Puts are the publicly traded options investors buy when they believe stocks are going lower. Calls are the options they purchase when they're betting on higher stock prices ahead.

The CBOE keeps track of how many puts and calls are bought and sold. These statistics are available at the CBOE Web site, www.cboe.com. When sentiment is neutral, about three calls are traded for every two puts. But when investors grow extremely fearful, the number of puts traded will actually exceed the number of calls for several days in a row. When put volume overwhelms call volume, it's a good signal that negative sentiment has reached an extreme and the overall market is nearing a bottom.

The Volatility Index. Known as the VIX, the Volatility Index is another important sign of investor confidence. It basically measures the level of complacency of stock market investors.

In neutral markets, the VIX normally hovers in the low 20s, a level that reflects investors' beliefs that the market is fairly priced. However, when a majority of investors fear that a big drop is imminent, they are more willing to dump stock at any price and the VIX can climb to 50, as it did in late July. At these higher levels, investor fears are usually overblown and the market actually has a good chance of rallying. You can track the VIX on www.cboe.com.

The Arms Index. The Arms Index tracks selling pressure and intensity vs. buying pressure and intensity on both the New York Stock Exchange and the NASDAQ.

In a neutral market, the Arms Index tends to hover around 1.0. Buying pressure lowers the Arms Index and selling pressure raises the number. When the Arms Index stands near 1.5 or more over a period of a few days, it means that selling has reached an extreme and the market is due to rally. The final Arms Index numbers for each trading day of the preceding week are published in Barron's each weekend.

The CBOE put/call ratio, the VIX and the Arms Index can tell you when the market has experienced climactic selling. Such indiscriminate selling creates buying opportunities.

EYECARE STOCK NOTES

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Ophthalmology Management Associate Editor Jerry Helzner has written more than 50 articles on stock investing for Barron's. He has been a regular stock market columnist for other business publications and was a member of the equity research department of a major regional brokerage firm.