Grab your pole and sharpen your patience. Today we’re going to explore how to bottom fish. This gambit involves identifying when a downtrend is ending, and an uptrend is beginning. It can be a tricky task, so I’ve penned this article with some tips to help.

All directional traders begin by learning how to spot and speculate on a single pattern. For me, it was the bull retracement. Though, back then, we called it a bull pullback. I’ve also heard it called a swing buy. The setup is simple. It’s buying a dip in an uptrend that is increasing in momentum.

The appeal of the pattern was clear. It allowed you to trade with the primary trend while offering a low risk-high reward entry.

Upon mastering my first setup, I set out to discover others, including the bull breakout, bear retracement, and bear breakout. Such maxims as “The trend is your friend,” and “a trend in motion stays in motion” bounced around my head as I sought to trade with, not against, the trend.

Quick aside. Do you know the appeal of learning more patterns or tradeable setups? It allows you to trade more by making it easier to find opportunities. As I’ve said before, a strong case can be made for trading more, not less.

Trading against the trend is not taboo. It just requires a higher skill set and a different mindset. As the name suggests, we’re fishing for the bottom of a downtrend. We’re trying to identify that moment in time when the balance of power shifts from sellers to buyers.

There is a great deal of variation between one bottom and the next. Some boast slowing momentum, and others form a W or double bottom. Some carve out an inverted head and shoulders pattern while others end with capitulation and a rapid reversal higher. The wide variety of formations is part of what makes bottom fishing challenging. You never really know what you’re going to get ahead of time.

But if you’re patient and wait for the right signals, you can increase your odds of success.

WORK Case Study

One of the stocks featured in our weekend Options report was Slack Technologies (WORK). Ever since its IPO, the stock has been trending lower. Bears have hounded it relentlessly, rejecting every rally along the way. But recently, their power began to wane.

Slowing Momentum

Momentum is expressed as the distance between pivots. In a downtrend, we look at the pivot lows. If the gap between them is expanding, then so too is momentum. If the gap between them is shrinking, then momentum is decreasing.

Take a look at the WORK chart below. Note how the distance between the pivot lows is compressing. This is exactly what slowing momentum looks like.

RSI Divergence

If analyzing the pivot relationships proves too difficult or if you want additional confirmation, you can use the RSI indicator. If momentum is slowing, you should the RSI carve out higher lows while the stock price is forming lower lows. This is known as divergence and confirms that momentum is slowing.

Note how the RSI of WORK stock has been forming higher lows ever since September.

Resistance Break

Not all slowing momentum signals result in massive upside reversals. Sometimes a downtrend slows, pauses, and then sells off anew. There are no foolproof patterns.

This is why waiting for an upside breakout can help confirm and complete a bottoming process. Once resistance is breached, the pattern of lower pivot highs is officially broken, thus, by definition, ending the downtrend.

WORK stock will do this when/if it rallies above $23.50

The Strategy

Now that we’ve identified WORK has a slowing momentum pattern, the next question is how to trade it. Do we buy stock or options? Do we use calls or puts? Do we do a spread or play naked?

You can do any of them.

However, for bottom fishing, I prefer high probability trades to increase the margin of error and my chance of success. The lower price tag of WORK makes it an ideal candidate for naked puts. Suppose we sold the Jan $20 put for 55 cents. If the stock stays above $20, you capture the max reward of $55. And, because of the credit you received, your expiration breakeven is down at $19.45, giving you a wide range of profit if WORK decides to monkey around for a bit.

If it were a more expensive stock, I’d use bull put spreads instead.