Can you tell if a stock is about to rebound?

Individual stocks do not exist in a bubble. Every publically traded stock is part of a larger financial sector. Here are some examples of market sectors and the companies that belong to them:

As a general rule, you can expect all of the stocks within the same sector to perform roughly the same [source: Abraham]. There are exceptions to this rule, of course, especially in the short term. If Nokia reports more smartphone sales than Apple, you might see a momentary bump in Nokia stock and a drop in Apple. But if you look at the bigger picture, you can expect both Nokia and Apple to follow the long-term trends in the consumer electronics sector.

How does sector analysis help you guess when a stock has hit its bottom and is about to rebound? If an individual stock generally tracks the performance of its sector — at least in the long term — then you can compare the performance of the stock to its sector to predict future price movements.

As a hypothetical example, let's say that Yum! Brands — which owns Pizza Hut, Taco Bell and KFC — saw its stock price drop 5 percent over the past year. In the same time period, however, the entire "leisure services" sector has grown 10 percent. Unless Yum! Brands is having some serious problems — major lawsuit, CEO in prison, employee strike — we can reasonably expect it to ride the trend of the rest of the sector.

What does that mean? It means that even though Yum! Brands is down, it's probably not down for long. In fact, a rebound might be on the horizon.

Share price is not the only indicator of the strength of a specific stock. When market analysts look for a stock with rebound potential, they pay particular attention to the relationship between stock price and trading volume.

First, let's define volume. Volume is a simple measurement of how many shares of stock changed hands during a single day of trading. It's important to note that each share has both a buyer and a seller. If a company's trading volume goes way up or down on a particular day, that's a good indication that investor interest in the stock is changing. If we throw stock price into the mix, we can start looking for signs of a rebound.

Here's how it works. If a stock's share price goes down, but trading volume is relatively low, that's called a weak move [source: Mitchell]. In other words, if volume is low, then investor interest is low, which isn't a strong indicator of a rebound. You need a lot of interested buyers to drive a stock price up; it's the law of supply and demand. The more demand for a stock, the more money investors are willing to pay for it.

If you are trying to predict a rebound, first you want to look for a sustained period of declining share price and a similar decline in volume. Then, just as trading volume tapers off, you want to look for a day — or an hour, or a minute! — in which the stock's share price still declines slightly, but there's a spike in trading volume. This is a sign that the last sellers are finally out of the market and buyers are now taking over [source: Mitchell]. If the buying trend continues, the stock price will rebound and you will have gotten in on the bottom floor.

Of course, you want to make sure the company itself is financially sound so that you don't end up with a bunch of worthless stock.

Stock analysts have developed a number of useful formulas for tracking this critical relationship between volume and share price. If you are serious about trading stocks, you should learn more about indicators like on-balance volume, Chaikin money flow and the Klinger volume oscillator.