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Signs Of Bottom? Wait For Follow-Through
Investor's Business Daily |
| September 26, 2001 |
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We’re little more than two weeks removed from a national tragedy. Consumer confidence is tanking. A bear market has raged for 18 months.
So how do we know we’ve hit market bottom? Even if we have, should you really be buying now?
Only the market knows for sure. But signs abound that the worst may be over.
Last week’s massive sell-off sent shock waves of fear through the market. The put/call ratio spiked to 1.21, its highest level in years. That meant option traders grabbed 121 bearish puts for every 100 bullish calls.
The CBOE volatility index, another fear indicator, surged above 57 as it jumped to extreme levels. Several bull vs. bear surveys caved in to negative sentiment after months of holding out hope.
When investors panic, give up and get out, the market is free to advance on a fresh wave of buying.
But beware. A possible bottom doesn’t guarantee trading success.
First, you’ll want to see a market confirmation.
That starts when one of the three major indexes begins to rally. That’s day one. Next, wait two days. The market often needs time to digest its initial gains. Make sure the index doesn’t undercut its low. If it does, start counting over again.
Starting on day four of the cycle, look for a follow-through session. That occurs when the Dow, Nasdaq or S&P 500 jumps at least 2% on higher volume than the previous day. Ideally trade will also exceed its 50-day average. The bigger the price and volume moves, the better.
The strongest follow-throughs occur between days four and seven of the attempted rally. Follow-throughs after the 10th day become less significant.
Even that’s not enough, though. Before the confirmation happens, you’ll want to compile a watch list of great stocks in leading industries. They should sport stellar sales and earnings growth and display uncommon price strength, even in a tanking market.
If stocks of that caliber start breaking out of sound price bases, that’s your sign to wade in carefully. Nab one or two of those breakouts. If they keep rising, carefully buy a few others until you’re eventually fully invested.
If they don’t work, remember to use key sell rules to preserve your capital. Selling when a stock falls 7% to 8% from your buy point is crucial at that stage.
The S&P proved the value of prudence nearly three decades ago. The index dived 50% from January 1973 to its October 1974 bottom.
The index staged several fake-outs along the way. A July 1974 rally suggested a possible bottom. But the S&P rolled over, plunging to a new low in September (see point 1 on accompanying image). |
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