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With the Nasdaq up 2% today on healthy volume, MarketSmith received a number of calls from investors looking for confirmation about the Follow-Through Day (FTD) we have been discussing in recent blogs. For those who don’t know, the Follow-Through Day concept was developed by my father, William O’Neil, to validate the sustainability of a new rally attempt, after a market corrective phase. No bull market rally has ever started without one. While today’s action is positive and represents accumulation—something we haven’t seen in a while—it is not an FTD, and certainly not a signal to begin plowing back into the market.
The current market correction has lasted a little more than two months, and this rally attempt began only three days ago. As discussed in last month’s webinar
, an FTD occurs four to seven days after a new rally begins. The reason we wait at least four days before calling an FTD is because we are looking for proof the rally is real. One or two days does not make a trend. But if after four days or more we can see that money is still flowing into the move, and institutions are not using this rally attempt as an opportunity to dump shares, we begin moving back into the market. Specifically, we are looking for significant, new demand on one of the major indices: a day where price is up over 1.4% and volume is higher than the previous day.
Take a look at the NASDAQ from 8/8/2007 (above) for an example of why we wait four to seven days for confirmation. The rally began on 8/6/2007. We got convincing price and volume action on day #3, but ultimately the rally was overwhelmed by institutional selling, and it failed.
So the earliest we could see an FTD would be tomorrow (day 4). But even if we do, I would apply extra scrutiny and begin wading into the market very slowly. In addition to the FTD market confirmation, we also look to leading stocks to signal it is safe to begin buying. While there are a few stocks with tempting breakouts today, most of the prior leaders (AAPL, PCLN) are moving up off their lows and are still pretty far from breaking out of a recognizable chart pattern. Several leaders like NTES and UA have met resistance and reversed at new highs multiple times over the last few months, as they tried to break out, despite the market correction. Who’s to say the same behavior doesn’t continue until we get solid confirmation from the indices? Most other leaders have not even fared that well. TSCO and RAX are two examples of prior leaders that are breaking down and no longer look healthy.
For these reasons, a cautious approach still seems appropriate at this point. You can protect yourself from the market volatility by moving in and out of the market incrementally, that is by making each decision prove correct, before getting carried away and making more decisions. Remember that moving back into the market is a methodical process that requires the market to prove its strength before we invest more in it.
Finally, and most importantly, I have been focusing on weekly charts to evaluate chart patterns forming on leading stocks and to assess the trend of the overall market. Keeping my eye on the weekly view has kept me from being tempted by some of the action we have been seeing on daily charts. It is pretty obvious from a longer-term time frame that most leading stocks—and the indices—still have work to do before setting up properly for another profitable rally.
President, MarketSmith Incorporated
Follow Scott O'Neil at Twitter.com/WScottOneil
Let's not forget this is June
Scott, you're the man
Thanks Scott for your blogs - - a wealth of good commentary. IBD Radio show, 6/2/2012, cited Paul Whitfield's study that from 2000-2011, no FTD during June or July lead to a "sustained new uptrend" ... that statistic to me further substantiate's your cautious approach at this time - - with the weekly chart perspective it may then take until at least August for the indices to show better patterns.
I'd like to pose a question that is unrelated to this commentary. In the absence of an ROE number (for example, newer companies with a shorter earnings history) is there another metric that can be used? Thank you for your insight.
ScottL: as always, thank you for the timely commentary. Your insights are very much appreciated by us all. I do have a broader question raised by rjcastorena is there a way to review podcasts fro IBD radio? I missed the review of FTDs by Paul Whitfield and would be very interested in an audio podcast or reprint of his study results. Thanks to all. For those who missed SON and Richard Marcus' recent webinar, I strongly recommend this to all as well. Brad
bjrad- check out www.investors.com/radioshow/ looks like all the shows are archived there and you can get a print version of the show notes as well.
also there is a podcast version you can subscribe to.
Scott, please take some sand out of my shoes and follow the grammar advice here: grammar.quickanddirtytips.com/a-versus-an.aspx and put an end to "...it is not an FTD..." which you often use.
Mea Culpa: If we read it as "FTD" you're fine, if as "Follow Through Day" not fine. I'll buy the letters. More importantly, great blog.
@dtempest: If I can’t get the ROE, I will fall back on quarterly and annual earnings, and place more emphasis on the pre & after-tax margins.
@wesfraser: I went back and forth on that one, but ultimately chose readability over proper grammar. In the shop, we say “today wasn’t an FTD” so that is how I will write it. Thanks
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