Picking, researching and analyzing charts of growth stocks all amount to nothing if investors forget one simple rule: follow the market’s direction.
That is why we wrap up the seven-part series on the CAN SLIM trading methodology with “M,” which stands for market direction. The letter is a strong reminder that whatever other research and chart reading you get right, it is worthless if you end up betting against the market.
IBD founder William O’Neil made clear, in “How to Make Money in Stocks,” that investors “absolutely must have a proven, reliable method to accurately determine whether you are in a bull (uptrending) market or a bear (downtrending) market.”
The best way to determine the direction of the market, O’Neil said, “is to look carefully at, follow, interpret and understand the daily charts of the three or four major general market averages.”
Growth Stocks Abide By Market Direction
IBD subscribers receive a close reading on market behavior each day after the market closes from The Big Picture. Before the open and during the session, Stock Market Today provides additional reporting and analysis of the market action.
The current market outlook is located in the Market Pulse, published alongside the Big Picture each day. There is nothing complicated about it. In fact, there are only three stages of market status: confirmed uptrend, uptrend under pressure and market in correction. An uptrend is the best time to buy stocks; under pressure means trade carefully; correction means go to cash.
Over time, in addition to the three basic status levels, investors should also learn to understand the main market topping and bottoming signals: distribution days and follow-throughs.
Big Picture analysis carefully tracks distribution days, numbers for which are listed on the daily Market Pulse. Distribution occurs when an index closes lower and volume for the session is higher than the previous day. If an index racks up four or five distribution days, particularly when they occur in a short period, it is a sign of rising pressure on that index to consolidate.
Know Your Distribution, Follow-Through Days
Therefore, even when growth stocks are often behaving well and sending no distress signals, increases in distribution days often suggest a change in market direction. Distribution day counts tend to pile up just before market status shifts to “uptrend under pressure,” and “market in correction.”
Follow-through days mark another change of direction, the point where a correcting market reverts to a confirmed uptrend. Follow-throughs occur when a benchmark index logs a significant gain, more than 1%, in higher volume. Watch for this signal on the fourth day or later of gains from an index low.
The most recent follow-through was that of the S&P 500, which rallied 2.2% on Nov. 4 — the day after the U.S. presidential election. The Nasdaq made its own follow-through the next day. Not all follow through succeed. But this one did, launching an uptrend that has since advanced nearly 27%.
Find Alan R. Elliott on Twitter @IBD_Aelliott
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