Battle Lines are Drawn

The stock market is putting up a valiant attempt to find a bottom and indeed there are some promising signs. However we cannot jump the gun and should wait for a follow through day. A follow through day typically occurs four to ten days from a recent low. Today is day four from the last low. To see a follow through day we must see higher volume than the day before with a 1-2% increase in a major index. Yesterday we had such an increase but the volume was actually lower than the day before. The fact that the bottom four days ago appeared as a key reversal during the day is promising indeed and then we saw a big up day like yesterday, but it just isn’t enough.

My readers are now mainly in cash avoiding this 10-13% correction. We do not know at this stage if it will get worse. As I have said before the best up days come in down market to draw people in. As hard as it is stay patient and wait for better prospects. We want to invest in an “odds favor” environment, we may be close or could just continue on down again. The best position to take is one of caution until we see a little more positive action. Those that try to get in at the bottom run a tremendous risk of going lower. It is better to be as sure as you can that the bottom is in then invest (no guarantees unfortunately).

Winning in a Down Market

The stock market has had another dismal week with all major indexes falling badly on volume as more distribution days pile up. It is hard for investors to stay out of the market during a down trend since stocks begin to look cheap but as I have said before you just have to stay out and wait for that follow through day as the signal to start buying. Do not think you are missing opportunities in fact you are doing very well by being in cash. You are not treading water you are increasing your buying power. As stocks fall your cash remains flat and so later you have greater buying power. Professionals measure themselves against the market indexes. They live and die on how much they beat the market by. Since the market has now fallen approx 10% from its peak you can consider yourself as beating the market by 10% if you are in cash and be proud of that fact.

The question is what to do in a down market. I am very busy in a down market and so should you. The best time to identify strength is when the market is weak. The powerful stocks that will take off first in the next up market are the ones that resist falling in down markets. So as the market falls you need to be identifying which stocks are not falling and which stocks may have recently jumped up on volume and are now holding steady. The stocks that are holding steady in this terrible market are the ones you need to be ready to buy when the follow through day occurs.

I am consistently updating my watch list on a daily basis looking for those strong companies. I will prune the list by pulling out stocks as they succumb to the selling and add to that list when I identify new companies that appear to be holding up well. I will not mention these companies now because even these strong stocks you should not be buying in a down market. You must wait until odds favor buying which is after the follow through day. When I see such a day I will start publishing my favorite stocks from the list I maintain daily. You should also be building your own buy list to be ready.

Market Looks Ugly

The stock market is showing so many negative signals now. It is below the 50 day moving average, down days are on heavier volume and the recent bounce up met resistance at the 50 day moving average as the market turned down again on increased volume. Just look at the chart below of the Dow, a picture tells a thousand words.

Graph courtesy of www.bigcharts.com

Notice the heavy volume down days then the rebound on lower volume. As the market moved back up the volume became less and less until it approached the 50 day moving average and got hit to the downside again. Only last week I mentioned to my readers beware of the up days in a down trend. Very often we will see many triple digit up days on lower volume to suck people back in before it tumbles again. Wait for the follow through day before buying stock.

The Sideways Action is Resolved

The sideways action of the last 3-4 weeks has now resolved itself to the downside. You may recall I said don’t buy until the market breaks out to the upside on volume which clearly hasn’t happened. We have now had some wild triple digit up and down days in quick succession. Big swings up then down then up again have been common which is very typical of a market that is in a topping process. This occurs because we have the buyers that we had on the way up but we also have the sellers who are getting nervous driving it down. Some days the buyers win giving a big up day other days the sellers win giving a big down day. As long as we have heavy buying and heavy selling we get the volatility and the sideways action as we have seen. It could have gone in either direction as the bulls or the bears give up first on their campaign. In this particular case we lost the buyers leaving only the sellers to drive the market down. The 50 day moving average has been broken on heavy volume so clearly the market is now in a down trend and my readers should be mostly in cash as their tightened stops have been hit. The graph below of the Dow indicates quite nicely what has been going on, see all the distribution days (red volume bars).

Graph is courtesy of http://www.bigcharts.com/

The downturn could end tomorrow, next week or next month I have absolutely no idea. Beware of the pundits claiming now is the time to buy but also beware of the pundits that say stay out of the market….nobody can know, let price and volume decide.

We have just one thing to do now which is stay on the sidelines and wait for a follow through day to indicate a turn. A follow through day is a big up day on volume followed by sideways movement with no real selling then another big up day to confirm (this is the follow through day). You absolutely must wait for the follow through day because any down trending market is volatile and you will see lots of triple point up days which are fakes just to get you in before the next plunge. We need to see the follow through day as a confirmation. However I must stress that even follow through days are not fool proof. No bull run will start without a follow through day but not every follow through day will lead to a bull run. All the follow through day can do for you is put you in an odds favor position.

Remember when we resume buying we start small in case the market fails again and build on the successes. Now is the time to go fishing or do the gardening and keep your powder dry ready for the next great run.

Focus on your Holdings During Tough Times

The distribution days are beginning to increase. The DJI (DOW) below shows three distribution days recently while other indexes are showing a lot more than three. Also the indexes have been moving sideways for 2-3 weeks now. Although odds favor a correction after a fantastic run up we just don’t know (nobody knows). We have to keep our gun powder dry and ease off on the buying until the market shows its hand. At this juncture it could quite easily move into a corrective down phase or conversely after some sideways movement break out to the upside again from its recent consolidation. As I said nobody can possibly know for sure but I would like to assume a downside move just so I can talk about how to handle the stocks you own in a down turn.


Graphs courtesy of www.bigcharts.com a great site for all your charting needs.

Compare the charts of DOW and CMG during the period when the DOW corrected approximately 8-9% (mid Jan to mid Feb). As I have said in the past when the main indexes start correcting down it is time to stop buying and concentrate on each of your individual holdings.

As you examine CMG which can be considered a leading stock with great earnings notice how it resists the corrective action of the DOW index. In fact each time it fell which was approximately 5% from its peak, then it quickly recovered its posture. In fact a number of times it fell only to recover quickly while the DJI continued falling. Another point worth noting was that even during the DOW’s correction CMG did not exhibit any high volume sell offs. The down days were in fact on much lower volume, certainly no panic. Now look at when the DOW stopped falling and in fact showed a little strength, CMG blasted to the upside on much increased volume. Clearly this stock was exhibiting no real sell off and was quick to show continued accumulation as the high volume up days kicked in. While the Dow was trading below its 50 day moving average CMG hadn’t even crossed the 50 day moving average. Once the Dow correction had ended CMG was quick to resume its uptrend and quickly gained about 40% from that point.

Now of course when your stock is in the thick of a down turn and you are a holding a lot of stock in a company the temptation is to take your profits and run. However the big profits are made by those that can hang in there. If the stock holding is keeping you awake at night then by all means lock in some of those profits, why not sell 50% of your holding. By locking in that profit you are essentially lowering your cost basis. If the stock starts moving up again you can always restart the buying of CMG.

Of course this is an example of what to do with a winner during a down phase of the stock market. Remember the Dow could have continued on down and CMG could also have plummeted. In this situation as the stock falls through the 50 day moving average and the sell volume picks up then most definitely you should sell. Even great stocks can simply become not worth their price if they are bought up to the skies. If in doubt sell some now and the rest as you become sure.