End of Day Rally Lift Stocks Off Their Lows

If you were living under a rock you would woken up not knowing what hit them as the market gapped lower.  Those who were reading headlines were woken up to “market plunging” and “fear over European debt spreading.”  Volume soared from start to finish as traders rushed in to sell stock in the morning only to buy them back at the end of the day.  Despite the fear and worry regarding Europe the market found a way to find buyers supporting the market.  At the end of the day we saw the S&P 500 find its way into positive territory marking Day 1 of an attempt of a new rally.

In an earlier post, we point out what a follow-through day is:

Follow-Through Day according to IBD (Investors Business Daily):

After a significant market correction, the market will look to regain its footing. Any up day then counts as Day 1 of an attempted rally.

The next two sessions, Days 2 and 3, don’t need to show much in the way of gains. As long as they don’t undercut Day 1′s low, the rally remains intact.

For a follow-through to occur, you want it to land between Day 4 and Day 7 of the attempted rally. On any one of those days, you’re looking for one or more of the major indexes — the Nasdaq, S&P 500 or Dow — to rise 1.7% or more in higher volume than the previous day.

Though a follow-through in that span gives the strongest signal for a new rally, one that hits anywhere between Day 4 and Day 10 can work. Follow-throughs that occur after Day 10 yield lower success rates.

Though this method may seem esoteric at first, keep in mind it has decades of IBD research behind it.

Just remember: Not every follow-through triggers a huge, new bull market. But no raging bull has ever started without one.

Changing market conditions have in the past affected the price gain required to announce a follow-through. Early IBD research stretching back several decades showed that a gain of 1% could signal a market turn.

In the white-hot 1990s, that threshold grew to 2% for the tech-stuffed Nasdaq.

Today, a slower-moving index such as the Dow Jones industrial average can occasionally follow through with a smaller gain, assuming other factors are in place. The Dow followed through on Feb. 14 of 2007 with a 1.25% gain.

Remember a key caveat when it comes to follow-through days: Every bull market starts with a follow-through day. But not every follow-through day triggers a new bull market.

While we may get a follow-through day this week or next it is not likely we’ll see a new bull market.  The technical damage done over the last month has been severe.  While we most likely will see a rally over the next few days, even lasting a few weeks it is unlikely to spark a new bull.  The heavy volume selling is much to severe to repair in a month.  There are a few stocks making bases right now, but they are weeks away from proper bases.  While you may be tempted to go long an ETF or former leaders remember the rally will most like only last a few days.  Our risk/reward on the long side simply isn’t ideal right now.

An interesting development was the failure for VIX to make a new high as the market made a new low today.  In addition, the VIX put in an outside reversal day indicating the VIX will work its way lower.  The most obvious observation will have the market going higher here.   Regardless, even though we’ll more than likely move higher remain discipline to avoid churning your account.

As the holiday weekend approaches, look for volume to slide lower as traders and fund managers leave to make it an even longer weekend!