Thursday, October 17, 2002

FOLLOW THROUGH


Well, so far the rally that started last Thursday seems to be hanging in there. How can we tell if this becomes a real bona-fide bull rally and not just a snap-back from the recent over-sold conditions? There are a couple of things to look for, and one, is some market follow through in the period 4-10 trading days after the rally starts. What's a "follow through" you ask? According to Investor's Business Daily - which is a daily Wall Street Journal-type financial newspaper (complete with great news reporting and idiotic, suspend your reasoning abilities, ultra-right wing editorial page), the conditions that define a "follow through" are market turnaround (like we had last Thursday), followed by one or more confirming days where the major indices (Dow Jones, S&P, etc.) rise more than 2% in price on volume greater than the day before. We had such a day on Tuesday, and now we've had our second one today. (Today, the Dow is up 2.97%, the S&P 500 is up 2.23% and the NASDAQ is up 3.24% - all on heavier volume than yesterday.) This definitely counts as a real follow through. I was more or less inclined to dismiss Tuesday's one - the price rise was great, but the volume was higher only because Monday was a holiday with light trading - virtually any normal trading day would have had volume higher than Monday's - never mind a follow through, so I was bound to not count it until today proved to be the real thing. I can't wait to read IBD tomorrow - I'll bet they'll be excited as the Weather Channel guys get when there's a hurricane.

Another thing to look for in determining if a new rally is the real deal or not, is to look at the number of new 52 week highs for the day as opposed to 52 weeks lows. Theoretically, a strong market should be pulling up a lot of stocks to new highs. If the majority of new highs/lows on any particular day are on the side of the new lows, then you can be sure that it is not a broadly based rally and won't have legs. The CBS Marketwatch "Market Summery Page" shows this sort of information every day. It can be located at . Looking at today's numbers, in the combined NYSE and NASDAQ, there were 85 new highs and 174 new lows. Not too good. On the other hand, we are coming back from a very serious low, it would be surprising at this point to have a whole of stocks already at new 52 week highs, wouldn't it? *IF* this rally continues (more in a bit), this factor will be worth taking a look at. But as long as we're at the CBS Marketwatch site, check out the volume divided between shares on the upside and shares on the downside. Even though there were twice as many new lows as new highs, volume-wise the story was completely different - the combined "advancing" volume for the NYSE and the NASDAQ was over 3 billion shares - the declining volume was only about 800 million shares - or only about 1/5 of total volume. Think about it - in a declining market, prices are falling and people want to sell. This is the exact opposite. Prices are rising and people want to buy. So this is a very healthy indicator. Extremely healthy - and this will do to illustrate market sentiment until the market moves into a more normal trading area. One other additional thing to look for, is what the price rebound is being caused by - is it caused by technical factors (i.e. like an overstretched rubberband, a market that heads too far in one direction will often "snap back" in reaction) - or is it caused by positive economic news indicating rising investor sentiment? Well in the past couple days, IBM and Microsoft have "beat the street" (i.e., their profit reports exceeded analyst expectations), and there was a HUGE housing start report this morning. It wouldn't be stretching credulity to think that the market rise represents rising investor optimism.
But how can we tell if it's *real*????

In a nutshell, there's this thing called the "Dow Theory" which is pretty basic. According to the theory, prices rise and fall in cyclical oscillating patterns. A stock in a falling price pattern will show lower highs and lower lows at the high point and low point of each cycle compared to the previous cycle. A stock in a rising trend will show higher highs and higher lows with each suceeding cycle. So it's important to look at what went on before in order to gauge where we are now. This recent low point was a retest of the July lows of July 23-24. Those lows were followed by a short sharp rebound that moved the market up to around the 9000 mark within a few weeks of the low before falling back. So that is our magic number - if we want to confirm a bull (i.e. "rising" market), our next high point before a major pullback has to go higher than 9000. If we pass 9000 and keep going, then a bull market is confirmed. And, if we get up to 9000 and then look around at our New Lows vs. New Highs, it should be more than likely that by that time the new highs should outnumber the new lows.

One additional point - on a technical chart watching basis, an important "bottom" process is known as the "double bottom" or "W bottom" - it looks along the line of a W on the charts - a low, an intermediate high (not as high as the preceding highs) and then another low. The rebound off this second low should then go higher than the intermediate high between the two lows, and then once it passes that point, the "bottom" is confirmed and we're off to the races. (If, on the other hand, it never reaches that intermediate point, or hits it and falls back, then the on-going downtrend is reconfirmed and life sucks - unless you're selling short). So looking at the current bottoming process as a possible "double bottom" or "W bottom", it's all in place and now we're riding the rebound up from the second bottom and hoping that when it meets the 9000 mark that it keeps on going. If it does, the long bear market which started back in 2000 will finally be over