Place bets accordingly

Just as the market peers toward another new low – BAM! – it’s a mega rally.

Our Follow Through Day (FTD) in the books from a few weeks ago will hold as long as Tuesday’s rally sticks.

But with a Fed policy announcement due Wednesday, anything can happen.

Remember, it’s not our job to predict what the market will due. But rather to take our evidence and place bets accordingly.

We could see a rally

Well it ain’t pretty.

As the broader market struggles to catch a bid, the majority of sectors are finding new multi-year lows, or coming close.

The S&P 500 is down about 45% from its peak a year ago.

This clearly is worse than the sell-off of the 73-75 bear market, which lost a little over 43% in two years.

The S&P 500 is trading at about nine times forward earnings. At the bottom of the 73-75 bear market valuation was about seven times earnings. But forward earnings are based on analyst predictions for 2009. Analysts polled by Thomson are predicting growth for next year, but the reality may very well be declines in earnings.

In other words, even as earning forecasts show good prices at historical bargains, the reality is they’re probably cheaper if earnings deterioration occurs next year. Given stocks’ tendency to be an indicator of future earnings, the viscious selling this year seems to be telling us the earnings growth outlook is about as bad as ever. Recession time.

The next technical support level for the S&P 500 is about 750, which was the low the last bear market in 2003.

But week to week price action in the broader market doesn’t adhere to fundamental logic.

We pretty much expect the market to do what most don’t expect it to.

Our volume indications, with Follow Through Days (FTD’s) in place from two weeks ago on the Dow and S&P 500, suggest we could see a rally form.

Should we get that rally, we’ll look for two things to fall in place:

1. Leadership from top earning stocks moving higher as a group.

2. Well-formed technical bases from which we measure our buy points.

Results from our scan for top earning stocks shows us a glimpse of hope as we actually have some candidates with a rally potential – as illustrated for paid subscribers.

All we need now…

It’s heavy buying accumulation on the heels of heavy selling distribution. (If you don’t know what this means read “How To Make Money In Stocks” by William O’Neil.)

But there’s no doubt what our underlying bias is, we’re giving the edge to the bulls.

Last week’s Follow Through Day (FTD) is just a small technical indicator telling us that institutions may be placing bets to the long side of the market.

All we need now is Leadership and technical bases to form…

What the market is saying

Everyone wants to call a bottom.

While there’s obvious attraction in buying as low as you possibly can, few actually succeed.

What trades lower usually trades lower, and what trades higher usually trades higher.

The stock market has a habit of screwing over the most amount of people that it possibly can. That’s why markets ususally bottom when things appear their absolute worst.

Up until last week’s big gain it could easily be argued that things couldn’t get worse.

Bankruptcies and bailouts rattled the entire global economy, the Vix “fear” indicator soared to a multi-year high and even Time Magazine was eluding to a depression with its Great Depression era soup line photo on its cover.

But even though famed value investor Warren Buffet is scooping up bargains, there’s a lot of other folks less smart touting a bottom.

As the ever insightful Barry Ritholtz layed it out in his blog, notorious “dumb money” like Barron’s Gene Epstein making his case for the bottom is something to beware of. Same goes for the CNBC talking heads and various other journalists who only write about, not trade, the market.

The beauty of our time-tested strategy is that we don’t need to rely on the subjective callings of others. We collect solid evidence and make our measured moves from statistically sound methods.

As intermediate term Growth Stock traders three things need to come in place for us to pounce.
1. A Follow Through Day (FTD) indicating institutional players are making bets to the long side.
2. Leadership from top earning stocks moving higher as a group.
3. Well-formed technical bases from which we measure our buy points.

We have our FTD, now we need to see No. 2 and 3 fall in place.

It’s that simple.

Another Follow Through Day

Well wudayaknow? A Follow Through Day (FTD.)

All bull markets have begun with an FTD, but not all FTDs lead to bull markets.

The FTD tells us institutions may be taking aim at the long side. The +1.7% moves on volume higher than the previous day’s indicates heavy commitment.

We’ve long believed the market is capable of a sustained rally. The extreme fear priced into the market has washed out a lot of sellers who have been keeping things down.

When the sellers run out of gas the buyers take hold.

How long a rally may run is beyond us, but we’ll get clues as the market slowly shows its hand with potential Leadership and volume trends via Accumulation and Distribution.

SPX, -9%!

Worst day since 1987. But doesn’t feel as bad as last week’s. Probably because it wasn’t a new low.

A lack of volume gives indication of less conviction from the Bears. But we’re not going to look too much into that.

We’ve been on the lookout for a Follow Through Day (FTD) to give us a sign that institutions are stepping up to support the long side of this market.

It would come beginning Thursday, with one of the major indexes posting at least a 1.7% move with volume greater than the previous days. FTD’s come between four and 11 days of a potential low.

And if we don’t get it, we’ll assume that down is the path of least resistance.

Looking for a Follow Through Day

After Monday’s massive move (the biggest on record for the SPX), we close Tuesday with a small loss.

Key now is volume. It’s a problem for Bulls that Monday’s move wasn’t on heavy volume, and even more of a concern that Tuesday was a distribution day (where heavy selling indicates institutions aren’t supporting this market.)

As intermediate-term traders we are now looking for a Follow Through Day (FTD), where beginning Thursday a move of at least 1.7% on one of the major indexes is accompanied by accumulation (buying volume greater than the previous day’s.)

An FTD will give us a clue that institutions are supporting the long side of this market. Perhaps setting up for a fall rally.

If not, we focus on finding the best short candidates.

Where the herd is

Magazine Covers.

As traders we know how often they mark the ends of trends. Growth companies that reach the front page of Forbes and Fortune usually hit a peak. Everyone that’s going to buy has bought. And the path of least resistance becomes down.

Of course these indicators aren’t as exact as mechanical watches, but they can tell a lot about where the herd is.

Big question is: When will all the selling be put in?

To catch a bid

The market can’t catch a bid.

Heavy selling across the board has been indiscriminate, which kills our outlook for Growth Stock buys.

We’ve been fortunate to have been maintaining a cash bias.

While the market has teased us with short-lived rallies, its never sustained itself long enough to set up decent buys.

Likewise, going short has come at a cost for most.

The government’s tendency to announce new rules or bailouts just when things look their worst has led to viscous short covering rallies.

The bottom line is it’s been a gambler’s market for those playing the intermediate-term.

Doing nothing in the markets is as much a postition as going long or short.

Most people have been getting knocked around. But we’ve been patient and will pounce whenever a decent opportunity presents itself.