In the stock market, nothing works 100% of the time. That's why you have to be prepared to deal with failed signals. In CAN SLIM, the market itself – the M in CAN SLIM – is the most important factor for making money. Your chances of grabbing profits in growth stocks increase when the market is acting right.
According to the O’Neil methodology, every major stock market bottom featured a follow-through day. It essentially confirms that a fledgling uptrend in stocks is underway.
After a significant decline in major indices such as the Nifty and the Sensex (think 10-20% or more), the follow-through marks a significant gain that typically takes place on the fourth day or later of a new rally attempt. The gain usually must be a minimum 1.5% but it can be as high as 3–4% or more. Without exception, the follow-through must also feature higher total volume versus the prior session.
All follow-throughs don't always result in lasting market uptrend. So, it is important for investors to reduce the risk of capital loss if market fails to rally.
How the "Pyramiding" Buying Strategy Reduces Portfolio Risk
One thing investors can do to reduce risk is avoid buying stocks anew with reckless abandon when a follow-through occurs. Use the pyramid method to enter your trades. That way, you test the water and put more money to work only if the trades go in your favor.
Pyramiding involves buying in installments instead of all at once. You buy a first piece with half of your allocated capital toward a single stock. If the stock moves up 2–3% from your initial purchase price, make a second buy with 30% of your allotted funds. If the stock goes up 4–5% from the proper entry point, use your remaining allocated capital to make a final buy.
One Red Flag That A Follow-Through May Fail
Follow-through signals are more likely to fail if distribution days occur in the first few days of a new uptrend. This is one key red flag. A distribution day, which points to institutional selling, involves a drop of 0.2% or more in the Nifty on higher volume than the previous trading session.
Generally, a distribution day within the few days of a follow-through leads to a failed rally. The risk drops off sharply after the fifth day.
A Second Red Flag
In the early stages of a new uptrend, strong action among leading stocks is crucial. If leading stocks are not doing well, then that is another red flag. Top-rated stocks should be breaking out of bases in big volume. Strong breakouts signal that professional investors are stepping back in to buy stocks.
Not Every Stock Market Follow-through Works
Read our last week’s article on: Overhead Supply Can Repulse A Stock’s Climb
Disclaimer: Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. It is for educational purposes only.