(Investor's Business Daily) - Stock market uptrends after a market correction are always confirmed with a bullish follow-through day in at least one major stock index.
One of the biggest stock market fallacies is that investors can't time the market and identify market bottoms. That's just not true.
Throughout market history, a specific signal — called the follow-through — has appeared at every stock market bottom.
A 40%-plus gain for the Nasdaq composite last year, for example, started with a follow-through day on April 6, 2020.
Stock Market Bottoms
To identify this signal, start by looking for an initial rally attempt in the Nasdaq or S&P 500. Any rebound from an index low will do. It can be a 0.1% gain or a 1% gain. As long as the index holds above its latest low, the rally attempt is intact.
Short-covering can give the market a temporary boost. So wait for the first three days to pass, and look for a follow-through on the fourth day or later of a rally attempt.
The follow-through will come in the form of a big percentage gain — at least 1.2% but preferably more — in higher volume than the previous session.
Higher volume is important because you want to see signs of institutional buying in the early stages of a new uptrend.
Of course, follow-through days don't have a 100% success rate. The ones that fail often show signs of distribution soon after the follow-through day. A distribution day is a higher-volume decline for an index, and it's a sign of institutional selling.
The strongest follow-throughs tend to occur after a big drop in the stock indexes. Follow-throughs after a quick 5% pullback might not work as well as one that occurs after a 10% sell-off. The Nasdaq's follow-through day in April 2020 came after a harsh 30% bear market for the index.
Recent Follow-Through Days
In the second half of 2020, the Nasdaq pulled back 13% starting in September. But the Dow Jones Industrial Average was the only index to follow through after that pullback. It rose 1.2% in higher volume on Sept. 30 on the fifth day of its rally attempt. But the follow-through day didn't have much staying power. Usually, follow-throughs happen on the Nasdaq or S&P 500.
In mid-October 2020, the Nasdaq pulled back sharply again, which ultimately spawned follow-through days for the Nasdaq and S&P 500. The S&P 500 followed through first with a big percentage gain in higher volume Nov. 4 (1) as volume rose from the prior day (2).
That was three days from its low. Wasn't that too soon, since the signal comes at least four days from a low? In this case, the S&P 500's close in the upper half of the bottoming day's range served as Day 1 of the rally attempt.
The Nasdaq followed through on the fifth day of its rally attempt, rising 2.6% in higher volume Nov. 5, 2020.
The follow-through days worked well, helped by a large number of technology stocks that were coming out bases at the time like Palantir Technologies (PLTR). Other notable breakouts around that time included Atlassian (TEAM), Element Solutions (ESI) and Tesla (TSLA).
Remember that follow-through days tend to work best when the market serves up plenty of actionable setups among top-rated growth stocks. The reason the April 2020 follow-through days worked so well was because of strong breakouts from likes of current Leaderboard stocks like Microsoft (MSFT), PayPal (PYPL), ServiceNow (NOW) and Nvidia (NVDA).
Also keep in mind that new leaders can emerge several weeks after a follow-through.
By KEN SHREVE
