Stock Rally Follow-Through: Has it Failed?

My primary objective in the stock market is to lose the least amount of money when I am wrong and make the most amount of money when I am right. As Friday's big sell-off clearly demonstrates, that goal's not easy to achieve in a market this random. After this week's "follow-through day," all bets are off on this signal of a fledgling rally.

My primary objective in the stock market is to lose the least amount of money when I am wrong and make the most amount of money when I am right. As Friday's big sell-off clearly demonstrates, one must be very careful trading a market this random.

We talked about the scenario of a weak rally attempt in our last blog, and this recent attempt to rally appears for the most part over. All bets are off for now regarding this fledgling rally. Individual investors should be watching their stocks closely.

For now, the stock market is extremely short-term trader driven. After Friday, I do not believe we are at a point to begin building any serious positions. Not getting whipsawed is something that can only be achieved over many years of trading and investment experience. Based on what I saw Friday, as an investor I would be looking to go more short than long. Sometimes the best option is to simply step aside and preserve capital, which is just what we are doing going into the weekend.

We discussed in our last blog post a “Battle Royale” shaping up with the bulls and bears, a battle which centers around the 200-day moving averages. This battle continues. Once critical levels of the major indexes can be determined, we can use this as an important “lean” or resistance level to trade against. We believe this new critical resistance level is somewhere around 1,085 on the Standard & Poor's 500-stock index. Potential uptrends after a correction are vulnerable to institutional selling in their early phase and it takes just one bad distribution day to scuttle a fledgling rally.

No Follow Through

Three days ago the market had a "follow-through day" on the Nasdaq Stock Market. (A follow-through day is an indication of a potential change of trend in place, which tends to signal a rally.) The day's volume was relatively anemic compared to other follow-through days I've experienced -- volume was light and barely above that of the prior day. In addition, the other major stock indexes did not confirm. A follow-through day should typically be accompanied by stocks forming proper patterns and/or the beginning of a break-out to new highs to convince investors to invest more.

Over many years of investing and trading, I've seen market shakeout and work through a situation like this. For now, however, the headwinds are pretty stiff. We know markets can go higher when circumstances appear to be bleak, and we must remain open to this possibility. The proof is in how stocks are acting: We identify and examine the top 12 leaders, and use this as one of our tools to help determine a failure of a rally.

Friday's sell-off is due in part to the weak jobs report. The stock market is a big discounter, so when the negative news of the labor market numbers hit the reaction was swift. You can pile on the additional uncertainty surrounding the confusing and misguided government policy in respect to the handling of the Gulf oil spill. (It is reminiscent of the Carter administration's bungled handling of the Iranian hostage crisis.) Add in the other world events, such as Iran's nuclear ambitions, Europe's economic uncertainty ... all are weighing on the financial markets. Slowing economic growth in Europe will have some effect on the U.S. economy, no matter how you dice it or slice it. It's best to keep things simple, however, and allow the price and volume of the major stock indexes, how and where leadership is developing, and other tools, such as out breadth and market internals, guide the investment plan.

On a positive note, some stocks on our list appear to be building constructive technical bases though it may take some time for these stocks to properly set up. Interpreting the price and volume reaction of some of these names on a big down day intraday is important to get a feel for the relative strength of these stocks to move higher once the market can regain its footing.

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