Look For The ‘Follow-Through’ Day

After an extended negative or bear phase in the stock markets, a sustainable upturn may be difficult to identify. To determine this turning point, it’s foolhardy to simply rely on instinct or personal judgement. A smart investor would rely on a tool based on historical research termed as ‘follow through day’.

So how does one figure this out? ‘Follow through day’, a system developed by William J. O’Neil, indicates an important change in the market. When a major index such as the BSE Sensex or NSE Nifty rises based on higher volumes than the previous day over a period of at least four trading days, it indicates that the market has bottomed out and the start of a sustainable upturn trend. This uptrend is validated when the index doesn’t make a new low.

So what are the parameters that one should assess to decide if we have a ‘follow through day’? They are:

• A major market index closing well above 1% on higher volumes,
• Positive price moves of leading stocks, and
• Positive market action in terms of support vs. resistance levels.

Further confirmation of a change from negative to a positive uptrend takes place when the market continues to gain with higher volumes and leading stocks start breaking out of their previous price ranges.

Here is step-by-step run up to a change in trend:

Day 1 sees a major index closing higher than the previous day’s close. One should not consider either the quantum of rise or the volumes at this stage. What matters is that the rally should sustain.

Day 2 and 3 should record a higher intraday low than that of Day 1.

At this stage of the ‘follow-through day’, a smart investor could decide to take positions in growth-oriented stocks which record high trading volumes. Remember if there are no stocks breaking out on ‘follow through day’, stay cautious.

Another word of caution: don’t start buying quickly. Test the waters with one or two stocks to ensure that they continue to record price rises and volume growth.

Remember, you may experience a ‘distribution day’ intermittently (days when there is a loss in trading volumes). However, such days don’t indicate a reversal in the uptrend as long as the intraday low doesn't fall below the previous low.

Look for ‘follow through day’ and start investing early to ride the growth curve.