Guest Author - Guido Deboeck

Getting out of the market when the market direction turns as it did in May (May 11-12, 2006) is quite an achievement. While the market corrects and you sit on cash, you don’t worry of the daily ups and downs. Question then is: when is it time to get back in?

Following the research done by Investors Business Daily, you wait till there is a rally attempt and then count from that day until there is a follow-through day.

A follow-through day happens when strong gains occur in any of the major indexes on day 4 or later after a first rally attempt. Strong gains are defined by IBD as an increase of at least 1.7% (it used to be 2% but this was percentage has been lowered) in an index accompanied with higher volume versus the previous session.

So far this has not happened! On Thursday June 1, the NASDAQ composite climbed 1.9%; the small cap S&P600 ramped up 1.8%, but the volume receded!

Volume, in essence the amount of shares that are exchanged on a daily basis, is the key to read supply and demand clearly. If the volume increases versus the previous session there should be a move or acceleration in price direction. High volume in rising markets reveals a high demand, while high volume in a declining market reveals a high supply relative to low demand. Hence, the key to figuring out when to get back into the market is to observe volume.

Tom O’Brien in his book Timing The Trade: How price and volume move markets (Tiger Financial News Network Inc, largo, Floriday, 2005) defines “quality volume” as significant moves on strong volume with pullbacks on lighter volume.

Once you are familiar with the above you may find it interesting to observe changes in the market direction as it occurs. Clearly, no market index is going to show a significant increase at higher volume, unless there are a sufficient number of stocks in that index that perform in that way.

So instead of waiting for IBD to confirm that a follow-through day has occurred, you start to look out for stocks that are already turning around (or never suffered from the market decline). For example, if we analyze the charts of the top twenty stocks in the IBD 100 as of Friday June 2, 2006, we find the following with increasing volume showing price increases: HANS, IFO, CRS, ANDE, BAS, CCJ, PMTI, and GRMN.

A similar analysis of the IBD 85-85 stocks and the IBD New America stocks may add to this watch list of stocks to buy when the market shows a follow-through day. Obviously, nothing prevents you from putting some capital to risk even before then.