Investors Business Daily - Understanding The Market Cycle

[KC Scott]

From IBD on identifying when a new uptrend in the market will begin:

Look For Follow-Through Day To Start Uptrend
BY DONALD H. GOLD

INVESTOR'S BUSINESS DAILY

Posted 1/18/2008
Understanding The Market Cycle

By now, regular readers of Investor's Corner know how important the market cycle is to investment strategy.

Today's column kicks off a special series that will examine each stage in the cycle, from the bottoming signals, to the art of stock picking, to sell signals, all the way to spotting a market top.

Today we'll look at the follow-through, which marks the end of a correction or bear market. It's the birth of a new confirmed uptrend.

A follow-through consists of a powerful rise in one of the major market indexes — the Dow, Nasdaq, New York composite or S&P 500. The index gain must be well above 1%. Volume must be heavier than that of the prior session.

Why is it so crucial to wait for this message from the market? If you jump back into a falling market too early, you'll be caught in a trap.


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Seventy percent to 80% of follow-throughs work. More impressively, there has never been a successful uptrend without one.

Timing is everything.

A follow-through is only valid in Day 4 or later of a rally attempt. You may see a big jump in the indexes the first, second or third day of a rally attempt. But historically, such early moves — perhaps fueled by short covering — aren't reliable bottoming signals.

How do you count the days of a rally?

After the market makes a low for the correction, look for any positive close in any of the main indexes. That gain marks Day 1 of the rally attempt.

That higher close can take place on the same day as the low, or it may come in a later session.

The index remains in a rally try unless it sinks to fresh lows.

Follow-throughs tend to happen within the first couple of weeks of a rally try. But if the signal comes, say on Day 22, so be it.

There have been cases in market history when follow-throughs confirmed new uptrends weeks after the market's lows.

And don't be put off by bad news headlines like economic problems, unrest in Pakistan or the latest celebrity split.

First, almost all headlines proclaim bad news. That's what news generally is. Second, if you wait for peace on Earth and an economic recovery, leading stocks will be well extended from proper buy points.

The market always looks ahead, and it may see a brighter outlook long before the news catches up.

The follow-through day is confirmation that big institutional investors are back in the market as aggressive buyers.

By this time, the market has already sold off, as the big guns scramble to unload shares. Then, at some point, they had likely moved to a stand-aside posture.

But eventually, institutions commit to buying again.

The follow-through is that day when the mutual funds, hedge funds and other major investors are back in full force. The race is on.

[KC Scott]

INVESTOR'S CORNER Look For Follow-Through Day To Start Uptrend

Focus On Earnings And Sales, Not Yields
Leaders' Breakouts Help Confirm Uptrend
BY JUAN CARLOS ARANCIBIA

INVESTOR'S BUSINESS DAILY

Posted 1/22/2008

Second In A Series:
Understanding The Market Cycle

What if the market rallied but the best stocks didn't?

Once the market has flashed a follow-through rally confirmation, leading stocks should join the fray.

They should break out of bases within days or a few weeks of the follow-through. If not, the market rally may end up a dud.

A follow-through, the subject of Tuesday's Investor's Corner, is when a major index surges on higher volume than the prior session. This occurs four days or later after the indexes have made a bottom.

Although every new market uptrend begins with a follow-through, not every follow-through necessarily starts an uptrend. That's why it's crucial to see top stocks breaking out. Their moves serve to confirm and solidify the nascent uptrend. The action of leaders acts as a pulse of the broad market.

By leading stocks, we mean those with superior fundamentals. These are companies with solid growth in their earnings and sales, and have other top financial attributes.

They attract investments from major Wall Street institutions, including many of the best-performing mutual funds.
Some of these leaders break out of bases the same day as the follow-through. Others take a little longer.

In every new rally, the leaders make their moves within the first four weeks of the follow-through, although some leaders may take as long as 13 weeks to hatch. Besides acting as market bellwethers, these leaders are usually the ones that make the best gains of the uptrend.

If a couple of weeks go by with few or no breakouts by alpha stocks, take that as a warning sign. False rallies tend to collapse in a few days.

In some cases, leading stocks won't break out, but will make another significant move, such as find support in a pullback to their 10-week moving average. As long as it's the first or second pullback after a base breakout, it may be considered a buying opportunity.

In the follow-through of Aug. 15, 2006, a few leaders broke out immediately. Infosys Technologies (INFY) cleared a cup-with-handle base the same day. It gained 42% until peaking in February.

Copa Holdings (CPA) broke out of a double-bottom pattern the next day. It raced 178% until it started its next correction. Apple, (AAPL) Cognizant, (CTSH) Guess, (GES) Precision Castparts (PCP) and other leaders started run-ups in the weeks that followed.

[KC Scott]

Buying At The Right Time Lowers Your Risk
BY PATRICK CAIN

INVESTOR'S BUSINESS DAILY
Posted 1/23/2008
Third In A Series:
Understanding The Market Cycle

A successful investor knows how to maximize profits and minimize risks.

Maximizing profits may sound sexier, but proper risk management is just as important. For stock investing, that starts with buying stocks at the right time. And that right time is when a stock breaks out of a proper base on heavy volume.

The breakout is when a stock pushes past a recent high. In a cup-with-handle base, that level is the highest point in the handle. In a double bottom, it's the middle peak of the "W" pattern.

With other base types, the buy point varies. But the idea is the same — bidding for the stock reaches new, significant heights.

When the buy point is breached, you want to see huge volume, of at least 50% above its 50-day average daily volume. That tells you it's not just small investors causing an irregular price movement.

Price spurts on light volume often fade quickly. When large institutions invest in a stock, however, the move is much more solid. And huge volume is the footprint of major investors.

By the time a stock gets to its breakout, it will be off its lows. Does that mean you give up some gains? Yes, but a wise investor's goal is not to get in at the lowest price point, but instead at the lowest risk.

Once you spot a company with superior fundamentals, institutional ownership and a sound base, be ready to buy when it crosses the buy point on active trading.

Once the share price advances 5% above the ideal buy point, it's considered extended.

That means your risk increases. At this level, buying would mean you're chasing a stock and putting yourself at risk of facing a shakeout.

Remember that a breakout isn't so significant unless it occurs from a proper base. Check the Learning Center at Investors.com for details on how to spot a good base. Investor's Corner will examine base patterns in coming weeks.

It is also common for a leading stock to make an initial advance then pull back to its 10-week or 50-day moving average.

The first or second time the stock rallies back from the average it offers another opportunity to buy.

It's in a buying range until it climbs 5% past the prior high. Look for volume to increase as the stock finds support, just like you would on a base breakout.

[KC Scott]

Returns Can Soar With Right Concentration
BY PAUL WHITFIELD

INVESTOR'S BUSINESS DAILY

Posted 1/24/2008

Fourth In A Series:
Understanding The Market Cycle

Had he been born in a different time and place, Napoleon would have made a great money manager.

The French general believed in speed, mobility and the rapid concentration of forces.

Many investors fail on that third item. Rather than concentrate capital on a few top-quality stocks, they spread their portfolios across dozens of stocks.

They do that to lower risk, figuring that if a few stocks falter, others may mitigate the damage.

But in reality, the usual result is a hodgepodge of poorly conceived positions that by their sheer number are hard for the individual investor to track.

Also, the more stocks you own, the more likely some will be of lower quality and not market leaders.

In a special series, this column has been discussing the main parts of the market cycle. After touching on spotting the start of a new market uptrend and how to time your stock purchases, today we go over building your portfolio.

So, once the market has made a rally confirmation and leading stocks are breaking out, how many stocks should you buy?

Even if you have a big portfolio, of $100,000 to $1 million, you should own no more than about six stocks at once. With smaller portfolios, even two or three carefully chosen stocks can be sufficient.

Consider why winners concentrate their holdings:

• A winner understands that concentration is necessary to make big gains. A loser probably doesn't realize that if a 5% position doubles, you've only increased your portfolio's overall gain by just 5%.

• A winner can tell you a lot about the few stocks he or she holds. They know precisely why they bought each equity. A loser with holdings in dozens of stocks can't tell you much about anything they own. They sometimes can't remember what the companies do, much less why they bought the stocks.

• A winner is aware that losses must be cut when they are small, and concentration of investments makes that clear. A loser is always willing to give a loss room to run lower and doesn't realize that small positions are no protection, especially when ignoring losses is your pattern.

Does concentration sound scary to you? Then reduce the size of each position until you are comfortable with the overall risk. A sound investment approach is to buy half of the dollar amount you plan to invest in a stock when it breaks out. Then buy smaller portions as the stock advances or reaches follow-on buy points.

Can you overconcentrate? It's not wise to put all your money in one stock. So, yes, there are limits to staking everything in one company.

In Japan, individual investors have a narrow focus on their portfolios. Most own just one to 10 stocks, according to research from Nomura Securities.

[KC Scott]

Average Up, Not Down, To Better Manage Your Portfolio's Holdings
BY MARIE BEERENS

INVESTOR'S BUSINESS DAILY

Posted 1/25/2008

Fifth In A Series:
Understanding The Market Cycle

When a stock is in a downtrend, you may be tempted to buy more shares, because that would lower the average price you pay per share.

But with "averaging down," the stock may keep falling, and you'd throw good money after bad.

A better way to manage your portfolio is to average up, so to speak. This may sound counterintuitive, but it's a good way of concentrating capital in your winning stocks.

As the prior story in our series on the market cycle pointed out, stick with just a few well-selected names as you see top stocks break out.

When you decide to get into a stock, buy half of the dollar amount you plan to invest in it when the breakout occurs.

If you see that it keeps going higher, you can add to your additional position once the share price is about 2% to 3% above your purchase price. If the stock keeps rising, add some more at 5% past your initial purchase price.

Every additional purchase should be smaller than the prior. That's why this portfolio-management technique is called pyramiding.

Another way to pyramid is by adding shares when the stock pulls back to its 10-week moving average and finds support.

The first two pullbacks after a breakout from a base give investors an opportunity to add some more to their existing positions. Look for increased volume as the stock rebounds from its support line.

Capella Education (CPLA) cleared a cup base past a 47.62 buy point on Aug. 17 1.



The day of the breakout provided investors with an opportunity to get their initial position.

That day, the stock closed about 1.6% past the buy point. After a brief pullback, it resumed its ascent 2. There, investors could buy some more of the stock at 3% above the buy point, or 49.04. Finally, at 5%, or 50 3, they could add more.

There was a chance to add shares when the provider of online post-secondary education pulled back to its 10-week moving average 4.

[KC Scott]

Cut Losses Short For Safe Portfolio Management
BY VINCENT MAO

INVESTOR'S BUSINESS DAILY
Posted 1/28/2008

Sixth In A Series:
Understanding The Market Cycle

There's a simple rule that will preserve capital, reduce your financial and emotional stress, and prolong your investment longevity.

If you're thinking of always cutting losses at 7% or 8%, you're right.

This simple rule is one of the most-often quoted in IBD. Yet it can be hard to follow for many investors.

But if you want to be successful in investing, you'll need good defensive strategies.

In this series on the market cycle, Investor's Corner has discussed how and when to buy leading stocks as they emerge with a new market uptrend. Learning to cut losses short is a key element of managing the stocks you buy. If you don't, you'll undermine the gains from your good stocks.

It's tough to watch your account dwindle away. And it can hurt your psyche as well. That's why you need a rule you can follow with discipline — something you can act on without regard to any other factors.

Losses usually start out small, and that's when they should be dealt with. Otherwise, they can grow big enough to do serious harm.

If you sell a stock that's down 7% from your purchase price, you need just a 7.7% gain to get back to even.

If you let that loss grow to 25%, it'll take a 33% profit to get back to even. A 33% loss requires a 50% gain to make up the loss. And if a loss swells to 50%, it would take a 100% gain to return to break-even.

All stocks are risky, and you can lose everything you put in. Some stocks, such as Enron and WorldCom, never bounce back.

If you bought a stock at 100 a share and it falls to 93 or 92, just hit the sell button and dump the stock. Don't sit there and hope, pray, think, or rationalize — just sell it.

It doesn't matter how highly touted a company is. You still have to follow the sell rule even if the company is a blue chip, institutional favorite or the top-rated firm in one of the market's best industries.

Sometimes an issue will bounce right back after you sold it. Instead of fussing over that and vowing to ignore the 7% or 8% sell rule, pat yourself on the back for having discipline. You can always buy the stock if it sets up again.

After you place a trade, general market weakness, industry news or specific company development can send shares reeling, often with little warning. It's good to know you have the 7% to 8% sell rule to act as your safety net.

Demand for alternative sources of energy fueled big runs for many solar power stocks last year.



San Jose, Calif.-based SunPower (SPWR) ramped up to an all-time high during the week ended Nov. 9 1.

The stock then pulled back, finding support at its 10-week moving average 2.

Some big buyers came in as SunPower tried to race out of its pullback. The stock was in a buying range as it found support at its 10-week line on high volume 3.

An investor could have bought around 110 to 130, when support was evident. But SunPower started flagging.

By the second week of January, most investors who bought on the rebound faced 7% losses 4, as SunPower violated its 10-week line 5. The stock has plunged more than 30% since that week's close.

[KC Scott]

A Simplified Method To Take Your Profits
BY CHRISTINA WISE

INVESTOR'S BUSINESS DAILY

Posted 1/29/2008

Seventh In A Series:
Understanding The Market Cycle

Selling a stock at the right time is just as important as buying at the right time.

But knowing when to sell can be tricky — particularly if you've invested in a stock that already has scored some sizable gains.

Even in a bull market, some stocks will stumble after hitting a series of new highs. Once a stock begins to fall, you don't know how far down it will drop.

If a stock you bought drops 7% to 8% below the price you bought it at, you should sell it immediately.

Don't sit on it and hope that it will come back. It might not, and you could be hit with a larger loss than you'd had if you had made a speedy exit. That was the subject of Tuesday's Investor's Corner in our series on the key parts of the market cycle.

You may also consider selling some of your stocks once they're up 20% or 25% from your purchase price. By setting these targets, in combination with cutting losses at 7% or 8%, you can come out ahead by a good margin.

With this simplified approach, you can afford to be wrong a lot more than you are right on your picks. This can be particularly helpful if you don't feel confident about understanding sell signals using stock charts.

Why set 20% to 25% for your profit target?

Because research into the market's most successful stocks found that most climb about 20% from the breakout of their first-stage base.

After that 20% rise, leaders tend to form their second-stage base. Breakouts from those patterns produce gains of 25% to 30%, in general terms, until they start their third-stage bases.

But there's one exception to that rule: If a leading stock surges 20% or more in just three weeks after its breakout, you may have found a true winner. In that case you should hold onto it for another eight weeks.

Of course, if the broad market weakens or turns into a bear market or other danger signs emerge during a stock's rally, you may need to sell before you have logged a 20% profit.



Consider Ceradyne. (CRDN) It broke out of a double-bottom base April 26, climbing above its 61.40 buy point 1.

Though it stumbled a bit in the days that followed, it didn't fall 7% below its buy point, so you would not have been forced to sell 2.

The maker of body-armor plates quickly recovered.

By early July, Ceradyne was trading around 76.75 — 25% above its original buy point 3.

Selling at this point would have allowed you to lock in a solid profit.

That would have been a smart move, too. Sure, you would have left some profits on the table by selling at that point. But Ceradyne hit its peak shortly afterward and then began to break down.

[KC Scott]

Use Moving Averages To Decide When To Sell
BY ALAN R. ELLIOTT

INVESTOR'S BUSINESS DAILY

Posted 1/30/2008

Eighth In A Series:
Understanding The Market Cycle

If you're on a boat getting rocked by waves, it may be impossible to get any sense of the vessel's real direction. Is it making progress or simply drifting at the mercy of each passing wave?

A stock can be just as beguiling. But moving averages — especially the 50-day and 10-week — give investors clues on when to sell.

In this series on the market cycle, Investor's Corner has discussed how to spot new market rallies, when to buy top stocks and simple ways to manage a portfolio. Now it's time to start looking at the next phase — sell signals.

Moving averages trace a stock's trend by adding closing prices over a given period — say, 50 days or 10 weeks — then dividing by the number of days or weeks in the specific period.

The results are plotted on stock charts, providing a smoother view of the price's general trend.

In IBD Charts at Investors.com, the daily charts display the 50-day line; the weekly charts show the 10-week average. The 10-week also appears in the mini-charts for the IBD 100, Your Weekly Review, Stocks In The News and other IBD features.

The 10-week or 50-day line is often used by institutional investors to buy more shares of a stock they own. So, a stock that dips to one of those averages and rallies back is probably getting support from institutions.

With most winning stocks, the entire uptrend never makes a serious break below the 50-day or 10-week moving average.

But once a stock slides sharply below its support levels in heavy volume, it may signal that major investors are moving out of it. This is a key warning sign for shareholders.

Some stocks will recover after several days and pop back up for more gains.

But if some weeks go by and the stock cannot rally back, the moving-average breach becomes a more serious warning.

The line may even harden into a ceiling of resistance, locking the stock below it into a long-term consolidation.

Apple (AAPL) broke out of a base in July 2005 1, sending the maker of personal computers and music players on a strong run-up.



The stock tested its 10-week line once during this uptrend 2, finding support. Strong volume on the rebound gave investors more reason to believe institutional investors were buying shares 3.

It was a different story in early 2006. The stock plunged below its 10-week line on active trading 4.

Apple tried to climb back above it but was foiled. Shares met resistance at the 10-week line 5, and the correction worsened.

For a time, the stock traded below its 40-week average.

Apple spent months forming a pattern. It didn't break out again until September 2006 6.

Another sell signal is when, after a big uptrend, the 200-day line turns downward or the stock's price trades 70%-100% or more above the 200-day average.

You can also spot a break in support when the stock closes a week below a trend line that spans at least a few months. The line should touch at least three price lows.

[KC Scott]

Your Stock's Gap-Up Surge May Be A Top
BY NANCY GONDO

INVESTOR'S BUSINESS DAILY

Posted 1/31/2008

Ninth In A Series:
Understanding The Market Cycle

Investors are thrilled when a stock they own keeps running up. But if it makes an accelerated jump in a short time, watch out: It could be setting up for a top.

Then at what point should you lock in your gains? Study the stock's chart. Learning how to interpret price and volume action not only helps you decide when to buy, but also when to sell a stock.

Today, Investor's Corner continues its series on the market cycle with a look at some more topping signals.

Winning stocks often signal the end of their runs in explosive fashion, a ramp-up in price that comes after an already long advance.

That's called a climax top or blowoff top. Frenzied investors, who can't get enough shares, ceaselessly bid the stock up. You can potentially maximize your profit by selling into that strength.

But why would a shareholder get out when there might be more upside left to go? Because after such a heady climb, the stock could suffer a steep, long-term drop. Better to lock in your profit while you can.

After a leader has made a big run from its breakout — generally a major run extending 18 weeks or more — start looking for signs of a climax top. Specifically, stay alert for a 25% to 50% or larger surge in just one to three weeks.

The largest weekly price spread since the start of the stock's advance is another symptom of a climax top.

Also consider it a red flag if the stock gaps up during an already-stretched advance.

SunPower (SPWR) more than doubled in price within the first four months of its November 2005 debut, before forming its first base.

The stock took off after clearing a flat base on heavy trade the week ended Jan. 12, 2006 1. It kept rising, finding support at its 10-week moving average.



By mid-October, the San Jose, Calif.-based solar products maker's shares had run up more than 140% from its January breakout.

Then the week ended Oct. 26, it vaulted 23% in brisk turnover 2, its biggest weekly gain since its IPO. The stock rose the next two weeks, also in heavy trade 3. It leapt 70% in those three weeks, a red flag.

It shot up as much as 33% the week ended Nov. 9 but pared its gains to 4% 4. When you suspect a stock is going on a climax run, be sure to check its daily chart, too.

On Nov. 6, the stock gapped up and rose 20.33 on its heaviest volume since its first trading day. Two sessions later, SunPower peaked.

Remember, you'll often see the biggest one-day point gain since the breakout in a climax top.

SunPower is still well below its 40-week line and is nearly 60% off its Nov. 8 high.

[KC Scott]

Study Volume To Find Sell Signals In Charts
BY PATRICK CAIN
Posted 2/1/2008

Tenth In A Series:
Understanding The Market Cycle

Selling a stock can be difficult, especially when it's made a lot of money for you.

You feel attached, you feel hopeful. This is where you get in trouble.

Remember, no matter how much you love your winner, it doesn't love you back. So treat weaknesses like weaknesses should be treated: Sell and move on.

Previous editions of this series on steps to take during each part of the market cycle discussed some of the most common sell signals. Today, we'll go over a few others.

One of the strongest signs to get out is when a stock makes new price highs on weak volume.

This indicates that fewer investors are willing to continue bidding up the stock. In other words, all the institutional outfits that want to invest in the company may already have bought shares.

A low-volume climb isn't a worry just at new highs. It also is poor action when a stock is trying to recover after heavy selling occurs near the top. A small price recovery in this situation is a red flag.

Another sign for concern is when a stock closes near its lows for several days, giving back most or all of each day's intraday gains. A reversal from new highs shows poor action, whether it shows on a daily or weekly chart.



Unfortunately, most sell signals come after the stock has peaked. But when your stock tumbles, don't always sprint for the hills.

A small correction can be normal and healthy. Do be weary and study the chart carefully if a correction of more than 12% occurs after new highs.

The way a company trades every day and week can reflect a sign of weakness. If price moves increase in fluctuation sharply, that may be wide and loose action. This chart characteristic is tougher to spot.

One way wide and loose action happens is in deep corrections, of perhaps more than 35%.

That often happens in late-stage bases when a stock has made a long advance and already has broken out of two or three bases.

Some stocks, such as new issues, tend to have larger volatility and sometimes can still be market leaders. JA Solar (JASO) was a big winner in 2007, despite its wide price swings.The head and shoulders pattern also can tell you a major price decline looms.

In this pattern, a stock makes a peak, slides lower, then rallies to a new high.

The stock drops from this peak (the head) but recovers to form another peak, at a lower price than the head. The lower highs are the formation's shoulders, which take five to seven months to form.

Guess (GES) had a long run, but faltered last fall as the stock made record highs on weak volume 1. That followed heavy selling in the prior peak 2.

A bearish reversal from its peak 3 started the stock's slide. Notice also the burst of volume as the stock made little price progress 4.

The price closed just 1% above the prior week's close. That type of stalling price action is known as churning.

A single sell signal may not be enough to justify selling a stock. But when a few of them occur, you might want to dump your shares. When the general market is in a correction, the room for error tightens.

Even if the whole market isn't falling apart, a particular industry group could be. If the leader in a group breaks down, odds are that soon no good stocks will be left in that group.

[KC Scott]

Distribution Days Help Spot Market Tops
BY PAUL WHITFIELD

INVESTOR'S BUSINESS DAILY
Posted 2/4/2008

Eleventh In A Series:
Understanding The Market Cycle

A fool-proof indicator for spotting a market top doesn't exist.

What then is an investor to do?

An investor first needs to ask two key questions: "What's happening in the general market indexes?" and "What's happening to leading stocks?"

Of these, the most critical is the action of the Nasdaq, S&P 500, NYSE composite and Dow.

In every market top you'll see a series of days in which the indexes close lower on higher volume than the prior session. That's called a distribution day.

The higher volume is a sign that institutional investors — the market's major force — are selling shares.

It becomes an alarm when several distribution days pile up over four weeks or so.

Not every down day on higher volume is a distribution day. An index decline of less than 0.2% isn't significant enough.

Also, some up days can be distribution days, too.

While the market is still climbing, watch out if an index closes with a meager gain compared with the past day or two.

Should this occur on the same or higher volume than the prior session, it could be stalling action.

Before the current correction, the Nasdaq suffered four distribution days in less than two weeks 1. Expanded to a four-week window, there were six distribution days 2. On Oct. 31, the Nasdaq reached its high and began to decline. A rally in late 2007 didn't get far.



Distribution days are the screaming meemies of the market. They often point to subsequent trouble.

Let's look at the other items.

Stocks leading a rally can point to a market top also. When a leader hits a chuckhole, the general market often loses a wheel.

For instance, on Oct. 11 a report on Baidu.com (BIDU) triggered a broad, general market sell-off. The JPMorgan Chase report wasn't especially negative. It said that Baidu's Q3 revenue would be below JPMorgan's previous forecast, but still in line with Wall Street's consensus.

The market's fearful reaction — a 1.4% loss for the Nasdaq 3 on increased volume — was telling. Earlier in the session, the Nasdaq was up nearly 1%, marking a new high.

Amid the Nasdaq's negative reversal, Baidu finished the session down 10%.

While Baidu's run wasn't over and the Nasdaq would reach its high three weeks later 4, the leader's fall on mildly negative news and the market's nervous reaction pointed to a loss of confidence.

As the selling intensified at the start of the year, more and more leaders flashed sell signals.

Solar-energy stocks, some of the hottest in the prior uptrend, rolled over.

Fertilizer stocks, also big winners in 2007, came under pressure too.

It's worrisome if you see high-rated stocks make breakouts but slide lower soon afterward.
Distribution days are the screaming meemies of the market. They often point to subsequent trouble.

[KC Scott]

Raise Cash, Play Defense In A Correction
BY DONALD H. GOLD

INVESTOR'S BUSINESS DAILY

Posted 2/5/2008

Twelfth In A Series:
Understanding The Market Cycle

Famous last words: "The market sure stinks, but this one stock is gonna go up no matter what. I just know it. I can't wait for this correction to end. I have to buy it now!"

You've also probably heard: "I'm in defensive stocks (soap, not Raytheon)."

Or how about: "I'm averaging down."

"The market can't keep falling forever."

"I'm a long-term investor."

There are many ways to rationalize a breach of one of the big rules of investing: Only buy stocks when the market is in a confirmed uptrend. That's the M in CAN SLIM.

In a multipart series, Investor's Corner has been discussing what investors should do in each phase of the market cycle.



So what do you do when the market is in a correction? Don't buy stocks.

For sure, prepare for the next uptrend. No one knows when that will be, but it's out there somewhere, and it's coming.

Keep your powder dry. Keep your watch lists updated. Go over your trades from the last uptrend, and try to learn from your mistakes.

Take advantage of all the research resources at your disposal at IBD and Investors.com. Read — or re-read — "How To Make Money In Stocks," by IBD founder and Chairman William J. O'Neil.

And stay in cash. Defensive issues rarely are growth stocks. In any event, it's smart to avoid all stocks when the market slumps.

What do you do with those stocks you bought in better times? As soon as the market turns to correction, go into your own defensive mode. Take some profits. Keep a short leash on losses. Raise cash.

How many torrid rallies and solid breakouts went bad since the correction began? Plenty.

Yes, there's is the occasional Informatica, (INFA) which is near record highs after a 12% burst on Jan. 31. But they are vastly outnumbered by faltering stocks such as Apple, (AAPL) Research In Motion, (RIMM) China Mobile, (CHL) Sinopec, (SNP) Google, (GOOG) Baidu.com (BIDU) or Chipotle. (CMG)

Maybe you noticed MercadoLibre, (MELI) an Argentina-based online marketplace. It came public in August at $18 a share. It had great fundamentals, and the stock soared through the end of 2007.

But it has since imploded. And the move down was steeper than the ride up. You had to move fast to get in — and even faster to escape unhurt. A stock like that makes a 2% T-bill seem like a great deal.

[KC Scott]

Keep A Watch List So You Don't Miss Out
BY PATRICK CAIN

INVESTOR'S BUSINESS DAILY

Posted 2/6/2008

Thirteenth In A Series:
Understanding The Market Cycle

A market correction can end surprisingly fast. If you're not ready, you might miss out on big winners.

So while you're on the sidelines as a correction unfolds, build a watch list and keep it updated regularly.

This pre-investing work will pay off and prevent last-minute cramming once the tide shifts.

In this series on the market cycle, Investor's Corner has discussed the principal steps to take in each phase. Today, we go over how to search for stocks that may lead the market when a new uptrend starts.

Remember, leading stocks usually form their bases during market corrections or bear markets. In this sense, market downturns nurture fresh leadership — and opportunities for investors.

Stocks for your watch list should abide by the same characteristics of strength you'd look for in good times. You want to see quarterly earnings and sales growth of at least 25%, for example. The next story in this series will examine the specifics to look for.

Start with Stocks In The News, which each day examines one or two stocks for both the Nasdaq and NYSE.

For each company, there's a brief analysis of its key fundamentals. These columns, found with the IBD stock tables, usually focus on stocks forming bases or those near proper buy points.

Check the Daily Stock Analysis at Investors.com. IBD market writers break down a chart pattern each day. Some focus on companies with superior fundamentals that may be forming bases.

Also online, you can scan the Screen Of The Day. It gives readers lists of stocks ranked on an array of criteria.

For a close look at promising companies, read the New America section. It highlights companies with innovative products, or those experiencing a growth spurt due to changing industry or economic conditions.

The Nasdaq and NYSE Real Most Active point to stocks making moves in big volume. Watch the ones rising in big volume; that could be institutional investors accumulating shares of the stock.

A handful of groups will emerge as leaders when the market turns around. Keep an eye on the industry group ranking and the new highs and lows tables. They can help you see emerging groups.

When the market is healthy, many readers find investing ideas by researching stocks in the IBD 100, Your Weekly Review and IBD Big Cap 20 with heavy black borders around their charts. Those "boxed" stocks boast superior fundamentals and are near proper buy points.

Use multiple tools to expand your research to the best degree possible. It's smart to go further, checking a company's Web site for more on its market and financials

[KC Scott]

Watch List Should Possess True Leaders
BY PAUL WHITFIELD

INVESTOR'S BUSINESS DAILY

Posted 2/7/2008

Fourteenth In A Series:
Understanding The Market Cycle

It doesn't do much good to put a stock on your watch list unless it has solid fundamentals and other traits of market winners.

That may not leave many companies, but it does afford you with the best opportunities to invest in.

As Investor's Corner starts winding down its series on the market cycle, we look today at the type of stock that should be in your radar.

What makes a stock a true leader?

Mainly, its financial performance stands out. Leaders historically have earnings gains of at least 25% in their most recent quarter or two, plus higher profit year after year.

Sales growth also should be 25% or better in the latest quarter. Return on equity and profit margins should also stand out.

IBD's 20 Rules For Investment Success, shown on this page, include the principal qualities historically found in winning stocks.

One way to find quality stocks that meet this tough criteria is to let IBD do the early work.

For example, in the late-August-to-October rally, IBD mentioned 122 stocks that were either breaking out, near a breakout or within a secondary buy area.

These mentions occurred in the Stocks In The News columns, the Real Most Active and The Big Picture. Others were charts with heavy borders in the IBD 100, Your Weekly Review and IBD Big Cap 20, denoting leading stocks in attractive chart areas.

A look at six big winners from the past rally shows that the timing was spot on. (See accompanying chart.)

Note that all six of these stocks were identified in September, the first month of the rally. Only 15% of the stocks identified that month sank below their buy points long before the general market went into its current correction.

Be aware that a "boxed" stock doesn't mean you should buy it blindly. These are names with strong fundamentals that merit further study. The same goes for any stock covered in IBD.

Follow-up research should focus on putting each stock through the much tougher test that IBD's 20 Rules indicate. Ask these questions as a basic litmus test:

• Is it a leader within its industry?

• Are its fundamentals among the market's best?

• Is it forming a proper base?

• Real leaders tend to form bases with steady price movements, not wide and loose patterns.

It's also encouraging when at least one top-performing mutual fund owns the stock.

[KC Scott]

Making The Most Out Of Market's Ups, Downs
BY MARIE BEERENS

INVESTOR'S BUSINESS DAILY

Posted 2/8/2008

Last In A Series:
Understanding The Market Cycle

The past few weeks, Investor's Corner took readers through the market cycle, explaining key steps to take in each phase. Today, we offer a synopsis for your reference.

• Follow-Through We started with the beginning of a an uptrend, which is marked by a follow-through.

Once the major indexes attempt to rally, look for at least one of them to surge on higher volume vs. the prior session. This rally confirmation occurs four days or later after the indexes make a bottom.

• Leaders break out A follow-through may be worthless unless leading stocks break out of bases they formed during the correction. There's usually a window of about 13 weeks for those fundamentally superior stocks to surge out of solid bases.

• Buy near proper buy points Buy only when a stock clears a proper buy point, or — following a breakout — the first or second time it rallies from a pullback to its 10-week moving average.

• Be choosy When you do buy stocks, concentrate on a few strong leaders, as opposed to buying many stocks. It will be easier for you to manage your holdings. This also will keep you in the highest-quality stocks.




• Pyramid your buys Manage your portfolio by "pyramiding." Buy about half of the amount you plan to invest in a stock right around the buy point. When you're up 2%-3%, buy more shares. When you're up 5%, buy the remainder. At each phase, acquire a smaller amount of shares. You may also add shares when a stock climbs from a 10-week pullback.

• Take some 20%-25% profits When your stock surges 20% to 25%, consider selling some stocks and take some profits off the table.

• Cut losses short Don't let your hard-earned profits evaporate into losses, and cut your losses short. Sell any stock that falls 7% to 8% below your purchase price.

• Watch for sell signals After the market has been rallying some months, sell signals may appear in your stocks. Look for climax runs or sharp breaks of a support like (such as the 10-week moving average). The series discussed others.

• Market tops Once you see leaders breaking down in heavy volume, it may be a sign that the market is topping. A build-up of distribution days over a few weeks often signals a market downturn.

• Raise cash Avoid buying stocks in a correction. Raise cash while you're still ahead. It's always better to sit out a market correction.

• Build a watch list But sitting out doesn't mean you shouldn't do anything. Market corrections provide an opportunity to prepare yourself for the next rally. Build a watch list of institutional-quality stocks.

• Seek the best stocks Use tools in IBD and Investors.com to find fundamentally sound stocks. Make your personal stock list and review those stocks on a regular basis to see if they're forming sound basing patterns. Studies show that 90% of bases of biggest winners were formed during market corrections. That's why you shouldn't underestimate this crucial part of the cycle.

Then it's time again to look for a solid follow-through, and the whole cycle starts anew.