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MARKET BUY, HOLD and SELL DISCIPLINE:


This section is a summary of Market Buy and Sell disciplines. These disciplines are critical because 75% of a stock’s move is related to the market (50%) and its sector (25%).


CONCEPT:
Think globally (Market & Sector),
AND THEN act locally (Specific Stock.).


Historic Indicators of Market Action:

  • JANUARY BAROMETER: With 91% accuracy, as the S&P 500 goes for the month of January, so goes the year. January 2012 was up, and with December and fiscal cliff negotiations to go, so far 2012 is up.
  • PRESIDENTIAL CYCLE: 2012 is the fourth year of a presidential term. Historically, the fourth year has been up every term since 1939. Since 1833 the average increase was 5.8%. So far 2012 with December and fiscal cliff negotiations to go, 2012 is up.
  • PRESIDENTIAL CYCLE: 2013 is the first year of a Presidential Cycle. Since 1833 the Post Election Year has gained 2.0%. It was up 20 times and down 24 times.

See the Stock Trader’s Almanac: 2013 for more historic information.

Contemporaneous Indicators of Market Action:

The Investors Business Daily (“IBD”) newspaper and its website, www.investors.com (and the related www.marketsmith.com) are the most accessible, cost effective and user friendly sources of market information for most investors. However in the past two years, brokerage websites such has www.fidelity.com have materially upgraded their free information, although it is still not as accessible as www.marketsmith,com. Read and study these resources, but below is a brief tickler.

  1. MARKET UPTURNS (“BUYS”): Two days are required to signal a market upturn. The following is condensed from IBD’s The Big Picture on March 7, 14 and 22, 2007.

    “Day 1 of a rally attempt is defined as any session during a correction (a market downturn) in which one of the major indexes (e.g. Dow, S&P 500 or NASDAQ) closes higher after hitting a low. Volume isn’t a factor, nor is the size of the market’s gains. What happens later on is what counts.” Following Day 1, “a single Distribution Day (a decline in a major index on higher volume than the prior day) is often enough to derail the rally attempt”…As is a day’s decline that undercuts the correction’s low.

    The second important Day is called the Follow-through Day or just Follow-through. “Every market uptrend has begun with a Follow-through Day.” “Following Day 1 of a new rally try, you’re looking for a Follow-through rally to occur on (trading) Day 4 or later. A Follow-through happens when one or more of the major market indexes clocks a big gain in higher volume than the previous session…”

    Be careful not to be fooled by two successive up days. Often short covering takes place on the day following a strong up day, and this short covering, while driving up prices and volume, is usually not an indicator that institutions are coming back into the market. Also, do not be fooled by up days on less than the 50-day moving average volume. This indicates a lack of institutional buying power (commitment) behind the market move. There was a lot of this in mid 2006.

    Historically, IBD called for price increases of about 1.7% on higher volume for both Day 1 and the Follow-through Day, but they have backed off this precision recently. They do still want a “big gain” on the Follow-through Day in higher volume than the prior day. “…while every market uptrend has started with a Follow-through, there have been false starts… Over the past decade, most successful Follow-throughs occurred at least two months (after) the top. (In the past decade, it has taken more than three months on average for a successful rally to take root.) Moreover, Follow-throughs occurring four or five weeks after a top were usually unsuccessful.”
    What should a long term investor do when the Market is in a confirmed rally?

    (1) As discussed under Market Downturns, you should prepare for the eventual upturn by creating a Watch List of stocks to potentially buy. These stocks should have (a) a PEG ratio below one and debt less than 25% of total capital (Recent and projected free cash flow growth [EPS as a weak proxy] should be better than 25%.), and (b) the stocks should have good IBD chart patterns (See the education sections of www.investors.com) indicating that institutions are buying them and that the stocks are not extended. AFTER IBD CONFIRMATION of a market “BUY”, then buy some of the best stocks on the Watch List. (2) Maintain good sell disciplines on individual stocks including those sell disciplines discussed later on this page.
  2. MARKET DOWNTURNS (“SELLS”): Markets often turn down and go into: (1) a “correction”, or (2) a “Bear” market. (A correction is a 10-15% decline in an uptrending or “Bull” market. A Bear market is a decline of 20% or more). The correction or Bear market often begin after three to four Distribution Days within 4 weeks. A Distribution Day occurs when a major market index, such as the Dow Industrials, S&P 500 or NASDAQ, is down on higher volume than the previous day. The Distribution Days are computed relative to a single index (e.g. the Dow, S&P 500 or NASDAQ), and are not cumulative across indexes. Additional “sell” disciplines are discussed below and on www.investors.com.

    “Remember that every stock eventually will get hit if a correction lasts long enough, even those with the strongest fundamentals and the most robust technical action.” Weed out weak stocks that break below their 50 day moving average. But if you are not an active trader, don’t try to time the market if you own mutual funds or good stocks for the long run. More comments on weeding out individual stocks are given below.

    Reality Check: If a stock falls from $100 to $50, it has lost 50% of its value. To regain $50 and breakeven at $100, that stock must increase in value 100%.

What should a a long term investor do when the Market signals “Sell”? (1) Use the PEG discipline discussed in my books to establish a watch list for buying after the correction is over when the market signals a “Buy”. The Watch List stocks should have the criteria identified above. (2) Maintain good sell disciplines on the stocks that you own - including that if you have stocks with PEGs well above 1.0 that are falling through the 50 day moving average line, sell them. If they are more than 20 % above the 50 day price moving average and hitting new highs on below 50-day moving average volume, sell them. (3) If you have an asset allocation target, rebalance now, i.e. reduce your commitment to stocks. (4) As a long term (2-3 years) investor, one of the biggest mistakes that I have made is selling low PEG stocks on market corrections, so long as the individual stocks did not create a 7-8% loss from my buy point and did not decline below the 50 day moving average. Also note that good “buy” disciplines for individual stocks are important because there is less likelihood of having to sell because the stock falls 7-8% below your purchase price.

Please see the next section for additional thoughts on individual stock buy and sell disciplines.


 
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