Ftd?

[Maxime A.]

Hi Mike,

It seems that the indices have made pretty good progress this past week and the leaders have also been acting well (at least that's how they look to my untrained eyes), so I was wondering whether IBD had declared an official Follow-Through Day? Looks like a no since Chris Karcher isn't yet on a buy signal, but if so I'm curious about the missing ingredient.

Also since we're entering the slow summer season, I was wondering whether there were any statistics on the success rate of FTDs when the overall participation of traders is low. Thanks,

Max

[Mike]

Max,

I was out yesterday and coudn't get to this question.

A Follow-Through day is a day on a major index where the price moves up significantly on volume higher than the day before on day-4 or later of a rally attempt. Bill O'Neil stated a week and a half ago that he considers 1.75% the current definition of a significant increase. Mareket volatility causes this threshold to change from time to time. We wait out the first three days in a possible rally as short covering causes confusion in reading sustained buying interest.

So what has happened? On 6/21 when we got a sizeable 2.2% jump up in price on the NASDAQ on volume higher than the day before. It was day-2 in a rally attempt, too early. A rally attempt begins on an up day after a market decline. The count continues unless another intraday low is made, where the count gets reset and we begin looking again for a fresh rally attempt. It is important to know that IBD's definition of a positive close is from close-to-close and not open to close.

There is a confusion factor however as it is possible to count a down day that closes near the highs of the day as a day-1 count. So a new intraday low and rally to close near the highs of the range but still below yesterday's close can count as day-1. June 16 comes close to meeting this definition when the NASDAQ closed in the middle of the range after trading lower. Two people looking at the chart could reasonably make a call in either direction on June 16. If you call it day-1 in a rally attempt then the action on June 21 was a valid day-4 FTD. My view of the action on 6/21 was that is was a true FTD. IBD took the opposite view however. The market has clearly rallied on low volume off of this signal and left most behind in cash.

My view of the long-term situation is that we entered a bear market after the 5/02/11 top. I could be proven wrong of course. Under the market has already topped scenario the current rally is building the right shoulder of a head and shoulders pattern. This would imply the rally coming to a halt before making a new high. I would be seriously wrong in my view if the market makes a new high and continues to rally. So 2887.75 on the NASDAQ is a key level in my opinion. Stalling action prior to reaching this level could be an optimum short taking point. We need to remain nimble without a fixed view and let the market tell us what it is doing.

[Maxime A.]

Mike,

thanks a lot for your informative reply! That's an exhaustive definition of FTD. It's interesting to think that if the market continues creeping up without having a valid FTD, most of the strict CANSLIM followers would stay in cash. I presume their take is that the foundation of the rally is shaky and that it's going to fail at some point.

Btw: has this method of detecting rallies ever failed to notice the start of an up leg in the markets?
Thanks,

Max

[Mike]

Max,

FTDs have preceded most if not all significant rallies in history. I don't know of an exception, on occassion IBD says the rally resumes after a small pull back that does not qualify as a correction. There certainly have been some challenging calls this year and last. IBD is admitting that maybe 6/21 was a FTD on the S&P500 with a 1.3% gain. This is a hingsight view based on the recognition that we just had a big up week. We all knew a relief rally was coming and we got one. Is it a real sustainable rall? Only time will tell.

Lets look at some statistics under the assumption that 6/21 was a FTD. Distribution soon after a FTD usually leads to rally failure. Distribution on the first day after a FTD has led to rally failure 87% of the time with 75% failure rate on the second day and 73% on the third day. We got distribution on all three days.

Undercutting the lows of a FTD has led to rally failure 90% of the time. We have undercut the 6/21 lows.

High probability of failure does not mean certainty of failure. My definition of failure is that the rally does not last long enough for normal CANSLIM investing. I equate this with rallies that last less than 5 weeks long and make less than 9% gain from the FTD close. We won't know based on this definition that we have a successful rally here until late July. In the mean time we watch the action of the leaders. Friday saw strong market internals with a Eureka condition. A Eureka as defined by Ian Woodward is a day where the ration of NYSE advancers to decliners is greater than 3 and the ration of advancing volume to declining volume is greater than 5.4 and the TRIN or Arms inex is less than 0.63. This all occured. Impulse indicators like this indicate bullish sentiment that pervades in time more than a single day. I still call this rally high risk however.

I also tend to select a leading index and watch the behavior of that index. What it does the market usually follows. I select the Dow Transporation index at this point as it is the only index that has now closed at a new 52-week high. If this index continues to rally I predict that the other indices will make new highs also. A quick reversal of this index probably means the same for the market.