Spotting a Stock Market Decline

Strong market moves frequently end in one or two-day reversal spikes. Those spikes often provide advance warning of significant market turning points. Here are signs that a market decline may be coming. Check this post on How to Use the Daily Stock Charts.

The market will rise sharply in the morning on very high volume, with volume running at close to 15 million shares during the first hour of trading

From 10:30a.m. (Eastern time) on, the market will make little or no progress despite heavy trading throughout the day.

By the end of the first day, almost all the morning's gains will have been lost, with the market closing clearly toward the downside. Occasionally, this process will be spread over a two-day period.

Steps to take: When you see the pattern, either sell immediately or await the retest of the highs that were reached during that first morning. Such a retest often takes place within a week or two, on much lower trading volume. This may prove to be the last opportunity to sell into strength.

The patterns seen during one-day reversals occasionally take place early in the intermediate advances, with the backoff representing a test of previous lows. If such action appears prior to significant market gains, do not sell. Rather, buy during any near-term weakness. The market will probably resume its rise. However, if such a trading pattern occurs following a period of several weeks or months of rising prices, the odds increase that a genuine one-day reversal is occurring. Then take protective action.

How to Call Turns In the Market

The adventurers who call turns in the stock market for a living depend on a number of indicators to identify a major turn. Every serious investor, however, should make some regular assessment of when a major move is more or less likely. Reason: 80% of the issues traded go with the overall market trend

Fundamental rule: Market moves usually exhaust themselves after traveling a maximum of 25% up or down from the 40-week moving average of the Dow Jones industrial average, Standard & Poor's 500 indexes, and the New York Stock Exchange composite index.

To calculate the moving average (usually called the current mean by professionals): • Average the closing numbers on the index for the past 40 weeks. Each week, add the current number on the index and drop the earliest week's number. Then recalculate the 40-week average. To read the results: The further the current average is from the current mean, the greater the chance that the market will shift direction.

Individual investor strategy: Keep the basic situation in view. Factor in what the forecasters are saying. Relate that to fundamental economic factors, especially interest rates, that affect the stock market. Make a personal judgment about the market trend. Use temporary fluctuations in the trend to execute strategy Investors anticipating a major rise should buy during temporary drops and vice versa.

When to Sell a Stock

It's very difficult to know when to sell a stock. Very little research has been done on the subject, and advice from brokers is usually vague and confusing. Typical comments: "Let's watch it one more day." "Can't tell it now, but you should get out on the next rally." "It's not doing well right now, but it's sure to come back over the long haul." If the stock you've bought has gone up, the two conflicting cliches on Wall Street are:" Can't get hurt taking a profit," and "Let your profits run."

What to do instead: When it comes to evaluating an individual stock, you should look for one thing-failure. This sounds austere, but what to look for is very specific: A stock that tries to rally fails to make a new high.

How to identify failure: The stock must sell below the price level at which it had held in a previous "correction" (decline). If you were to look at this sequence visually, on a stock chart, you would see a series of lower highs and lower lows. That type of action establishes failure. It defines the stock's trend as down, not up.

Sell! Put aside all hopes that the stock will stabilize or rally wildly or that it will come back if you hold it long enough. The market is telling you, in no uncertain terms, that something is wrong. You don't have to know what or why. That information frequently doesn't come out until the stock has tumbled a very long distance down. You've made an objective decision. Stick with it.

When to decide to sell: When the stock market is closed. That way, each little gyration won't emotionally affect your decision. After you've made an objective decision, use a protective stop order. How it works: Tell your broker to sell the stock automatically when it drops below a certain point.

You can use stop orders effectively even if the stock rises. Each time the price advances. cancel the old stop order and enter a new one. One arbitrary rule: Set the stop order price at 10% below the current market price.