Advancers lead decliners by a 17-to-1 ratio on the NYSE Tuesday and 10-to-3 on the NASDAQ. The DOW was up 3.5% with the NASDAQ up 4.2% making it seem like we had a follow-through but volume was lower. Besides, the NASDAQ violated the reversal range intraday on Friday and then again this past Monday. Because of this violation, the count had already reset and Tuesday’s huge gain acts as day 1 for a new rally. I know this can be confusing but it makes sense after you study the rules and then watch it happen over several years.

We can’t call this a follow-through on day 6 for the DOW because trading volume dipped from yesterday’s totals. The count does not reset because we have not violated the intraday low from the reversal day or day 1 of the rally attempt. Leading stocks didn’t do much to lift the market today so it is better off that we didn’t have a suspect follow-through. Rebounding financial stocks lead the market higher, not something we can hang out hats on.

Read up on the CANSLIM rules if you don’t completely follow what I am talking about when it comes to reversals, rallies and follow-throughs.

Past CANSLIM Articles:

• CAN SLIM Breakdown
• IBD’s 20 Rules for Success
• Understand the ‘M’ in CANSLIM

I am not getting overly excited about the 3.55% move in the DOW, the 3.98% move for the NASDAQ and the 3.71% jump for the S&P 500. Today’s action does raise some interest but trend reversals and new bull rallies can’t be confirmed after one day of action. All major bull markets started with a reversal and then a follow-through within the next four to ten trading days.

This idea was first revealed by William O’Neil, the founder of Investor’s Business Daily, and became a cornerstone in his CANSLIM investing method. I believe this theory to be accurate but it is not an exact science. Before I describe this method, I would like to be clear that my indicators are still pointing down and my screens are still focusing on shorts. It’s a good time to write about reversals and follow-through days even though I don’t think this rally has legs but my opinions must be checked at the door.

The key to understanding this follow-through philosophy is that reversal signals usually occur after a significant market correction, not a minor market correction. The reversal and follow-through in 2003 was classic and one I like to refer back to when looking at the present market. Both the reversal and follow-through days must move at least 2% to the upside on above average volume.

If today acts as day 1 of a possible reversal, then the next two days are not very important except for one fact: the market must not undercut today’s low as that would kill the start of a new rally. As long as prices stay above today’s low, the rally attempt is safe.

The follow-through day should come within four and ten days of today’s reversal although O’Neil’s original rules stated that the follow-through should come between day 4 and day 7. One of the major indexes must move higher by 2% or more on larger volume than the previous day to qualify for a follow-through. Multiple indexes participating with a follow-though shows conviction that the market has sustainability to move in the new direction.

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I wrote an article on October 15, 2007 titled How to Make Money Selling Short, precisely when the general market indexes were topping. I am not going to take full credit but subconsciously my charts were giving me signals that the market was showing the major red flags and signals of what we are seeing today. This is a direct quote from that blog post from three months ago:

I have (privately) screened several potential shorts over the past couple of months but this market is not ready to roll over just yet. I was early with my shorting analysis in 2006 so I do not want to make the same mistake in 2007. However, more and more stocks seem to be building bases like the ones from the bubble burst in late 1999 and early 2000 (examples in the charts provided).

When I short stocks, I look for longer term trends, not short term swing trades (rarely ever day trades). The shorts I want look like the charts in this post (they take months or even years to complete). I want the high flyers that will be crushed over the next several months. Just as I like riding trends higher, I like riding trends lower over the intermediate to long term (4-12 months). I am trend trader at heart and it is what I do best.

We will have bounces to the upside over the next few months and the Fed will try to stop the bleeding but the stocks that are due for crushing blows will be dealt those blows eventually and we all can profit from them. Stocks may move 20%-50% (in both directions) at times so be careful. I will spend the remainder of the week posting up charts that look ready to become long term losers. Charts similar to the examples below. Give the charts time to form, be patient because many of these will look to move higher at times (as soon as this week and next) prior to their inevitable fall.

Complete Blog Post Repeated from October 15, 2007:
The title of the post is borrowed from the book “How to make Money Selling Stocks Short” by William J. O’Neil. It’s an ideal book for investors that focus on trading longer term trends and don’t necessarily do this for a profession (i.e.: day traders).

The book contains some excellent strategies for finding prime shorting candidates or stocks that are about to enter a declining stage that may offer excellent risk/reward setups for buying put options.

(CLICK FOR LARGER IMAGES)

I consider several of the techniques in the book to be reverse CANSLIM? Study the charts from the past that have setup ideal shorts and then screen for those same characteristics in stocks trading today. Many of the ideal shorts from past market declines have held the reverse characteristics of an ideal CANSLIM stock (that you would want to buy).

Many traders believe that the most obvious area to place a short would be near the peak of stock’s trading range but studies have found this to be untrue.

Characteristics of Longer Term Trend Shorts

• Most ideal longer term “trend” shorts take four to twelve months after the peak price to setup on the weekly chart with the majority of these shorts triggering between six to nine months.
• Look for stocks that had prior up-trends and support levels that can now act as downward resistance or entry areas.
• Once a stock tops and starts to consolidate, you want it to slice through the 50-d moving average and then the 200-d moving average.
• A crossover between the 50-d m.a. and the 200-d m.a. is ideal and is graphically presented on each chart in this post
• The odds of success increase with each failed attempt for the stock price to recover these major long term moving averages.
• Head and shoulder tops can also serve as ideal setups for potential shorts if they take at least five months to develop.
• A decreasing relative strength line and a negative pattern on the point and figure chart can also confirm that the stock is rolling over and setting up an ideal short.
• Finally, volume should be increasing and the stock should be under distribution as it violates the major moving averages and starts to break former support levels.

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Investor’s Business Daily sister company, Daily Graphs, is running a free week to their premium tools over at investors.com. My favorite and most used tool is the Daily Graphs Custom Screen Wizard.

All Daily Screens on this blog come from one of the eight scans I developed and described in detail in the post: Fundamental Screens and Scans

So far, the two scans below have been giving us the most opportunities in the market.

1. Quality Stocks with a new IPO within the past two Years
This screen scans for high quality stocks that have debuted to the market with the past two years (IPO’s).

• Earnings Per Share (EPS) Rating: Greater than or equal to: 30
• Relative Price Strength (RS) Rating: Greater than or equal to: 30
• Market Capitalization (MM): Greater than or equal to: 100.0
• Current Price: Greater than or equal to: 10.000
• Current 50-Day Average Volume (1000): Greater than or equal to: 100
• IPO Date: After 2006

2. Institutional Sponsorship Increasing
This next screen looks for high quality stocks that have increasing institutional fund sponsorship from one quarter to the next. As you know, this is very important for any stocks I cover and then buy. Every case study on this blog includes detailed institutional sponsorship analysis.

• Earnings Per Share (EPS) Rating: From 60 to 99
• Relative Price Strength (RS) Rating: From 60 to 99
• % of the number of Mutual Funds Owning for Current Quarter vs. Prior Quarter: Greater than or equal to: 10%
• Stocks trading at new 52-Week High and Percentage price is below 52-Week High: From 0 to 15
• Current 50-Day Average Volume (1000): Greater than or equal to: 100

Enjoy the free week; the tools are excellent for all CANSLIM, swing, trend trading and buy-at-new-high investors.

Below is a quick overview of the CANSLIM buying and screening strategy that I will use for the daily screens on chrisperruna.com

• I start by analyzing the fundamentals (accelerating earnings, sales and ROE) by using a combination of several screeners on the web to narrow down my list of quality fundamental stocks. The custom screen wizard from Investor’s Business Daily is one of my favorites.
• Next, I study the charts (technical analysis) and look at every stock screened. I pay particular attention to stocks that are poised to move and especially stocks with potential to move quickly. I am a trend-trader by nature but I have no problem making swing trades when the reward heavily outweighs the risk.
• I could never buy every stock that makes the daily screens but I try to include only stocks that look poised to make a move for those of you interested in buying certain candidates. The daily screen is just an equity research list, not an automatic buy screen.
• Finally: No investor is perfect and losses are part of the game when it comes to Wall Street. You must understand that these daily screens give us stocks that will allow me to maintain an expectancy to come out ahead each year. I will have as many winners as I do losers on these screens but I will only take the best risk-to-reward setups and will execute my game plan so the winners are consistently larger than the losers. This method is profitable if you follow the basic rules and control your emotions.

In order for my screening method to work, the “M” in CANSLIM is the MOST important aspect to the system’s success. For those of you not familiar with CANSLIM, the M stands for market health, if the market is weak, DON’T BUY long. No matter how good the fundamentals and technicals look, stocks will have a high risk of failure during weak markets.

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