One Day Wonders or True Bottom?

Thursday, July 20, 2006 | 08:26 AM

Rallies like yesterday's embolden bulls and chasten bears.

The question of the day is: Was this merely a vicious bounce in a longer downtrend, or was this the start of something new and wonderful?

On CNBC, I watched the Bulls pound their chests, while the bears ate crow. But history shows that a full celebration after the recent technical damage is premature. While it's foolhardy to ignore a day where the Dow rockets up 200 points, it's just as dangerous to close your eyes and plunge in blindly.

Over a year ago, I discussed a methodology for determining whether these surges were one day wonders or true bottoms. It is via a statistical study done by William O'Neil, the founder of IBD.

To quote that column from last year:

"O'Neil found that he could separate the "one-day wonders" from the important turning points by finding evidence that large institutions had regained their appetites for equities. While there are no guarantees, this method has a very respectable track record.

Historically, that would be evidenced by a significant follow-through rally four to nine days after the first big move up after a longer downturn. Requirements include the major indices rallying 1% to 2%, and on greater-than-average volume, in that five-day window. It opens next Monday."

We are now in a "confirmation window" which runs about 10 days.

Of course, a market rally does not make all of the prior concerns simply disappear. Oil prices, inflation, slowing GDP, declining housing, waning earnings momentum and Middle East War(s) do not merely go away because the animal spirits were in full throat for one day.

Stay tuned . . .

>

Source:
One-Day Wonder or Key Turning Point?
RealMoney.com, 4/22/2005 9:17 AM EDT
http://www.thestreet.com/p/rmoney/barryritholtz/10219249.html

Thursday, July 20, 2006 | 08:26 AM | Permalink | Comments (68) | TrackBack (0)
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Comments

I'd add that we've already had two of those confirmation days during this downturn, only to have them negated by lower lows. The beauty of O'Neil's system, as I see it, is that by trading stocks instead of the indices, even if the confirmation is negated you can still make money before cashing out.

Posted by: Bynocerus | Jul 20, 2006 8:42:18 AM

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