Tuesday, February 5, 2008

I.B. Ranting

After persistently running higher for almost two weeks, the market finally began its pullback today. I am not a participant in the pullback, but rather an observer. While the overbought readings indicated there would likely be one soon, my studies indicated risk/reward was unfavorable in trying to short it.

As far as I’m concerned the action during this pullback becomes very important. I demonstrated last week that the first several days following a Follow Through Day are a pretty good predictor of success or failure. After 2 days we are still holding up. I’ll continue to monitor the action carefully.

Warning…rant coming…

One issue that has been raised is whether last Thursday was in fact a Follow Through Day. IBD apparently failed to label it one. In Friday’s Big Picture column they wrote:

“Given the market's volatility since late December, you'd need to see bigger gains than Thursday's to signal a fundamental shift in the market's trend.
As noted in Thursday's Big Picture, it's almost a moot point even if the market did manage to assemble a follow-through session of powerful gains in heavier volume. The reason? There are virtually no stocks close to proper buying positions right now.”

From my perspective, Thursday satisfied the requirements IBD previously laid out for Follow Through Days. Due to their perception of volatility and breadth they remain negative on the market's prospects. As they should, they are deriving their outlook from multiple readings of market health. Unfortunately it seems they would like to advertise the Follow Through Day as a magic indicator that never fails. Therefore, either they make excuses or change the definition of it so that it appears not to fail. Should this rally take hold I have no doubt they will refer to last Thursday as a Follow Through Day in a future publication. It is a tool that uses volume and price action. Breadth, while important, is a separate matter.

Whether Follow Through Days always work is not important to traders. What is important is whether they can be utilized as an effective tool for helping to identify market bottoms. So far we’ve seen that they have been about 55% accurate and risk outweighs reward. (part 1 and part 3) I’d say they have some utility. Constant refinement of the definition to retrofit recent market conditions destroys much of that utility in my eyes.

The McClellan Oscillator is a terrific tool for measuring the market’s health. Should the McClellans decide to constantly adjust the way it should be calculated, it would fail to be as useful.

The Follow Through Day study I laid out and have been discussing the last few weeks has identified Thursday as a Follow Through Day based on the original definition offered by William O’Neil. For purposes of my study and my trading it shall remain one whether it works or not.

…end of rant.


High Plains Trader said...

Justifiable rant in my opinion. Retrofitting doesn't do anyone any good and it only destroys, or has the ability to destroy, their integrity.

Anonymous said...

Rant away. I've been frustrating with this aspect before, and you're right, retrospectively, they will claim it as FTD should this rally progress. They will not only do it in some distant publication, but will claim it into this very same rally. It has happened before, more than once.

Tim said...

As a CANSLIM type trader I too am disenchanted with the changes of the follow through day throughout the year. But, O'Neil has been doing this longer than me and so I listen to his view.

That being said, I believe O'Neil wrote in his book that a follow through day does not justify buying unless you see high earnings growth stocks breaking out of sound bases.

Since there is currently nothing fitting the 2nd part, my opinion matches IBD's that the recent follow through day is not valid.

Anonymous said...

RH, I sense you've a frustration with using
judgement regarding the labeling of follow

On the one hand using judgement is bad:
its no longer really measurable, testable,

On the other hand, there are three inevitabilities:
death, taxes, and indicator whipsaw.

So, knowing when other conditions make
an indicator moot can be a good thing.

Nevertheless, if in the future, they
point to Thursday as a follow thru
for the purposes of demonstrating
how well FTDs work, that would be
downright deceiving.

Anyway, keep up the good work.

Anonymous said...

Great observation.

I wonder what other data they're obviously using to base their decisions.

I think they've got other criteria they don't mention and felt (probably correctly) this rally is bogus.