Timing the market may appear to be a herculean task. But investors who know how to invest can cut through the noise and zoom in on true market signals can achieve that goal with reasonable success.
Breaking down this task into simple steps is really all it takes to improve the odds of getting back into stocks at the right time after a market downturn.
It may be tempting to start buying stocks on the first day the S&P 500 or Nasdaq rebounds. But that alone tells you nothing significant; the market can easily return to its losing ways.
If a rebound can be sustained, indexes will begin a rally attempt and confirm it in the form of what IBD calls a follow-through day. This is how history shows that bottoming signal happens:
How To Invest: Spotting Market Bottoms
The first sign of a market low starts when the S&P 500 or the Nasdaq, or both, closes higher. That's Day One of the rally attempt. If an index closes lower but in the upper half of the day's price range, it also may count as Day 1.
The rally attempt continues as long as the index stays above the lowest price level of Day 1. If it breaks below it, the rally attempt is over and the market has to try again.
The first few days of the rally attempt, you need to just sit and watch. Then, starting with the fourth day, look for the index to make a big jump, closing the session at least 1% higher. Why the fourth day? Earlier rallies are suspect because short sellers may drive stocks up at the first sign of a bottom.
There's another essential element: Volume must increase from the previous session in the index that rises 1% or more. If the combination of a big index gain and higher volume occurs in the S&P or Nasdaq, that tells you a follow-through day is happening.
How To Invest: Signal To Buy Stocks
Once a follow-through is in place, investors should be increasing their exposure to stocks with some starter positions. If the market uptrend holds up, more breakouts should pop up, and investors can further raise exposure.
But while every major market bottom has had a follow-through, some follow-throughs flop. There was one on Oct. 6 (1).
Caution remains the better part of valor. Watch the market's leading stocks for sell signals and keep your selling tool kit ready.
Also watch out for distribution days. These are days when indexes come down in heavier volume. If they appear soon after a follow-through, that is a sign the uptrend will fail.
How To Invest: The Nasdaq's November Follow-Through
Last October, the Nasdaq had fallen 12.8% from its July highs. The index made its first up day Oct. 27 (2), which became Day One of the rally attempt. The index kept climbing and on Nov. 1 — Day four of the rally attempt — the Nasdaq surged 1.6% in higher volume (3).
With that follow-through, investors who bought stocks went on to ride a strong uptrend. The Nasdaq gained 14.8% by year end.
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