A follow-through day doesn't always come when you want it, but shouldn't be ignored when it does. When the Nasdaq composite notched its follow-through day this week, we didn't like its position due to wedging. Here's why.
Where The Nasdaq composite Recovery Attempts Went Wrong
Some stock market corrections are slow and grinding. Some corrections last just a couple of weeks. It remains to be seen how this one plays out but here's how it started.
A CPI report on July 11 ushered in a nasty reversal for the Nasdaq composite and a major rotation to small caps and more defensive areas (1).
Whenever you have an action in a market index, it's important to watch the reaction as well. A recurring theme of begrudging and wedging action in the index transpired as the correction unfolded.
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Take the start. After the July 11 reversal, the next few days were up but still within the range from the July 11 high to low (2). A wedge is when your lows are getting higher each day and the index closes up but progress is just not coming freely. They usually need a shakeout to resolve themselves.
Losing The Moving Average Lines
As the Nasdaq composite gapped down and closed below its 21-day line (3), the following reaction was an early indicator of a troubled trend. Again, the attempted rally didn't make much of a recovery attempt before seeing another reversal as soon as the index poked back above the 21-day line (4).
The index quickly lost its 50-day moving average on another gap down the next day (5). Here again the recovery was lackluster. After a week's time (6), the index tried to get back above the 50-day line but was still not making a serious challenge to the space of the gap down. After a single close above the 50-day line, the index showed another reversal the following day (7).
On Aug. 5, the "wall of worry" the market needed to climb seemed unscalable (8). It wasn't just the unwinding yen carry trade. Economic data brought up recession fears. Bond buying skyrocketed. Expectations for a rate cut of 50 basis points or more seemed to be the prevailing market wisdom. There was talk of maybe even starting the cuts before the next Fed meeting. As bad as it looked, things could have gotten much worse.
Then the buyers stepped in to push the Nasdaq composite to an upside reversal at its 200-day line. But the recovery over the next week, again, left a lot to be desired.
Is This Time Different?
The next five days showed each day with a higher low. Another example of wedging. Progress remained begrudging and the index couldn't even recover above 17,000. A final shakeout would clear weak holders to fuel a move and that was our hope.
Instead, we ended up getting a follow-through day (9). Truth is we didn't really want it in that position, especially with another CPI report coming the next day. But we treat follow-through days seriously even knowing that many fail. So we added the ProShares Ultra QQQ and ProShares Ultra S&P 500 on SwingTrader, despite our misgivings.
An undercut of the follow-through day low gives us feedback that a rally failure on the Nasdaq composite may be imminent. Retaking the highs from the last reversal (7) would suggest a continued move higher.
Rather than succumb to fear, complain about the position or hesitate, we start with incremental buying on the follow-through day. In the end, we let the market decide.
More details on past trades are accessible to subscribers and trialists to SwingTrader. Free trials are available. Follow Nielsen on X, formerly known as Twitter, at @IBD_JNielsen.
