Tariffs, bonds, global economy, earnings season, etc. There are plenty of reasons that are leading to uncertainty for investors and that is playing out with big moves in the stock market indexes.
Just this past week, the Nasdaq composite saw a gain of 12.16% in a single day, the second highest gain going back in 50 years of history. So was that a buying opportunity? Not so fast. Many of the top gains historically don't necessarily pan out in the long run.
The Strongest Days Aren't The Best Days
Looking at the top 20 gains of the last 50 years on the Nasdaq composite, not including the most recent one on April 9, there is a noticeable pattern for when they happen. One was after the Black Monday crash in October 1987. Ten were from the time period after the dot.com bubble popped between March 2000 and the bottom in October 2002. Three were during the "Great Financial Crisis" in 2008-09. Three happened around the Covid crash in 2020 and one from the bear market of 2022.
The top 20 gains in the Nasdaq composite tend to happen during a crisis and are often surrounded by the 20 worst days. In fact, of the 20 best gaining days, half of them were undercut in less than 10 trading days.
Charts Over News Help You Focus During Market Volatility
That points to a strong danger zone, at least initially, when you see those big gains. Knowing that history, what action did we take on SwingTrader April 9 when the Nasdaq shot up over 12%? We didn't do a thing that day.
Case Study: 2020 Covid Crash
This historical example of 2020 illustrates the danger of getting excited from big up days. In late February, movement started getting larger on the downside (1) followed by big gains shortly after (2).
As March unfolded the uncertainty whipped investors back and forth violently. Gap downs and huge losses (3) would flank strong gains (4).
Since we keep our stops tight when swing trading any venture in on these strong up days would immediately get punished and trigger stops. Most likely well beyond the 3% level we like to keep as our maximum.
Within a week things got even worse with some of the biggest historical losses (5) surrounding some of the biggest historical gains (6). Moves around 10% in either direction on a daily basis don't provide enough of a trend to go long or short.
How A Follow-through Day Acts As A Signal
So how do you know when you can get a tradable rally? One large day isn't enough. We also look for a confirmation of the strength by waiting for a follow-through day on the fourth day or later once a rally has started. In 2020, the first strong gain after the March 23 bottom was one of those historical gainers that saw a 8.1% explosive move up (7). While it would be nice to be in one day off the bottom, that wasn't our signal to act.
Instead we waited to see another day of strength, at least 1% or more on volume heavier than the day prior. That day didn't come on the Nasdaq composite until April 6 two weeks later (8). Notice how the index didn't go straight up immediately. Within those two weeks there was a lot of movement but much tighter than what was seen in the violent moves of the prior month. Plus, when the follow-through day happened, it was the first close above the 21-day line in six weeks.
It's important to note that not all follow-through days work. It's a big reason we go in incrementally instead of all in at once. When they don't work, you often get that evidence quickly. Our patience for the signal gave us one of our best years in 2020 and is the reason we didn't use April 9 as a signal for buying.
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.
