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How to Improve Attention to Detail During Market Corrections

Note:  This article is meant to help you learn from the market and does not serve as investment advice for any specific group or individual.  For more information, please read the HSR Terms of Use.

The semiconductors are just one example of using the majority opinion (market facts) to stay on the right side of the market.

There are many more examples of negative stock price behaviors for the week ending 04/30/10, but I won't discuss them here.

Please excuse my digression, but I wanted to be sure that you were aware of the critical nature of facts.

Remember, facts represent the market's opinion and the only way to get facts is to look at the market (use stock charts).

If you're not using stocks charts, you're not able to tell what the majority of investors are doing in the market.

Now that you've had a chance to understand the importance of market facts, let's get into the three (3) categories of stocks that can help you better track market corrections.

Before starting this exercise, you should take every stock (operating companies only) in the market or just the liquid stocks (if you prefer) and arrange them into the following groups by industry group/sector:

Category 1 - Stocks Basing

Category 2 - Stocks Breaking Out

Category 3 - Stocks Refusing to Base

I know that this is a lot of work, but you'll be better off after it's done because your stock list will be broken up into specific categories that allow you to evaluate the market using specific facts.

You can use Excel or an equivalent software program to log your observations on the stock market.

Each weekend, you can update your file with the new changes.

Category 1 - Stocks Basing

Category 1 will allow you to keep track of stocks/groups that are setting up in bases.  A base often forms during a market correction and is a precursor of market leadership.  With this category, you'll better recognize the groups that have the potential to break out in a leadership role for the market.  Conversely, you can monitor the groups that may breakdown if the group/market takes a turn for the worse.

What are these stocks doing on a weekly basis and do you see any of the base behaviors described here?

Generally speaking, you can put a stock into the basing category after it closes below its 10 Week MA for the first time since the start of its uptrend (see chart 2A).

While there's no guarantee that it won't rebound and continue higher in the following weeks, the first close below the 10 Week MA often precedes a stock's basing phase (see chart 2B).

Historical Stock Chart Examples 2A & 2B:  AK Steel (AKS) and '06 Steel Stock Leadership

Click to enlarge 2A

Click to enlarge 2B

I've also noticed that sometimes the market will hit new lows within a correction, but a stock that's basing doesn't (see chart 3A).

This bullish divergence is important.  Is it related to a specific industry group (see chart 3B) and what might this say about the economy/market?

Historical Stock Chart Examples 3A & 3B:  BHP Billiton (BHP) and Group at the '04 Market Bottom

Click to enlarge 3A

Click to enlarge 3B

When a stock breaks out of a base, you can move it into the next group (Category 2).

Historical Fact on the Importance of Bases:

The 1991 Bull Market started with base breakouts en masse.  For the week ending 01/11/91, stocks from different sectors were set up in mature bases that looked ready for liftoff.  This was very bullish and their future leadership out of those bases helped the market rally 45% (Nasdaq) in only 3 months.  The big market rally began in earnest on 01/16/91 and included many base breakouts for the week ending 01/18/91.

Category 2 - Stocks Breaking Out

Category 2 will help you gauge the market's health and see what stocks/groups are breaking out before and/or during a market rally

A base breakout tells you that a stock may be setting up to lead the market higher.

Keep in mind that base breakouts can happen as the market is hitting new lows (Leading Base), on a rally off a low (Bottom Base) or after a low is already established (Reinforcing Base).

I wrote about the Base Cycle here.

This fact about the market shows you why it's a good idea to search for stocks that are breaking out regardless of the market's current condition.

You might learn something about the market by identifying what stock/group is breaking out.

When a stock breaks out of a base, it will usually do one of three (3) things:

  1. Roar Higher
  2. Grind Higher
  3. Fail




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