How to figure out the correct time to enter markets after steep correction

Indian markets have been through a major shakeout since the start of September 2018. The NIFTY has lost approximately 10.5% and the SENSEX is trading 10% lower when compared with the levels at the beginning of September. A few negative macro factors, including rising oil prices and the rupee falling to an all-time low, caused the Indian stocks to shed gains accumulated in the previous three to four months.

Amid this steep correction, it is natural for investors to fall in the trap of cheaper valuations. They risk catching the falling knife and may end up suffering more losses. The prevailing thought would be, “This stock was looking good at 350 levels. It is surely more attractive at 250 levels as there is no significant change in fundamentals.” Sadly, markets don’t work that way, especially amid a bearish stance and the current volatility. But then again, historically, major gains were also realised just after steep bearish cycles.

So what’s the trick to book profits without exposing ourselves to unreasonable risk? That’s what the M in the CAN SLIM methodology is there for. The markets may look menacing, but this is not the time to stay passive. Rather, investors need to actively look out for the market trend.

After forming successive lower lows, the NIFTY showed some resilience on October 12 and ended in the green (chart 1). This is where we keep a lookout to see whether the market can sustain this resilience for three days (including the first day). For that to happen, it shouldn’t breach the lowest level made on the first day (October 12). And since the NIFTY 50 remained above that level until Tuesday, we changed the market condition to a Rally Attempt on October 16 (third trading day from October 12). On Day four (October 17), the NIFTY ended in the red but still didn’t breach the lowest level of 10,328 made on Day one. Hence, for now, the market remains in a Rally Attempt.

Chart 1-Rally attempt

But here’s the most important point. The market may be in a Rally Attempt, but the Confirmed Uptrend is only possible after spotting what is known as a “follow-though day”.  A follow-through day is observed when the market, which is already in a Rally Attempt (true for the current market), demonstrates significant gains (above 1.5%) in a day, along with a higher volume than the previous day. Both conditions must be met.

When the markets are looking bumpy and news channels are throwing thousands of unreliable opinions, the follow-though day acts as your friend and gives the signal to enter the market. A follow-through day gives free rein to investors to act on the stocks which are breaking out, so a proactive watchlist should always be kept ready.

Currently, the NIFTY hasn’t demonstrated follow-through day, but this is the time to closely keep a lookout for one. It is a strong signal and almost all the big market rallies start with a follow-through day. The same was demonstrated when, on April 5, Marketsmith India changed the market status from a Rally Attempt to a Confirmed Uptrend as the NIFTY 50 gained 1.9% on the day with higher volume than the previous day. This was the beginning of a strong rally and the NIFTY 50 gained 14% in the next five months.

Chart 2-Follow though day

Look out for leading stock breakouts,  they tend to give maximum returns through the rally. Britannia, Nestle Indian, Abbot, VIP industries and Mindtree were some of the stocks which showed early breakouts at the time of April 5, 2018, follow-through day.

Related: Tricks to Identify Stock Market Bottoms – MarketSmith India Webinar 16th October 2018

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