In the stock market, nothing works 100% of the time. That’s why you have to prepare to deal with failed signals. In CAN SLIM, the market itself – the M in CAN SLIM – is the most important factor for making money. Your chances of grabbing profits in growth stocks increase when the market is acting right.
According to William O’Neil methodology, every major stock market bottom featured a follow-through day. It essentially confirms that a fledgling uptrend in stocks is underway.
After a significant decline in major indices such as the Nifty and the Sensex (think 10% or more), the follow-through marks a significant gain that typically takes place on the fourth day or later of a new rally attempt. The gain usually must be a minimum 1.5% but it can be as high as 3–4% or more. Without exception, the follow-through must also feature higher total volume versus the prior session.
All follow-throughs don’t always result in lasting market uptrend. So, it is important for investor to reduce the risk of capital loss if market fails to rally.
How the “Pyramiding” Buying Strategy Reduces Portfolio Risk
One thing investors can do to reduce risk is avoid buying stocks anew with reckless abandon when a follow-through occurs. Use the pyramid method to enter your trades. That way, you test the water and put more money to work only if the trades go in your favor.
Pyramiding involves buying in installments instead of all at once. You buy a first piece with half of your allocated capital toward a single stock. If the stock moves up 2–3% from your initial purchase price, make a second buy with 30% of your allotted funds. If the stock goes up 4–5% from the proper entry point, use your remaining allocated capital to make a final buy.
Example: The chart is of Dr. Reddy’s Lab. It has a strong fundamental and growth story. The breakout (1) from a flat base was on above average volume. If an investor wants to invest INR 5,00,000 in the stock, then start by 50% (INR 2,50,000) on the day it breaks out. You can see that the stock went down post the breakout and a sell signal (2) was there as it breached 21-DMA. Had investor invested, INR 5,00,000, the loss would be INR 25,000 (~5%). But, with Pyramiding, the loss would only be INR 12,500 as the initially investment would only be INR 2,50,000.
One Red Flag That A Follow-Through May Fail
Follow-through signals are more likely to fail if distribution days occur in the first few days of a new uptrend. This is one key red flag. A distribution day, which points to institutional selling, involves a drop of 0.2% or more in the Nifty on higher volume than previous trading session.
Generally, a distribution day within a few days of a follow-through leads to a failed rally. The risk drops off sharply after the fifth day.
A second red flag
In the early stages of a new uptrend, strong action among leading stocks is crucial. Top-rated stocks should be breaking out of bases in big volume. Strong breakouts signal that professional investors are stepping back in to buy stocks.
Related: Should you Average it Up or Average it Down?
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