What happens after a sell off

Market go up, correct, go up. So this sell off is good. As the rally progresses fresh long side opportunities become rarer or more risky. A sell off like this washes out some of the excesses. New sectors , new stock emerge post sell off. More than that most of the time intense sell off phases involve a cluster of down days where most of the damage happens, after which again long strategies work.
So I am excited by this sell off. All the strategies I follow work best when there has been a correction in market. When earning expectation is low , earnings lead breakout work best. So by middle of this quarter again the earning expectations for next quarter will become the market theme for some stock and pre earning drift and post earning drift strategies will work.
On momentum side also sell offs are good. While long term momentum or relative strength is good, short term relative strength is not. That is one of the reason for the CANSLIM approach to insist on buying breakout post corrections (Cup and handle, double bottom, flat bases). So you must find a stock with high yearly relative strength but short term that is 60 to 30 days relative strength being low, plus it is within a certain percent of its yearly high (you can do this mathematically as against following chart patterns). Those kinds of set ups you will find only after a market correction. The top 2% momentum scans also will show lot of those kinds of plays later in correction.
The really strong stock with potential to go up a lot, just hang in to the top of their range (usually within 25% of top of range). They are the real resilient ones which just dart out once the intense selling phase is over. So corrections are good as long as you are ready to capitalise on the post correction action.

Note:
This is also one of the reason the 65 day number of stock up/down 25% or more indicator works well. It indicates extreme momentum at levels below 200 and those levels are as a rule not sustainable.

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2 comments:

Larry said...: Thanks again for an informative post. I'm wondering what a momentum scan is? Just guessing, I'd say it's volume times the price change. Is this right?

Thanks again!; Jan 22, 2007, 4:57:00 PM
Pradeep Bonde said...: Momentum is function of price change.
A IBD kind momentum or Relative strength scan is something like this in TC2007
0.4 * (C * 100 / C65) + 0.2 * (C * 100 / C130) + 0.2 * (C * 100 / C195) + 0.2 * (C * 100 / C260)
Where it is a weighted average of 1 year, nine month, six month and three month price change. There are many ways of calculating momentum , many of them probably better than IBD approach. The objective essntially is to rank stocks and pick the top 2 decile or 1 decile for long entries because they are the one with momentum.
In simple language find car moving at 100 miles per hour rather than 25 miles per hour and enter with tight stop. For a given time frame that allows you to maximise opportunity as you are in the fastest moving stocks.; Jan 22, 2007, 6:03:00 PM

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