A follow-through day is a day of improved stock market performance after trading activity begins counteracting a slump. While it may not be a sure sign of sustained improvement, understanding a follow-through day and the market conditions surrounding it can help you know when it’s a good time to increase your trading activity. Working with a financial advisor can alleviate any concern around making these decisions as they will monitor your investments and make necessary recommendations or changes for you.
Stock Market Cycles
In its over 200-year history, the American stock market has risen and fallen dozens of times. These cycles are characterized by high trade volume and healthy gains while the market goes up and low trading and losses during market downturns.
Stock market cycles are neither entirely predictable nor are they arbitrary and random. However, numerous metrics and data sets help investors predict what will happen next in the market. One of those is a follow-through day.
What Is a Follow-Through Day for Investing?
A follow-through day is Day Four or later of a bear market rally and is defined by a gain of at least 1.25% with a larger trading volume than the previous day. Although a follow-through day signifies a recovering stock market, the market can drop again. However, no bear market in history has turned bullish without a follow-through day.
After a new low, when a major stock index closes at a higher price than the day before, it means the market is attempting to rally. Of course, it’s impossible to be sure if the rally will be successful, but a follow-through day can help indicate if the rally will turn into a sustained upsurge in the stock market.
For the rally to continue after the first day, the next two days cannot experience stock prices that drop beneath Day One. As long as stock prices remain above this benchmark, the rally is live. On the fourth day or later, a follow-through day will show itself through a significant gain in price and volume in one of the major stock indexes, such as the S&P 500 or Nasdaq Composite. If a follow-through day occurs, it’s a sign that the market may turn bullish for the long term.
Often, by the time news media and market reports indicate the end of a rough period in the market, it’s too late for the average investor to profit from rising stock prices. Watching for a follow-through day can help investors identify when the market bottoms out and start investing early in a recovering market.
Follow-Through Day Example
The global financial crisis of 2007 did not experience a more permanent upturn without a follow-through day occurring first. In the worst part of the crisis, investors experienced severe losses. The S&P 500 stock price dropped by over 50% and did not make a recovery until spring 2009.
Then, on March 7, 2009, the S&P 500 traded higher than recent lows. The trend continued until March 12, which became a follow-through day with the S&P 500 trading 4.1% more volume than the preceding day. After this increase, a bull market commenced, leading to soaring stock prices lasting over a decade.
Spotting a Market Bottom
Spotting a market bottom is crucial to know when to buy stocks again. So, instead of – or in addition to – listening to television pundits, look at the numbers. The major stock indexes provide information that gives you key insight into stock market cycles. A few days into a rally, it’s impossible to tell if the new upward trend will stick or fizzle out. However, looking at daily market averages can help you track the actual change in the market. Whether prices increase on average per day is a better indicator than trader sentiment or one specific company’s stock rising in price.
A successful follow-through day can signify the end of a market bottom, after which it generally becomes profitable to resume investing. Usually, a follow-through that induces a successful turnaround happens between days four and seven of a rally.
Cues for a Market Turn
While the idea of “timing the market” may have some traction in the mainstream, the stock market tends to reward educated guesses over certainty. Among the most common ways that traders assess whether the market has hit a firm bottom are technical indicators. Here are a few indicators that help investors know when a bull market is poised to emerge:
- Fear and greed index – This metric is a helpful indicator of whether the market as a whole is overvalued or undervalued. If it’s undervalued it may be set for a rebound.
- Moving averages – When an index’s 50-day moving average crosses above its 200-average it is a bullish indicator; when it falls below its 200-day average it is a bearish indicator. Moving averages come in two types, simple and exponential.
- Relative strength indicator – It measures the speed and magnitude of an asset’s recent price changes. A relative strength indicator, a momentum indicator, helps traders identify assets that are potentially overbought – meaning they are trading above their true value – or oversold, meaning they are trading below their true value.
- Bollinger bands – This tool analyzes a stock’s volatility by comparing its daily price against its simple moving average. Investors create a chart with the stock’s price data. Then they overlay its simple moving average. They use the price and the average to calculate the Bollinger bands, which in turn they overlay on the chart. With the moving average they can see how a stock’s price has been trending over time. With the Bollinger Bands they can predict whether that trend is likely to change in the near future based on recent trading patterns.
- Interest rates – These usually have an inverse relationship with the stock market. In other words, when the Federal Reserve lowers interest rates by cutting the federal funds rate, equities have a better chance of rising.
The Bottom Line
Follow-through day is a day of significant trade volume and stock price increase after at least three days of stock prices not dipping below recent lows. It can signify to investors that a bear market is fading, and it may be a good time to resume buying. However, a follow-through day is not an ironclad guarantee that a bull market is coming. Sometimes, rallies fail, and the market flails even more. However, no bear market has turned without a successful follow-through day.
Tips for Investing
- If you’re having trouble making sense of the stock market, you can get help investing from an experienced financial advisor. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Now that you’ve gotten an understanding of follow-through day, let’s dive into the details. Here are five strategies for investing in a bear market.
©iStock.com/gorodenkoff, ©iStock.com/Zoran Zeremski, ©iStock.com/miniseries