During stock market corrections, it can be easy to make the mistake of tuning out the daily market action. After all, the stock market isn't going up, so what's the worst that could happen? Well, you could miss some of the next uptrend's biggest winners.
Recent history is indicative of how fast the stock market trend can change, which underscores the importance of being prepared.
Four days after the Nasdaq undercut its May 12 low — which sent IBD's stock market outlook into "market in correction" — the Nasdaq staged a bullish follow-through day on May 26 with a 2.7% gain in higher volume. This means our market outlook went to a confirmed uptrend, ending the market correction. Now, it's time to put that preserved capital to work.
How To Prepare For A Stock Market Rally: The Follow-Through
First, let's explain how we get to a confirmed uptrend. When the market is in a correction, look for at least one major index to attempt a bottom. The first day the index closes higher counts as Day 1 of its attempted rally. The action on Day 2 and Day 3 is irrelevant as long as the index doesn't undercut its latest low. If it is undercut, the rally try is done and the market needs to try again.
On Day 4 and later, you are looking for the Nasdaq or S&P 500 to rise sharply in higher volume than the previous session. That's a follow-through day. It gives investors the green light to start buying leading stocks breaking out past correct buy points. It should put your portfolio and mindset in sync with the stock market action by gradually committing capital to leading stocks.
Use each purchase as feedback on the current strength of the market rally. Don't panic if you miss the first couple of breakouts. If the stock market uptrend is real, there will be plenty of time to buy stocks and make money. This is an important strategy because previous follow-through days have failed this year. While no rally has ever begun without one, not every follow-through succeeds.
Be sure to check out IBD's Bear Market Guide on how to handle a stock market correction
How To Find Leaders During A Stock Market Correction
As it turns out, you can find many of the next uptrend's leaders while the market is still correcting or in the early stages of a new uptrend.
One way to do this is by using the relative strength line. The RS line measures a stock's price performance vs. the S&P 500. If the stock is outperforming the broader market, the RS line angles upward. If a stock is performing worse than the broad market, the line will point lower.
The RS line is in all IBD and MarketSmith charts. In addition, the IBD Stock Screener includes a list of top-rated stocks with relative strength lines at new highs.
MarketSmith also has the "RS Blue Line Dot" list, which screens for RS lines at new highs. Other useful MarketSmith lists to use when a follow-through happens are "Breaking Out Today" and "Near Pivot." The latter shows stocks nearing buy points in bases, and the other flags stocks rising past buy points. But investors need to check that volume is strong and that breakouts don't fade — two common problems lately.
Keep an eye on Stock Market Today columns and The Big Picture. Both will highlight stocks in new buy zones. Also, check the IBD Stock Lists.
Callon Petroleum, Eli Lilly, Ulta Beauty, World Wrestling Entertainment and Zim Integrated Shipping boast RS lines at or near new highs as the market starts a new confirmed uptrend.
Stocks To Watch: Callon, Eli Lilly, Ulta, WWE, Zim
Wednesday's IBD 50 Stocks To Watch pick, Callon Petroleum, is moving rapidly up the right side of a new cup base that has a 66.58 buy point, as U.S. oil prices trade at their highest levels since March.
The RS line is already making new highs ahead of a potential breakout, a good sign. The stock was also featured in the most recent Stocks Near A Buy Zone column.
IBD Leaderboard stock Eli Lilly is back below a flat base's 314.10 buy point after a breakout attempt. Its RS line hit a new high on the breakout day.
Ulta is building a V-shaped cup base with a 438.73 buy point in the wake of the company's strong first-quarter results on May 26. At this point, the stock should settle down for at least a week to form a handle. In the meantime, the RS line is pulling back after hitting a new high at the end of May.
Recent IPO Leader Zim Integrated Shipping is tracing a cup base that has a 79.05 buy point, according to IBD MarketSmith chart analysis.
Be sure to follow Scott Lehtonen on Twitter at @IBD_SLehtonen for more on growth stocks and stock market news.
