Not Sold on the Uptrend

 | Nov 28, 2012 | 7:45 AM EST
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In case you missed it, Investor's Business Daily called a new market uptrend after Friday's shortened session of trading that saw major averages follow through with solid percentage gains on the fifth day of a rally attempt. The call was surprising to me because of the market's light volume, but I decided to embrace it nonetheless.

Unfortunately, Tuesday's higher-volume decline by the S&P 500 already calls the nascent uptrend into question. After a follow-through day, it's generally not good to see a higher-volume decline in a one- to three-day window after the follow-through day. Market precedent says the nascent uptrend may not amount to much. Investors got spooked by comments late in the day by Senate Majority Leader Harry Reid, who said little progress was being made in the fiscal cliff talks.

In Monday's "Big Picture" column, IBD Chairman William J. O'Neil cited some factors supporting his conclusion that Friday's gains confirmed a new uptrend for the major averages. He noted that during the recent correction, "most of the indexes made three waves down and the last one was a little steeper." That resulted in the put/call volume ratio rising above 1.0 a week ago -- further evidence of a market bottom, according to O'Neil. The thinking behind "three waves down" is that a lot of sellers get shaken out of the market, making it easier for an uptrend to gain traction.

I bought two growth names last week and two more this week for my Ultimate Growth Stocks model portfolio. A buy signal from the market doesn't mean it's time to buy stocks with reckless abandon. It is, however, OK to nibble at some fundamentally and technically healthy stocks and see if they work. If you're sitting in a profitable position soon after buying, that's a good thing. It means the nascent market rally could have legs. If, however, new buys don't make progress or head lower, there's no reason to look for more stocks to buy. Why throw good money after bad?

Another ingredient of a sustained rally is new leadership. Names such as Apple (AAPL) and Facebook (FB) have bounced off their lows, but it's very questionable whether they will be able to provide sustained leadership. I tend to doubt it.

It's good to see institutional-quality stocks breaking out from bullish technical structures in the early stages of a new uptrend. There have been some, including India-based HDFC Bank (HDB) and eBay (EBAY), but not many. Small-cap Medifast (MED) broke out bullishly on Tuesday but with a market capitalization of $489 million and an average daily volume of 142,000, it's not what I consider a liquid, institutional-quality name.

The bottom line is that Friday's mild buy signal was good to see. The rally could still have legs, but Tuesday's bearish session means I'm in no hurry to add new names to the portfolio. I'll watch what I have for now and wait for the market to tell me if my timing was right or not. If Friday's follow-through day amounts to something, I own names I believe can outperform. If it doesn't, I'll move to capital protection mode.

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