The Dow Theory says that stocks move in trends. These trends resemble waves, or steps: an advance, a consolidation or a pullback, another advance. A downward trend is defined as a series of lower highs and lower lows; an upward trend is defined as a series of higher highs and higher lows. At some point in a downtrend, the market will fail to make a new lower low and instead turn up and make a high that is higher than the immediately preceding lower high. This will indicate a primary change of direction from down to up.
IBD/William O'Neil
One of the best systems for determining market direction was developed by Investor's Business Daily founder and legendary investor William O'Neill. At some point a declining market attempts to rally off its most recent low on huge volume, which is called "day one of a rally attempt." If this attempt is followed by another strong move up within threeto 10 days, it serves as confirmation of a new rally, called a "follow through day." Not every rally attempt results in a new rally, and rally attempts sometimes do fail, but no market rally has ever started without a rally attempt and a follow through day.
Secondary Indicators
The market is comprised of individual stocks. Every new bull market is led by a new crop of leaders. A new uptrend starts when these leaders start breaking out of sound bases in high volume. It takes study and practice to understand bases and breakouts. Stock action that seems insignificant to the untrained eye may be very important for pinpointing new uptrends early. A secondary indicator that is easy to use is a list of stocks making new 52-week highs and lows. Most stocks decline in a down market, so the list of new 52-week lows tends to grow longer while the list of new 52-week highs shrinks. When the market turns up, the number of new 52-week highs begins to increase while the number of new 52-week lows shrinks, indicating that more stocks are turning up.
Contrarian Indicators
It's always darkest before the dawn. A sure sign of an impending change of direction is the height of doom and gloom. When the mainstream media and most financial advisers and professionals turn negative on the market, the market is about to make a comeback. This indicator is approximate and can serve as an early warning but should not be used as a timing signal.
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