How To Determine The Direction Of The Stock Market Today Using The IBD

In William O'Neil's book The Successful Investor, O'Neil explains how to determine the direction of the stock market using the IBD. The IBD is the Investor's Business Daily which he publishes. One of the major premises of his strategy is the "M" in CANSLIM which stands for market direction. He states that 3 out of 4 stocks in the market will follow the overall trend up or down. Therefore, it's crucial to invest only in times when the market is in an overall uptrend. I thought it was interesting then that the "M" is at the end of the acronym instead of that beginning because of it's importance. I guess that would have made it MANSLIC instead then which just doesn't sound right! Anyway, in The Successful Investor, he puts it as step one in the five steps he outlines to make money in the stock market.

I think for most of us, when we look at stock market investing, as it's reported in the media, hear that market might have went up or down. That information on it's own doesn't really provide the full picture of what is really going on. The reason is that on any given day, the stock market could have went down and we could be in the middle of a bull market. A bull market is one that is a market on the rise. It could have also went up and we might be in the middle of a bear market or a market on the decline.

So, if a given day we can't really tell the overall trend, what does he recommend. He recommends two things. One is looking at the market over a period of time and the other is looking at how much volume (the actually number of shares that traded) there was when on the day the market went up or down.

The first question he answers though is what is the market?

He actually refers to it as the "general market" and defines it as a collection of market indexes. They are the S&P 500, the Dow Jones Industrial Average, the New York Stock Exchange Composite and the NASDAQ Composite. A stock market index is a weighted measure of the price performance of a group of stocks that represent a certain category of stocks. As an example, the NASDAQ is a broad collection of stocks traded on the NASDAQ stock exchange. An index can be used to represent many sections of the stock market. The indexes he mentions though, represent a cross section of the market that he feels should be watched closely to determine whether you should be either in the market or sitting on the sidelines.

For each particular index, he says to focus on the price and volume action of the index each day and compare it to the previous day. The price and the volume can be either higher or lower than the previous day. Let's look at each scenario.

The index could be higher today on higher volume. This is good news for the market. A higher closing price on higher volume indicates that investors (or the big money as I like to call it) are accumulate shares.

The index could be higher today on lower volume. This isn't a sign of accumulation of shares of stock by the big institutional money. Therefore, while you are happy the market's priced closed higher, it's not a sign of demand for stock in the market. It could represent what's called stalling action of the market if it closes higher on lower volume.

The index could be lower today on higher volume. This is bad news for the market. A higher closing price on higher volume means that those big investors are selling more shares than they are buying which is causing the price to fall. This is what is called a distribution day. O'Neil keeps track of these days in the Big Picture column in the Market Pulse feature. Five to seven days of distribution within a few weeks will change the current market outlook or trend downward.

The index could be lower today on lower volume. The is neutral news for the market. While you'd like the market to go up every day, even the strongest markets will take a respite on the rise and so for the most part it doesn't represent either good or bad news really other than it was a down day in price.

Each day, you'll want to review the four indexes to see what the price and volume was for each day and I've started to keep track of it in a spreadsheet.

Inside the paper each day, there is a Current Outook in the Big Picture's Market Pulse. It will have one of the three following outlooks:

1. Market in a confirmed uptrend - this is the prime stock buying time
2. Uptrend under pressure - this is the time you would want to not buy and watch your portfolio for possible liquidation
3. Market in correction - this is the time you want to be on the sidelines

If the market is in a confirmed uptrend, each day you will want to watch carefully for distribution days that might change the current outlook. The same goes for the uptrend under pressure.

If the market is in a correction however, you will change your focus and start looking for accumulation days. The first such accumulation day when the market closes higher on higher volume is an attempted rally. Once the market is attempting to rally, you'll then be watching for the market to confirm the rally with what is called a follow through day. A follow though day is a day when the market closed higher on strong volume.

O'Neil is careful to say that not every confirmed follow through day will lead to a bull market but all have started that way. He suggests that it fails around 25% of the time if I remember right. In any case, many people are critical of his strategy because it isn't 100 percent correct but no strategy is and you'll want to remember carefully watch the market even if you jump back in once the rally is confirmed.

How To Use The IBD To Determine The Direction Of The Stock Market Today

Here's what I do to get a handle on the stock market's direction each and every day.

1. Go to investors.com and check out what the indexes did today. You can find them at the top of the home page. Blue means and increase and red means a decrease.
2. Decide for yourself what kind of day each index had -- accumulation or distribution day, attempted rally or follow through day or if today's action is neutral.
3. Watch the IBD TV Market Wrap video to confirm if you are correct in your analysis and if you were wrong, make a note to remember the reason your wrong in your analysis to get it right the next time.
4. Read the Big Picture column and check out the Market Pulse which gives you the day's action, current outlook and a distribution day count.
5. In the second section of the IBD, check the How's The Market page to look at each index again. Pay attention to the accumulation and distribution rating of each index as well as the 200 day moving average.
6. Once you start getting the hang of it, start keeping a spreadsheet to keep track of it as well.

So that's how I use the IBD to figure out how the stock market did today but more importantly what the overall market trend is. With practice, you'll find that you can do it as well (instead of relying on others who might want to manipulate our investing).