Market Direction

Deeper Explanation

O'Neil called market direction the "M" in CAN SLIM and described it as the most important of all seven criteria. The reason is arithmetic: approximately three-quarters of all stocks move in the direction of the major market indices. In a bull market, even mediocre stocks tend to rise. In a bear market, even the best stocks tend to fall. No stock selection system consistently generates positive returns against a sustained market decline. O'Neil developed specific criteria for identifying market tops and bottoms. Distribution days — days when a major index falls 0.2% or more on higher volume than the prior day — signal institutional selling. When distribution days cluster (five or more in a four-to-five week period), the market is likely shifting from an uptrend to a downtrend. Follow-through days — sharp upward moves in a major index on heavy volume, occurring four or more days after a market low — signal the likely beginning of a new uptrend. The discipline of reducing exposure during bear markets is one of the most difficult skills in investing because it requires selling when you feel wrong (near market tops, sentiment is usually positive and the economic news still seems good) and buying when you feel wrong (near market bottoms, sentiment is usually terrible and the news is frightening). Watching market direction does not require macro forecasting or economic analysis. It requires simply observing what the indices are doing: Are they making new highs or new lows? Are up days accompanied by higher volume than down days? Is the market staging constructive base formations at major support levels, or breaking down through them? These are observable facts that do not require predictions about the future.