Follow-Through Day Signals Rally, Plus 3 Darvas Stocks to Watch

by Darrin Donnelly on September 1, 2010

Click on chart to enlarge.

Click on chart to enlarge.

The market roared to an impressive follow-through session on Wednesday, signaling the potential start of a new rally. 

A “follow-through” day is the term coined by Investors Business Daily founder (and Nicolas Darvas admirer) William O’Neil.  It occurs when one of the major indexes roars to life, typically between the fourth and seventh day of a market rally attempt.  “Roars to life” refers to an exceptional gain of 2% or more on volume greater than the previous session.

Wednesday marked a clear follow-through day for the NASDAQ as it climbed 3% on increased volume on the fourth day of a rally attempt.  (See the chart that accompanies this article.)

O’Neil’s extensive studies have shown that a follow-through day often signals the start of a new market uptrend. 

However, a follow-through day doesn’t ALWAYS ensure the start of a new rally.  Follow-through days can and do fail.

Dr. Chris Kacher, a former trader for O’Neil’s company and (surprise, surprise) a big fan of Nicolas Darvas’ teachings, has taken the study of follow-through days and their success rate to a whole new level.  His results show that follow-throughs are extremely effective in marking the start of a new uptrend, but they needed to be acted upon with caution for best results.

In particular, Kacher has found that follow-through signals should be NEGATED if the index reverses and falls below the low established on a follow-through day.  Or, in the case of a gap-up (like we saw on Wednesday), the follow-through should be negated if the index falls below the closing price from the day before the follow-through.

This means that if the NASDAQ turns around and falls below the 2114 mark (see the blue line and red arrow on the accompanying chart), then we should disregard the follow-through day and go back to bear mode.

There will be good reasons to test the strength of Wednesday’s follow-through as we close out this week.

First off, the S&P 500 and the Dow Jones Industrial Average both closed Wednesday right around their 50-day moving average lines.  This line can often be a point of resistance that bats the market down and causes it to reverse lower.

From a fundamental viewpoint, the new Employment Report will be released on Friday and this jobs number has a tendency to swing the market wildly. 

Typically, the end of a week before a three-day holiday is fairly quiet, but we’re not exactly in a typical market environment.

In short, pay close attention to how we close this week out.  A strong finish means a strong rally is likely upon us.

3 Stocks to Watch

Don’t be afraid to EASE into new positions right now, but be ready to bail if the market reverses on us.

I’m watching three Darvas stocks in particular: NFLX, BIDU, and PCLN.

I actually initiated a very small position in NFLX on Wednesday.  It’s still within a Darvas Box, but I wanted to establish a lower cost basis if this stock breaks out like I think it might.

BIDU is our good buddy that we just recently closed out, but it’s still holding strong and should be considered a market leader to watch closely.

PCLN is another big earner currently racing towards new highs. 

Market leaders like these are excellent indicators for the direction of the market.  But beyond simply being indicators, I think they should be on your watchlist right now for potential buys on breakouts. 

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