The traits of lesson 1 tell you which stocks to buy. This lesson is about whether to buy at all. Most stocks follow the general market: O'Neil estimated that about three in four move with it, and in a broad decline even the best growth stocks usually fall, often further than the index. Growth traders therefore check the market first, every day, and adjust how much they own before they think about what to own.
Reading the market's trend
Use the major indexes: the S&P 500 for the broad market and the Nasdaq Composite, where growth stocks carry more weight. Three readings set the trend:
- Structure. Higher highs and higher lows mark an uptrend; lower highs and lower lows a downtrend.
- Moving averages. An index above a rising 50-day average is in a healthy intermediate trend; a close below a falling 200-day average marks a long-term downtrend. See moving averages.
- Volume. Volume on index ETFs or total exchange volume shows whether large investors are buying or selling.
Two volume patterns are especially useful. The first is a cluster of heavy-volume down days, often called distribution days: sessions where the index falls meaningfully, a common threshold is 0.2% or more, on higher volume than the session before. One such day means little. Four to six of them within about five weeks, especially while the index stalls near its high, show that large investors are selling into strength, and corrections often follow.
The second marks the end of a correction. After the index makes a low, it begins a rally attempt. Growth traders look for a confirmation day, usually from about the fourth day of the attempt: a strong gain, commonly 1.5% or more, on higher volume than the session before. Confirmation does not guarantee a new advance, and some fail within days, but major advances have generally begun with one. Until it appears, buying breakouts carries a much higher failure rate.
Breadth: how many stocks take part
An index can rise on a handful of large stocks while most stocks fall. Breadth measures participation: the number of advancing against declining stocks, the share of stocks above their 50-day and 200-day averages, and new 52-week highs against new lows. A healthy advance shows broad participation. When the index makes a new high while fewer stocks are above their 50-day averages and fewer make new highs, the advance is narrowing, and narrowing advances are more fragile. The Learn article on market breadth explains each measure.
Leaders as a market indicator
Leading stocks often turn before the index. Late in an advance, former leaders begin to break down on heavy volume, gap down on good earnings or fail in their breakouts, while the index still holds up on other stocks. When several leaders fail at once, the market's advance is usually in its later stages. In a correction the reverse holds: stocks whose RS lines make new highs while the index falls are the leaders of the next advance in waiting (lesson 2). A watchlist that fills with such stocks during a correction is itself a sign that the decline is maturing.
Sector and group rotation
Leadership in a bull market is usually concentrated in a few industry groups, and it rotates. Rank groups and sectors by relative strength over one, three and six months, and focus on the top of the list. A strong group gives a stock a tailwind: funds buying a theme spread their money across its best names, and a breakout in a leading group is more likely to follow through. Groups that lead for many months tend to stay strong until the theme behind them changes, while one-week jumps often reverse. See sector rotation for how rates, the business cycle and earnings revisions move money between sectors.
Why most leaders fall with the market
When the market turns down, funds face redemptions and reduce risk. They sell what they can sell easily and at a profit, which often means their best performers. Growth stocks also carry high valuations that depend on distant earnings, so they react strongly to rising interest rates; that is a large part of why many fell 50% or more in 2022 while the Nasdaq Composite lost about a third. And their prices swing more than the market's, so the same decline hits them harder. Leaders that hold up best in a correction, with RS lines at or near their highs, are the exception worth watching, not a reason to keep buying.
How to apply it
Match your exposure to the market's state. A simple scheme:
| Market state | What you see | What to do |
|---|---|---|
| Confirmed uptrend | Index above a rising 50-day average, broad participation, leaders breaking out | Buy at proper buy points; build toward full exposure |
| Uptrend under pressure | Heavy-volume down days clustering, breadth narrowing, leaders failing | Stop new buys except the very best; tighten stops; take some profits |
| Correction | Index below its 50-day average, lower highs and lows | Mostly cash; keep the watchlist and note RS new highs |
| Rally attempt confirmed | A strong up day on rising volume after a low | Start with small positions; add only if they work |
- Entry: take new buys only in a confirmed uptrend, and prefer stocks in the top-ranked groups.
- Stop: your stocks' stops do not change with the market, but in an uptrend under pressure, tighten them or reduce size.
- Target: exposure, not price, is the target: let the market's state set how much of the account is invested.
- Invalidation: a confirmed uptrend fails when the index undercuts the low of the rally attempt; return to cash and wait for a new confirmation.
Common mistakes
- Buying breakouts in a correction. Most fail, however good the stock.
- Predicting the bottom. Waiting for confirmation costs a few percent; guessing early can cost much more.
- Watching only the S&P 500. The Nasdaq and breadth often weaken first for growth stocks.
- Confusing a sector's one-week jump with leadership. Look for groups that lead over months.
- Staying fully invested because the economy looks fine. Markets often turn months before economic data do.
In Clear Tape
The Today page shows the sector heatmap on the Free plan: for the S&P 500 or the Nasdaq-100, each block is a stock sized by market value and colored by the day's change, grouped by sector. The fear and greed score is also free. Tools and Pro add the Market breadth card, built from the most liquid US stocks in Clear Tape's screener after each close: the number of stocks advancing and declining, the share above their 50-day and 200-day averages, the number at 52-week highs, and the average change by sector. Tools and Pro also include the morning brief. Pro adds the sector map, posted before every open, from which the brief names the leading sector, and the daily pre-market analysis.
Note that the preset trading systems do not check the market for you. The Volume Base Breakout preset, for example, leaves out the optional rule that SPY must be above its own 50-day average. Apply the market check yourself before acting on any signal. See pricing for what each plan includes.
Summary
Read the market before the stock. An index above a rising 50-day average with broad participation and leaders breaking out is the environment where growth stocks pay; clusters of heavy-volume selling, narrowing breadth and failing leaders call for caution; a correction calls for cash and patience until a strong, high-volume up day confirms a new uptrend. Within a healthy market, look for leaders in the strongest groups.
For educational purposes only. Not investment advice.