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You can get everything else in the CAN SLIM formula right, but if you get this wrong, you will likely fail.

That’s how important it is to be able to assess the general market direction.

You absolutely must know how to determine if you’re in a bull or bear market.

The general market refers to the most commonly used market indexes. They include the S&P 500, Nasdaq, Dow Jones (DJIA) and the NYSE.

The best way to determine the overall market direction is to check several of these major market averages.

Look at their price and volume changes on a daily basis so you will spot market tops and bottoms early.

In a bear market, stocks will normally open strong and close weak. The opposite is true in bull markets.

Listening to analysts and other influencers is not advised. Make your own decisions.

You need to understand the flow of a normal business cycle, paying special attention to recent cycles.

It usually takes a few pullbacks before a bull or bear market will end.

Additionally, some sectors lag behind. Capital goods industries such as railroad equipment and machinery are usually late to turn.

If you have a 33% loss, you need a 50% to break even.

This is why you must always preserve any profits made during a bull market and cash out before the bear market takes it all.

When you notice a major reversal from a bull market to a bear market, put at least 25% of your portfolio into cash as fast as possible.

Stay out of the market until the bulls take over again. This is often 6 months or more.

If you use stop loss orders but need to sell earlier, ensure you cancel the stop-loss so you don’t accidentally sell stocks you no longer own!

When a market tops out it will come under distribution while it’s advancing.

When checking the major indexes, there will come a day where, during the uptrend, volume will increase from the day before but the index price will not rise as much as expected for that amount of volume.

The market will probably close down and the spread may be a little wider than normal.

Normal liquidation near the peak will usually happen on several specific days over a month or so.

After a market top out, there will usually be several rallies.

You can spot the initial feeble bounce back if the index price increases on the third, fourth, or fifth rally day, but on volume that is lower than the prior day.

Other signs include when the index makes little positive progress compared to the day before and if the market recovers less than half of the initial drop.

After the first rally failure, it is a good sign to sell more.

Besides looking at the daily averages, check out the leading stocks.

If they start acting strange after several years of a market advance, take heed.

Look for faulty bases, characterized by being wide, loose, and erratic.

Another sign is a ‘climax top,’ where a stock will advance more rapidly for several weeks after having advanced for many months.

When the market leaders start to show signs of decline and the laggards start to rally, it means the bull market will soon end.

A typical bear market has three stages of decline. Between each decline is a rally which many will start to buy into.

Wait these out until the real bull market begins.

A rally attempt starts when a major market average closes higher after a decline in the previous session. Wait until the fourth day to see if the rally continues. You want to see increased volume, which will likely happen before the seventh day of the rally.

The price may then drop, but that doesn’t necessarily mean the rally has failed. These pull-backs at the market bottom are common, testing the support level.

The market bottom is not a signal to go all in. Any stock you buy must still meet all of the CAN SLIM criteria.

Apart from what has been covered so far, there are additional things to look for which can help confirm market tops and bottoms.

These are secondary indicators. Use them as confirmation.

One way is to look for divergence of key indicators. Check several averages to see if they are diverging, i.e., moving in different directions or one is moving much faster than another.

You can also look at options traders movements. If the volume of call options is greater than the volume of put options, it means option speculators as a group are bullish.

Yet another group to look at is the overall opinion of investment advisors.

The short-interest ratio reflects how bearish speculators in the market are.

Interest rates are very telling of the basic economic conditions. In particular, keep an eye on changes in the Federal Reserve Board’s discount rate and the fed funds rate. Historically, three successive significant hikes in the Fed interest rates have marked the beginning of bear markets.

Conversely, the lowering of the fed rate often ends bear markets.

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