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When Follow-Through Occurs, Don't Rush Into Stocks Blindly

Just because it stops raining or snowing doesn't mean motorists should drive at full speed. Road surfaces can still be treacherous, so it's smart to maintain a moderate speed. Before this turns into a driving class, let's apply this safety concept to the stock market. In this case, the storm represents a market correction, and the drivers are investors anxious to load up on stocks when the skies clear — or when a follow-through has occurred, there's been a follow-through rally confirmation.

The follow-through is the most reliable bottoming signal in the market, but do not take it as a license to become immediately fully invested in stocks. View the follow-through as a green light to step back into the market in careful, deliberate steps.

One reason for this cautious approach is that while follow-throughs have marked every significant market bottom, not all follow-throughs result in lasting rallies. The follow-throughs of Aug. 23, 2011 and June 15, 2012 went nowhere, and anyone buying stocks on those stillborn follow-throughs faced a market in which sellers remained pervasive.

So, next time you've spotted a follow-through or read about it in The Big Picture, plan on entering the market and raising your exposure a little at a time. Buy one or two stocks that break out, then see how they act. If you're making money, it's a signal to step a little more on the gas pedal.

You can also control your exposure to individual stocks by "pyramiding." That's when you buy half your target full position at the , then buy 30% of the position once the stock is up 2%-3% from the buy point. You make your last purchase — 20% of the position — when the stock is 4%-5% above the entry level.

This is how this scenario could have played itself out this year: MercadoLibre (MELI), the Latin American e-commerce firm, broke out of a at 90.64 on March 6, just one day after the market made a follow-through. (See a daily chart.) Let's assume you have a $50,000 portfolio and you're partitioning $10,000 of that into the stock.

A 100% commitment would mean buying 110 shares at 90.64 each. So, on the , you buy 55 shares, for nearly $5,000. Two days later, it rose nearly 3% above the entry, meaning you would have bought 33 shares at 93.06. The next session, MercadoLibre had climbed 5% above the buy point, leaving a final purchase of 22 shares at 95.17.