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The Anatomy of a Correction

After a down day Wednesday, let’s look at how corrections can often play out – with a slow start and then, suddenly, turn real fast.

The Market

Finally a down day. In fact, we’ve had two red days in a row, something that hasn’t happened since early October near the low. So that’s a change.

Before we get to the statistics and indicators, I want to talk about the anatomy of a correction. Not all corrections happen the same way. But most start off slowly, and then all of a sudden they get fast.

Just take a look at the chart of the S&P 500 from this year. Even tiny corrections like we saw late February into March had about a week of sideways, then a down day that came back most of the way, allowing complacency to continue. That was followed by a day of flat to up. And then we got the two-to-three day rug-pull.

Look too at mid-March. It’s not exactly the same, but there’s the reversal followed by a down day that looks like it tried, but couldn’t, go down. Then we saw a big rally back to the high and a one-to-two day rug-pull before milling around at the bottom and rallying again.

In late April it was a week of sideways to grinding up, a day and a half on the downside. Then we saw a nice rally day and then a rug-pull -- only this one lasted the entire month.

July and September were really no different, were they? It is rare to see a massive reversal off a high that doesn’t attempt to rally again. I mean, how else is complacency supposed to build up if you go down that fast? The dip buyers have to feel good, don’t they?

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Notice that with the exception of August, the lows tend to be one-day affairs. It is human nature to want to buy, but not sell. That is why we often see lows that appear to be V bottoms, but highs tend to be more rolling in nature. (I will discuss V bottoms at a later time.)

So was Wednesday “enough” on the downside? My indicators say not so fast.

Breadth wasn’t bad. That is the first sign that we have seen since Nov. 1 that breadth has outperformed the S&P. Notch that up to “better.” It hasn’t helped the McClellan Summation Index, which needs a net differential of positive 1,500 advancers minus decliners to halt the current decline. Remember positive 2,000 and this has stepped a toe into oversold territory. That tells me there is likely some more downside before this correction is over.

Another minor positive is that the number of stocks making new lows – while still too high -- for the first time in a week did not expand beyond the day before. And we were down Wednesday, so at least in some names the selling finally dried up. That is how corrections find their way to being over.

The Volatility Index may have closed red and I cannot explain why it did so -- but the arrows on the chart below show different patterns for the VIX in all those instances. So, I would say unless the VIX breaks under 12 – which is not my view -- it’s all part of the same pattern. Let’s say the S&P rallies Thursday and the VIX sits here, unable to fall much further. To me that is all part of the correction process.

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All in all, I think Wednesday was constructive in that some complacency was wrung out and the selling dried up in some stocks. But I don’t think we’re quite done yet.

New Ideas

I filled my tank with gas Wednesday and I paid $1.98 a gallon for premium. That has to be some sort of extreme, don’t you think? I do wish the DSI for oil was lower (it’s currently 57), but perhaps some of the names are oversold enough to rally. The VanEck Vectors Oil Services exchange-traded fund (OIH) - Get Free Report for oil service stocks bounced right off a short-term uptrend line. Since I have been asked about this often I thought I would note that on a risk-reward basis, at least you know where you’re wrong now.

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I had a request to review the chart of Beyond Meat (BYND:Nasdaq) which has been awful and probably has some more tax loss-selling to come as the year winds down. But, yes, in the near term it has a small double bottom and again, your stop is very close if you want to play for a short-term rally. You might have to wait until next week for a rally, when we get a bit more oversold.

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Today’s Indicator

The Volume Indicator is overbought at 55%.

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Q&A/Reader’s Feedback

Helene welcomes your questions about Top Stocks and her charting strategy and techniques. Please send an email directly to Helene with your questions. However, please remember that TheStreet.com Top Stocks is not intended to provide personalized investment advice. Email Helene here.

Range Resources (RRC) - Get Free Report finds itself mere pennies away from making a new low. My view on stocks that have come down so far and reach prior lows is that they rarely break on the first trip down to those lows. The question is what kind of bounce do you get off the low? If the bounce is crummy, then the likelihood of breaking those lows goes up not down.

So what’s a crummy bounce? In this case I’d say something that can’t get up and over $4. Or worse, something that can hardly rally and instead digests the recent decline by going sideways.

The best scenario would be a plunge under the recent lows that then quickly recaptures the low. In other words, the next week or so should tell us a lot about this current retest of the low and how it should trade going forward.

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AT&T (T) - Get Free Report has had a terrific run and has given up a lot in recent days. I think there is decent support in the $35-$36 area, so I would expect a bounce from there, but I think if you’re bottom fishing in one of the phone stocks for yield, then for the time being I’m still interested in Verizon (VZ) - Get Free Report in that $58-$59 area.

Verizon (VZ) - Get Free Report needs to get up and over $60 to make me feel better, but it has done an admirable job of digesting the gains with the current pullback.

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