Sep 9, 20203 min read

Is the Correction Over?

Following the record highs established last week, key U.S. stock indexes posted one of the sharpest 3-day losses. The S&P 500 Index (SPX) declined 258.84 points or -7.21%. The blue-chip Dow Jones Industrial Average (INDU) dropped 1,734.45, or -5.94%. The broad-based Nasdaq Composite Index (COMPQ) plummeted 1,236.86, or -10.24%, and the Technology-laden Nasdaq 100 Index (NDX) plunged -1,384.32, or -11.13%.

Today, Wednesday, 9/9/20 U.S. stocks staged another strong rebound recovering part of the losses from the three-day market sell-off. SPX closed the day at 3,398.96, appreciating 67.12 points, or 2.01%. INDU gained 439.58 points or 1.60% to 27,940.47. COMPQ jumped 293.87 points, recording one of the largest gains since the end of April 2020, or 2.71% to finish the day at 11,141.56. NDX also jumped 327.59, or 2.96% to close the day at 11,395.85.

Although today’s rally is positive, it may be too early to say the correction is over.

Why?

The biggest gains were heavily concentrated within two S&P sectors, namely the Technology sector (XLK +3.26%) and Materials (XLB +2.58%). The remaining 9 S&P Sectors underperformed the SPX Index (+2.01%), at least from a relative perspective. This would imply the stocks that declined the most over the past three days also rebounded the most. A rally that lacks breadth often warns of a technical bounce.

Although some of the key indexes rebounded from their respective 50-day moving averages and maintained above prior breakouts there were no key reversal patterns (i.e., positive outside day, gap up, island reversal, etc) to reaffirm a selling climax or market capitulation.

The overbought/oversold technical indicators have contracted over the past three days, but they are not yet trading at oversold levels that often produced strong and lasting recoveries/rallies.

Based on the above it appears that today may have been the start of a technical oversold rally.

So, what is needed to confirm the end to a market correction and the resumption of the Mar 2020 rally?

Lacking key reversal patterns it is not uncommon to witness a period of consolidation lasting several days to weeks before the resumption of the next sustainable rally. A period of backing and filling process (technical base) is technically constructive as this helps to reset the market, and most importantly, to convince the buyers to return.

Technically speaking, most sustainable rallies often have several things in common. That is the indexes must surpass previous reaction highs (negate lower-high patterns) and surpass key Fibonacci retracements.

Typical technical rallies/recoveries often gravitate toward key initial resistances near the 38.2%-50 retracement of the decline. Pivotal secondary resistance is also available near the 61.8% retracement zone. The ability to surpass the above two key resistances can lead to a retest of the September intra-day highs.

Summarized below are the key short-term resistances for SPX, INDU, COMPQ, and NDX.

SPX (3,398.96)

Resistance 1 = 3,424.77-3,427.59 (9/9/20 intra-day high and the 38.2% retracement from 9/2/20-9/8/20 decline)

Resistance 2 = 3,455.13-3,458.13 (9/8/20 high and 50% retracement)

Resistance 3 = 3,479.15 (9/4/20 high and 61.8% retracement)

Resistance 4 = 3,588.11 (9/3/20 intra-day record high)

INDU (27,940.47)

Resistance 1 = 28,127.44-28,206.21 (9/9/20 intra-day high and the 38.2% retracement from 9/3/20-9/8/20 decline)

Resistance 2 = 28,332-28,350 (9/4/20 high and 50% retracement)

Resistance 3 = 28,537-28,540 (9/4/20 intra-day high and 61.8% retracement)

Resistance 4 = 29,199.35 (9/3/20 intra-day high)

COMPQ (11,141.56)