U, W, L, or V-shaped Recovery?
Recession shapes are often used by economists to define the different type of economic recessions. This specific terminology is an easy way or an informal way for economists to quickly describe the type of recessions and their recoveries. The four most popular used terms are U-shaped, W-shaped, L-shaped, and V-shaped. The shapes basically convey the length and magnitude of the recoveries. V-shaped tends to be the shortest and steepest of the shapes. L-shaped is the most severe of the four scenarios.
Technicians also have similar definitions to describe a major market decline and the ensuing recovery and rally. We use almost the same identical terminology to describe a stock market decline and the subsequent recovery/rally.
So, the question then becomes is the recent severe correction of 15%-16.5% setting the stage for a major bottom and a sustainable recovery/rally? And if so, what type of recovery? Will it be a U, W, L, or V-type recovery?
To confirm a major bottom and the start of a sustainable recovery/rally it depends on several important technical factors including improving market internals such as expanding market breadth, emergence of market/sector/stock leadership, technical base, improving investment sentiments, contracting implied volatility, expanding volume, and most important price performance.
Enclosed below are three key U.S. stock indexes (S&P 500 Index – SPX, Dow Jones Industrial Average – INDU, and NASDAQ Composite Index – COMPQ). We will focus exclusively on one of the most important factors for confirming a major market bottom and the sustainable of the recovery/rally – namely, price performance.
To solidify a major bottom the market in question will need to surpass key technical resistance zones. These resistances often coincide with major retracements (38.2% and 61.8%), moving averages (50-day and 200-day), significant gap downs, important trendlines, previous major technical breakdown levels, pivotal reaction lows/highs, and various technical patterns (pivotal right/left shoulders, necklines, heads etc.).
The general rule is the more convergences of these technical factors along the same level the stronger and the more significant these resistance levels become on rallies. Although there may be numerous overhead resistances the ability of the market to surpass a prior major breakdown often defined by the extension of a major trendline, a 61.8% retracement level, and the crucial 50-day or 200-day ma will often lead to the resumption of the primary and dominant trend.