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Stocks

Market Crash or Correction?

Brandon Wendell
Instructor, CMT

Investors and traders have been extremely nervous watching the markets recently and wondering if we are headed for a market crash. From the beginning of the year to the end of October, the S&P 500 Index is only up a little over one percent. You would think that this was a mild year, but after investors put down their bottle of Pepto, they will tell you it has been a wild ride. The average swing between highs and lows has been 10.8%.

How to tell if we are headed into a bear market.

So, the big question accompanying the recent drop in price is whether this is just a simple correction or the start of a bear market? Before I declare either, let’s look at what the markets are telling us. After all, the key to where the markets are likely to go is within the market itself. Economic reports and company data are delayed data. What gives us a glimpse into the future and clues us in to the onset of a market crash is the price action on the chart itself.

Looking to the S&P 500 index, the monthly chart is not telling us to panic. I am using the RSI as a momentum indicator and the 13-period exponential moving average to assist with the trend identification. On the monthly chart, the 13 EMA will show you the approximate yearly trend. Notice how when prices closed below the 13 EMA, the index made a lower low in price before resuming the overall uptrend. This does not suggest a bear market but would warn of weakness and the potential for that bear market to begin. In October, the index DID NOT close below the EMA.

S&P 500 chart

Looking at the RSI, we see a major momentum warning. When prices are making higher highs in an uptrend, they should be doing it with increased momentum. On the chart above, the RSI is showing the higher highs in September and October were made with less bullish momentum. This is a signal called negative divergence and is very bearish, a good indicator that a market crash may be nearing. . Since the divergence occurred while the indicator was reading above 60, no new lows should be made before another rally.

So, the S&P is in a correction and should be able to make some more rallies before we get a bear market. Last week I tweeted, (@traderbdub) that the S&P futures bounced from a daily demand and will seek out a supply zone at 2767 before selling off. The next daily demand is 2510 on the index.

How to read a price chart to determine market direction

Now we will have to watch this price movement carefully. If prices simply break the February 2018 lows, then the weekly uptrend that has been in place since the 2016 election will have been broken. However, if price makes a lower high before making the lower low, that would be the signal of the start of a bear market.

The RSI is showing a major warning of a shift from the bull market.

For now, the S&P is only showing a correction in price. But that could easily change. What is scary is how close the current chart looks like the typical map of a price bubble.

Chart of a stock market price bubble.

If you were wondering about the other major market indexes, the Dow Jones and the Nasdaq Composite indexes are exhibiting the same patterns and price action as the S&P 500.

Dow Jones price chartNasdaq price chart

Free Trading WorkshopSo, for now, the markets are correcting but this is eerily close to signaling the start of the bear market and potential recession in the economy. Bear markets are not to be feared but rather they offer great opportunities to the educated and skillful traders and investors. To build the required skills to navigate a market crash, you need knowledge. You also need the experience to build skill. You gain this experience by practicing with the help of a mentor. Build your skill so you can take advantage of the market opportunities by joining Online Trading Academy today.

Disclaimer
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.