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Is the Correction Over?

Simon Maierhofer

Three days of selling erased 18 days worth of S&P gains. Since then stocks have recovered, but is the correction over or are lower prices yet to come?

To answer this question, it helps to understand why stocks sold off, especially since there was no real news catalyst.

Last week the ETF Profit Strategy Newsletter outlined various conditions that were likely to result in a pullback.

Slowing Breadth and Momentum

The S&P (SNP: ^GSPC - News), Dow Jones (DJI: ^DJI - News) and Nasdaq (Nasdaq: ^IXIC - News) saw incremental gains in late February but breadth (McClellan Oscillator) and momentum (RSI) did not confirm price action. The February 29, ETF Profit Strategy Newsletter update warned that: 'RSI did not confirm today's high. This is a common technical setup for a breakdown of some sort.' The Russell 2000's (Chicago Options: ^RUT) turn south was also worrisome.

Precious Metals Meltdown

On February 29, gold and silver saw declines of more than 5%. The February 29, ETF Profit Strategy update cautioned that similar precious metal sell offs preceded lower equity prices in April 2010 and April 2011.

Too Long Above the 20-day SMA

Below is an excerpt from the March 4, ETF Profit Strategy update: 'As of Friday, the S&P has closed 50 consecutive days above the 20-day SMA. The S&P has had four similar such streaks since the March 2009 bottom. The chart below (original chart posted below) highlights those periods of time. The longest streak was 52 days with no close below the 20-day SMA (Sep. 2  - Nov.15, 2010).  We note that it has been tough for the S&P to remain above the 20-day SMA for more than 50 days.'


As it turns out, the streak lasted only one more day for a total of 51 days above the 2-day SMA. A glance at the chart shows that such streaks are generally followed by some sort of a correction but don't have to mark a top.

Technical Evidence

Volume, the most basic technical indicator, spiked noticeably during Tuesday's sell off and has slowed since. This suggests that conviction behind the sell off was stronger than the recovery that has followed since.

Monday's (March 5) ETF Profit Strategy update warned that a decline on Tuesday would trigger a bullish low-risk entry (higher prices) and recommended to adjust stop-losses accordingly.

After today's price action, it's prudent to be careful and let the market reveal its intentions. When the market speaks, we listen. And the most important thing the major indexes tell us is how they behave around key resistance areas.

A break above resistance will mean higher prices (new highs) while a failure to overcome resistance will point towards another leg down.

The ETF Profit Strategy Newsletter outlines the key short-term resistance level and provides a quick and easy to follow short, mid and long-term outlook for the market.

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