There are a couple of common downside correction patterns. One, is typical in a very strong uptrend, where there is a single down leg where the major indices retrace a shallow amount (e.g., 38%), or perhaps half (less often, as much as 62-66%) of the prior advance. When such a corrective pullback is over, it's over. It's usually short-lived.
A full-blown correction has more than a single segment to it. In fact 3 segments, designated in wave theory as an initial down leg 'a', followed by a rebound 'b', then another down leg 'c' that often carries further than the first decline. Sometimes that second down leg is about equal to the first, which becomes a measured move objective. The principle point is that the bigger market corrections tend to have down, up, then down price swings. I think we're in such a correction but I'll look at both the single segment pullback possibility versus the down-up-down (or a-b-c) variety.
If the primary trend is up, the first part of a correction is down naturally, in the opposite direction. The next segment is a rebound. That's the fake out 'b' segment of an a-b-c correction.
In this first rebound the bulls tend to assume the primary trend has ALREADY reasserted itself. However, the proverbial other shoe then drops, as after a relatively minor rebound typically (e.g., a 38, perhaps 50% retracement of the first decline), another decline ensues. A second decline that will often see lower lows by some degree and a 'degree' of decline such that the second downswing 'c' could be a fibonacci 1.6 times more than the first decline 'a'.
If you keep in mind that down-up-down (a-b-c) corrections are common when a good-sized setback occurs in a bull market advance, you will be rightfully cautious in jumping back in on the bullish bandwagon on the first rally. Best to wait to see if that other shoe drops!
A ONE-SEGMENT (SIMPLE) PULLBACK
This is a correction that's a single downswing, followed by a resumption of the prior advance: a decline that, even though sizable, is pretty much a straight down affair that retraces 50% or more of the prior advance. If an index or stock's upside momentum has weakened significantly, a pullback might equal an amount that retraces 62-66 percent of the prior advance. (An index or stock that was strong might only see a 33-38% retracement.) If this is a single segment decline, the prior uptrend will then resume.
If we look at the Nasdaq Composite (COMP) correction to date, as seen below, the index seems to have found some support around the 50% retracement mark. As the index gets oversold, traders get nervous continuing to sell into this situation. Some short-covering and bargain hunting buying comes in, etc. What we've seen so far is pretty much a straight line decline. There was a recent 3-day pause, but which had the appearance of a bear flag type pattern representing only a pause before selling then resumed.
The S&P 500 (SPX) Index has had a deeper retracement so far, one equaling nearly a fibonacci 61.8 (I round to 62) percent retracement in terms of intraday lows. A rebound from SPX's intraday low today also occurred as it did with the Nasdaq Composite.
I have some (technical) reasons to think that an S&P retracement, especially if we assume that this correction is going to be a single downswing only, may carry still lower; i.e., to around 1070, equaling a 66% retracement, 'filling in' an earlier (highlighted) price gap and also touching support implied by a key trendline on the weekly chart, seen after the SPX daily chart.
The aforementioned reference to possible SPX weekly trendline support around 1070 relates to the previously broken major down trendline seen below on the weekly chart; this upside breakout occurred several weeks back.
An SPX rebound from the 1070 area would suggest that prior resistance (a trendline), once pierced, had 'become' subsequent support. This is a common chart phenomenon. (The corollary is where support, once pierced, 'becomes' resistance later on in a rally phase.)
AN 'A-B-C' (DOWN-UP-DOWN) CORRECTION
My current outlook is for a multi-segmented correction that commonly occurs after a rally has gone on for a lengthily period. This is where the first decline is not the ONLY one that occurs. Let's suppose that the first segment of an a-b-c correction ended today in the S&P (500).
The down 'leg' we're in and MAY have completed today is labeled 'a' on the daily chart below. From today's low or wherever the current decline ends, a rebound would be common, but one that only retraces a relatively small portion of our first decline; e.g., between 38 and 50 percent of down leg 'a' as highlighted on the chart. After this rally (up leg 'b') runs its course, another decline sets in, down leg 'c', that then carries to lower lows and perhaps closer to where a bearish rising Wedge pattern began. The scenario I've outlined is one plausible way that a 'typical' correction might play out. Stay tuned on that!
The same projected scenario is highlighted on the Nasdaq Composite chart below; i.e., that of an a-b-c (down-up-down) correction within a still major uptrend. Here I've highlighted a situation where a relatively shallow fibonacci 38% retracement occurs, relative to an initial down leg 'a'.
The projected levels I've highlighted are speculative but I would emphasize more the pattern of a major correction as it often unfolds. One that is MORE than just the single stage decline we've gotten used in recent months. I think the prior rally has gone on long enough and been 'one-sided' enough to call forth a more complex correction. One that will 'correct' some extreme bullish overblown expectations that were probably unrealistic. The times are not easy and an advance is only going to be mostly uninterrupted for so long.
GOOD TRADING SUCCESS!!