A Welcome Relief Bounce, But Don’t Be Too Trusting
While breadth is strong, new lows still outnumber new highs two to one.
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After three days of misery, there is a little bounce action on Wednesday morning. Bounces like this provide great relief and often go further than you think, but they can be dangerous. Typically, they last long enough to create the feeling that the worst is over, and that is when you need to be extra cautious.
V-Shaped Bounces Versus Overhead Resistance
In recent years, there has been a greater tendency toward V-shaped bounces where the market goes straight back up after some corrective action. That is not what traditional technical analysis expects.
The traditional view is that bounces after a correction will run into overhead resistance that will prevent sustained upside movement. The theory is that many investors are ready to sell at breakeven after the stress of watching a sharp drop. They just want to get out and are happy that they didn’t lose. That is what overhead resistance is all about, and it can be quite powerful.
In recent years, more computerized trading and algorithmic methods have overridden this very human emotion to break even. That has resulted in more V-shaped moves, but humans are still ultimately the primary drivers of the market and the theory about overhead resistance can be self-fulfilling. I do not expect a V-shaped bounce at this point.
What the Action Looks Like Right Now
Currently, breadth is running strong at 68% gainers, but there are twice as many new lows as new highs, at 130 to 63. Small-caps (IWM) led on the way down, and they are leading on the way back up. Biotechnology (IBB) jumped nicely but is giving back some of the early gains already.
I’m not inclined to chase new entries here, primarily because I’m not convinced that the worst is over. We have some major jobs news coming up, and negative seasonality is going to continue to be a factor. I may look for some exits into strength, but overall I’m pretty happy with position sizes, so there is no great pressure to reduce.
Watch the Close
The close Wednesday will be particularly interesting. Institutional investors tend to act at the close, and the close tells you more about the health of the action than some energetic early buying.
At the time of publication, Rev Shark had no positions in any securities mentioned.
