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V- or M-shaped correction?

By Colin Twiggs
November 16, 2018 9:00 p.m. ET (1:00 p.m. AEST)

First, please read the Disclaimer.


Last week I mentioned that there are few "V-shaped" corrections and plenty with a "W-shape". There are also a few with an "M-shape", leading to a major market sell-off. Here are some examples on Dow Jones Industrial Average.

2001 is the only good example I can find of a V-shaped correction.

Dow Jones Industrial Average

It rolled over later in 2002 into a more conventional W-shape bottom with several tests of support at 7500.

Dow Jones Industrial Average

This was followed by the banking crisis of 2008 which started with an M-shape in 2007. Successive false breaks above resistance (orange arrows) were followed by breach of support (red arrow).....before Lehman Bros filing for bankruptcy on September 15 led to a major capitulation.

Dow Jones Industrial Average

2011 is nowadays considered a secondary movement but at the time caused widespread alarm. Starting with an M-shaped top, it broke support in August before forming a W-shaped bottom with several tests of support at 11000.

Dow Jones Industrial Average

2015 was a more conventional W-shape precipitated by falling oil prices.

Dow Jones Industrial Average

Now, in 2018, we have the makings of either a W-shaped correction or an M-shaped reversal. The false break above resistance at 26500 is definitely bearish but was followed by a bullish higher low at 24000.

Dow Jones Industrial Average

There are three possible options:

  1. Completion of a W-shape correction, with breakout above 27000;
  2. An M-shaped reversal, with a fall below 23500; or
  3. A lengthy consolidation reflecting uncertainty, as in 1999 to 2001.
Dow Jones Industrial Average

At this stage, option 1 is most likely. Buybacks and strong Q3 earnings are likely to counter bearish sentiment.

That would change if we see:

A negative yield curve, where the 3-month T-bill rate crosses above 10-year Treasury yields;

Yield Differential

Rising troughs above 1% on the S&P 500 21-day Volatility Index; or

S&P 500

Bellwether transport stock Fedex follows-through below support at 210.

Fedex
Remember that there is nothing stable in human affairs; therefore avoid undue elation in prosperity, or undue depression in adversity.

~ Socrates

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Colin Twiggs is director of The Patient Investor Pty Ltd, an Authorised Representative (no. 1256439) of MoneySherpa Pty Limited which holds Australian Financial Services Licence No. 451289.

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