Technical Correction

A technical correction is a decrease in the market price of an asset or entire market after extensive price increases. A technical correction occurs even when there is no evidence that the increasing price trend should cease. A correction is typically a change of 10% or more from the peak high or low however traders may use varying percentage levels. A technical correction is often caused when investors temporarily slow down their purchases of securities, which commonly leads to a throwback or pullback toward resistance or support levels respectively.

A technical correction can occur when a price gets overinflated in a bullish trend or when the price experiences an extreme selloff. Technical corrections can be easily confused with a potential reversal. Thus, it is important for a trader to discern the difference between a correction versus a reversal breakout. There are many broad market factors influencing a security’s value that can be important to follow in conjunction with a security’s price in order to identify a correction. Several studies and patterns have also been introduced to help a trader discern a technical correction.

While technical analysis relies on following chart patterns of a security for trading signals there are still a variety of reliable common macro indicators that can important to follow. The Dow Theory introduced in the 1890s also provides some basis for technical correction identification.

The Dow Theory suggests that while markets experience trading volatility due to the ingrained market making processes that facilitate execution, generally security prices will follow some trend. This belief has led to the widespread use of envelope channels and specifically Bollinger Bands for creating resistance and support trendlines around a candlestick pattern.

Envelope channels are one of the most popular macro considerations for identifying and understanding a correction. If a security experiences a significant change from the direction of a trend without the impact of a resistance or support line, a trader will typically look to macro factors to confirm the change is a correction. One of the greatest macro factors is volume. A correction will typically occur with low volume which shows that there is not strong sentiment for the price. News about the security is also important to review for discerning a technical correction. Since securities typically trade with trend, no significant announcements or important factors affecting a security price can also help to confirm a correction.

Similar to other types of market movements, several technical analysis studies and patterns have been introduced to help support the identification of correction patterns for trading plans. Throwbacks and pullbacks are two common patterns that can help indicate a correction. Elliott’s Wave Theory is also a popular methodology explaining corrections through the use of motive waves and corrective waves.

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