Are Stocks Approaching a Correction?

With fear back in the market, the question arises: is this a topping pattern?

The stock market continued to fluctuate on Tuesday, with the S&P 500 index gaining 0.02% compared to Friday’s closing price. Last Thursday, the market sold off after a higher open, despite NVDA stock rallying by over 9% following its earnings release. On Friday, the market rebounded, and since then it has been basically moving sideways.

On Friday, I asked “Is this a downward reversal or just quick profit-taking?” The market rebounded and retraced its Thursday daily loss of 0.7%, so there is still a chance that it is only a flat correction and a consolidation within an uptrend. Yesterday’s trading session didn’t change much.

However, this morning, the S&P 500 index is expected to open 0.5% lower, breaking back below the 5,300 level. It will retrace some of the Friday’s rebound, likely staying within a consolidation.

Last week, investor sentiment improved, as indicated by AAII Investor Sentiment Survey on Wednesday, which showed that 47.0% of individual investors are bullish, while 26.3% of them are bearish. The AAII sentiment is a contrary indicator in the sense that highly bullish readings may suggest excessive complacency and a lack of fear in the market. Conversely, bearish readings are favorable for market upturns.

The S&P 500 keeps going sideways after breaking below the upward trend line, as we can see on the daily chart.

Are Stocks Approaching a Correction? - Image 1

Nasdaq 100 Remained Relatively Strong

Last Thursday, the technology-focused Nasdaq 100 index reached a new record high of 18,907.54 before closing lower. It seemed that a more pronounced profit-taking action was coming; however, since Friday, it has been gaining again. Yesterday, the Nasdaq 100 closed up 0.32%, nearing its all-time high. Today, it is likely to open 0.6% lower, extending a consolidation.

Are Stocks Approaching a Correction? - Image 2

VIX – Closer to 13

The VIX index, also known as the fear gauge, is derived from option prices. In late March, it was trading around the 13 level. However, market volatility led to an increase in the VIX, and on April 19, it reached a local high of 21.4 - the highest since late October, signaling fear in the market. Recently, it was going lower again, and on Thursday, it was the lowest since November of 2019 at 11.52. Yesterday, the VIX closed near the 13 level.

Historically, a dropping VIX indicates less fear in the market, and rising VIX accompanies stock market downturns. However, the lower the VIX, the higher the probability of the market’s downward reversal.

Are Stocks Approaching a Correction? - Image 3


Futures Contract Breaks Below 5,300

Let’s take a look at the hourly chart of the S&P 500 futures contract. Last Thursday, it pulled back from a new record high of around 5,368 and fell by almost 100 points. However, Friday saw a rebound and yesterday, it was as high as 5,339. This morning, the market is trading lower, breaking below the 5,300 level. The support level is at 5,270-5,280, among others.

Are Stocks Approaching a Correction? - Image 5


Thursday’s trading session might have led to a deeper correction; however, on Friday, the stock market advanced on technology sector strength. Yesterday, the market didn’t do much, remaining within a consolidation.

This morning, the S&P 500 index is likely to open 0.5% lower. So, is this a topping pattern? For now, it looks like another potential profit-taking action following recent record-breaking advances. However, a decisive breakdown of the 5,250 support level, which was marked by local highs from March and April, would likely lead to a deeper correction of the advance from the early May local lows.

In my Stock Price Forecast for May, I noted “Where will the market go in May? There's a popular saying: 'Sell in May and go away,' but statistics don't consistently support such clear seasonal patterns or cycles. The safe bet for May is likely sideways trading, with investors digesting recent data suggesting that inflation may not be transitory, and the Fed could maintain its relatively tight monetary policy. However, economic data isn't entirely negative, and strong earnings from companies may continue to fuel the bull market.”

For now, my short-term outlook remains neutral.

Here’s the breakdown:

  • The S&P 500 has further extended its short-term consolidation despite last Thursday’s pullback and a temporary fear factor for the market. Today, the fear seems to be back, but for now, it looks like a move within a consolidation.
  • On Friday, April 19, stock prices were the lowest since February, indicating a correction of the medium-term advance. Recently, the S&P 500 retraced all of its mid-April sell-off, reaching new record highs above 5,300.
  • In my opinion, the short-term outlook is neutral.

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Thank you.

Paul Rejczak,
Stock Trading Strategist