Where will the next small stock market correction bottom?

We’ve just decided to sell all of our UPRO (3x ETF for the S&P 500). We want to buy back our stocks when the upcoming small correction bottoms.
Where will the S&P 500 bottom? We are looking for confluences of technical support levels. Here are some potential targets that we’re waiting for. We will adjust these targets as time goes on.

6% decline

The basic definition for a “small correction” is a 6% decline. 6% below May 9’s intraday high brings the S&P to 2259.
Incidently, 2260 is also approximately the S&P 500’s 23.6% retracement level of the S&P’s big rally since February 2016. See the following weekly bar chart with fibonacci retracement lines.

There’s a reason why it’s more likely for the S&P to stop at the 23.6% retracement level than the 38.2% retracement level (2172). The S&P’s previous 2 small corrections retraced 38.2% and slightly more than 23.6%, respectively.
This is the June 2016 correction (38.2% retracement).

This is the October 2016 correction (slightly more than 23.6% retracement).

History shows that in a big rally that has small corrections within in, the S&P’s successive small corrections retrace to shallower and shallower fibonacci retracement levels.
This means that if the last small correction retraced to 50%, this small correction will AT MOST retrace to 50%. It will probably retrace to 38.2%. Then if this rally retraces to 38.2%, then the next small correction after that will AT MOST retrace to 38.2%. It will probably retrace to 23.6%…..
There’s a simple reason for why this happens. While the big rally continues and the market grinds up over the long run, the S&P’s small corrections are still 6-12%. Hence, the small corrections’ magnitude as a portion of the entire big rally becomes less and less.
Using this idea, it’s unlikely for the S&P to reach the 38.2% retracement level of 2176. That would be a bigger 9.4% correction. 2176 is also the S&P’s resistance before the last small correction began in August 2016. This is now a very formidable support level.

More likely targets

The S&P consolidated at 2228 on its way up from October 2016 to the present. The S&P’s flat consolidation is more obvious in the futures market than in the index. 2228 on the S&P’s futures corresponds to 2233 on the index. 2233 on the index is a 7% correction for the S&P. This is a very likely target because 7% corrections are more common than 6% corrections. Here is the support level on the futures.

If energy sector weakness is to be the driver of this small correction as we predicted, than we can also use XLE (energy ETF) as a target. History shows that although XLE’s declines often precede the S&P’s declines, XLE and the S&P usually bottom together. And when the S&P does fall, XLE will still fall a little bit more (despite having gone down already).
$64 is a very good minimum target for XLE. That’s XLE’s 50% retracement level and corresponds to a 6% decline in XLE. Here’s XLE’s weekly bar chart.

Other targets that aren’t very important

The S&P’s 200 daily moving average is at 2251 and going up by more than 1 point per day. By the end of May, it’ll be above 2259 (the minimum target for a 6% correction). So this target is useless because it will be reached anyways.
The S&P’s 50 weekly moving average is at 2229 and going up 6 points per week. If the S&P makes a fast correction, this target will be useful. As you can see in the following chart, this moving average has been good support during the last 2 small corrections (June 2016 and October 2016).

Bottom line

  1. The minimum target is a 6% decline (2259 for the S&P). This is our minimum definition of “a small correction”. We will also use XLE’s minimum target of $64 as a minimum target for the S&P 500.
  2. We expect the maximum target to be 2176 (9.4% correction).
  3. The most likely target is 2230 (approximately 7% correction).

It is notoriously hard to consistently pick the exact bottoms of small corrections. The bottom tends to have no correlation with news or fundamentals. It is also impossible to build a technical model to consistently catch the bottom.
So the easiest thing to do is to just buy when the S&P falls 6% (reaches 2259) and then wait for the small correction to bottom. Perhaps that is what we will do. However, we will probably wait for the 7% target (2230). Over the past few years the market has constantly been overshooting the minimum targets. This is a result of High Frequency Trading and increased volatility in the markets.

4 comments add yours

  1. I didn’t realize the correlation between XLE and the S&P 500. That’s really interesting and something that I’m going to have to start paying more attention to. Thanks for sharing!!! I always love reading your analysis.

  2. I agree we are due for a market correction soon. But I’m sure most of us wouldn’t mind, as it would bring more value to the market and make a few nice entry points to buy.

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