Well the stocks and indexes go up and down all the time , if a stock or index is in bullish trend it just doesn’t go up in a straight line it has its own moments of pauses known as corrections or pullbacks or retracements likewise for a bearish trend , it works like a person taking breath you can only fill your lungs with a limited amount of air and hold it for a limited amount of time , you ought to exhale after sometime , can you keep on inhaling without exhaling ? No , similar logic can be applied to the stock market.
So but how can one identify if the sudden downward movement in a bullish market trend and sudden upward move in a bearish market trend wont last and is just a correction or if it will turn the trend other way around , below we will learn how you can identify this easily.
Correction in the stock market refers to the phase of profit booking where the stock moves slightly in the opposite direction of the trend that it has been in this is known as a pullback or correction , but the stock recovers and again resumes the trend thereafter.Reversal on the other hand means a full fledged change in the trend that is the correction turns into a full on change in trend , bullish to bearish or bearish to bullish.
Correction vs. Reversal –
Look at the technical chart of Infosys on NSE –
Look at the chart where we have also plotted 3 moving averages , Infosys made higher highs and higher lows and any selling or correction was withing this parameter and the stock kept making higher highs and higher lows ( marked by green arrows on the chart ) , also look how the stock was decisively above all the moving averages of 50,100,200 , these 3 MA generally help us make quick decision whether the stock is in bullish or bearish trend in the short term , middle term and longer term , so infy was above all 3 and kept making higher highs and higher lows, this is a healthy trend with a healthy correction or pullback , i would be more concerned if Infosys wouldn’t have correction and started moving upward in almost vertical trend , such market trends don’t last long and fizzle out soon.
Now look at the right side of the chart marked by Red arrow , see how the stock made double top chart pattern ? (marked by resistance area in blue color) and as soon as the stock failed to make higher high and made lower low and lower high this indicated that it is not a correction but is a reversal , combined with this the 50 day MA also acted as resistance , thus we see there were many confluence , double top formed , 50 MA acted as resistance and stock made lower high and lower low , that should be the signal to go short on the next high , the stock falling below the 50 and 200 MA also indicated that the trend has changed in the short and medium term .
Another Example of correction vs reversal on chart –
Below is the technical chart of Cadila healthcare on NSE –
Now let us look at a stock that was in bearish trend and was making lower high and lower lows , any buying or pullback was easily distinguished by bears and the bearish trend continued , also see how the stock was below the 200 MA ( 200MA also acted as the resistance twice ) and then went even below the 50 and 100 MA , hence solidifying the bullish trend , any buying was only limited and acted as small and healthy corrections made by profit booking by bears.
Now look at the right hand side of the chart marked by green arrow see how the stock broke its bearish chart formation and first made higher high and then higher low this was the signal that it is no more a correction but a trend reversal , look how decisively the stock also moves above all the moving averages and then took support at the 200MA which previously acted as resistance further indicating that downtrend has ended and reversal has occurred in the stock .
Final Thoughts on Corrections and Reversals –
So we have learned hot we can distinguish between the corrections and reversals in the stock market this simple technique when implemented in any trading strategy can be beneficial , but people might think why such corrections and reversals happen in the stock market ? They are a part of the cycle – accumulation , participation and distribution which happens in almost every stock or index in fact one should be more frightened if pullbacks and reversals don’t happen in a stock or index because such bullish or bearish moves without any correction will later lead to not just a correction or reversal but lower circuits or upper circuits .