The Reversal against what is usually the current uptrend in a commodity, stock, bond, or index when there is an over-evaluation for a certain asset. These reversals generally take the asset in a down trend temporarily.
See If You Can Mark The Market Corrections!
Market Correction Definition: A Further Explanation
There are just three types of traders if you think about it. Those who are long, those who are short, and those who are uncommitted. The people who are long are, of course, those who have purchased contracts, while the opposite holds true for those who are short, who have sold contracts. Then there are those who have not committed themselves either way.
Have you ever wondered why the prices sometimes just bounce up and down between these support and resistance levels? I’ll give you a Common Sense viewpoint.
How many times have you seen prices hover around a support area and then the price starts to rally all of a sudden? The people who are holding long contracts are very happy. The only thing they are regretting at this point is that they did not buy more when the price was lower. They are hanging around, waiting for a small market correction (price to drop back), so they can buy additional contracts at a lower price.
On the other hand, we have the people who were short the market. They are not real happy about this because they wanted the price to drop because they are losing money. About this time, the shorts are thinking they are on the wrong side of the trade, and it might be time to get out with a small loss rather than risking even greater losses. But they are waiting for the same market correction that the longs are waiting for, so that they can get out at a better price and have a smaller loss.
The thing is, both the longs and the shorts want the same market correction to take place! Think about that for a moment. Both sides of the market want the correction to take place, just for different reasons.
The other group, the “Undecideds”, sees that the market is taking off, but they too want to see a price correction take place before they jump in. So now we have everyone, the longs, the shorts, and the undecideds, wanting the price to reverse a little. Each one has a different motive, however.
So now you have everyone trying to push the price down. That’s why you see these pullbacks. Of course, the opposite scenario holds true if the market is in an uptrend and the trend reverses. Everyone wants the price to go back up a little for the same reasons.
But what happens if the price goes back down? Glad you asked. Previously, we talked about the price going up and then dropping back down a little. This, by the way, is also called a “pullback.” When everyone started buying contracts on this pullback, this created another support area, didn’t it? If this pullback continues and the previous support is broken, then the following scenario takes place.
Everyone who was buying is now looking at it like they made a mistake, and they want to get out of their long positions by selling their contracts. The shorts, on the other hand, wish they had not bailed out, and want to go short again, or at least add to their positions if they did not get out already.
This “yo-yo” effect is what keeps prices hovering around the trendline so much of the time. So keep in mind, when a trend is deeply penetrated, it took a lot of energy to do it. This is one of the reasons that the third time the trend is broken is usually a really good indicator that the trend has changed direction.
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