So what typically occurs after strong selloffs like we saw Tuesday? When considering the potential influence an individual bar may have on future bars it is important to consider the positioning of the bar we are studying. A sharp selloff coming when the market is extended up has a whole different meaning than a sharp selloff when the market is extended down. Let’s first look at the current situation to see what I’m talking about.
Here we see the sharp 1-day selloff has typically led to a muted bounce that then rolls over to make new lows. Instances are a little low. When I loosened them to a 2% drop I saw the same pattern.
But what if the market was at a 5-day low instead of a 5-day high? Results in that case would be much different:
Here we see a sharp initial bounce that is followed by more upside. In this case the sharp selloff is possibly exhaustive. That’s not the case when coming off a top. The expectation turns from negative to positive based on where the sharp selloff is occurring. So remember, when considering the meaning of a bar or pattern or of bars it is also important to consider the positioning.