A technical correction on the stock markets: Its function

When trading on the stock markets, notably when you complete your chart analyses, you have already noticed or heard of technical corrections. But what exactly is a technical correction, what are its particularities, the factors that cause one and the differences between a technical correction and a stock market crash with which it should not be confused. This is what we shall examine and explain in this article.  

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A technical correction on the stock markets: Its function

Definition of a technical correction on the stock markets:

We shall commence by defining more precisely exactly what a technical correction on the stock markets is. This ‘correction’ could in fact be described as a type of trend reversal. It is often expected or at least an unsurprising event and is generally a negative phase. When we talk of observing a correction it is generally due to a recorded drop in an asset price of at least 10% and stops a general rising trend in a clear and identifiable manner. Of course, more often than not, a technical correction therefore corresponds to a temporary drop in the price of a quoted asset which has been experiencing a rising trend.

Technical corrections are generally relatively short and are normally not directly followed by a slump. However, a technical correction can sometimes occur prior to a real decline so it is important to know how to interpret it correctly.

The frequency in the occurrence of technical corrections varies according to the asset. A technical correction may impact a stock market overall and thereby affect a stock market index, even impact stock markets around the world and stop growth worldwide. But a technical correction can also simply affect a single stock market asset, caused for example by a disappointing announcement or financial result. Technical corrections can affect any or all assets quoted on the financial markets so can therefore impact shares as well as bonds, indices, commodities and even currencies.

 

What are the causes of a technical correction?

Of course technical corrections to an asset price do not happen by chance. They often occur as a reaction to an over-evaluation of an asset by the markets and lead to a better balanced asset price. It is therefore possible using a comprehensive analysis to anticipate this type of technical correction.

However a technical correction doesn’t always occur due to a particular fundamental factor. A correction can simply arise due to strategic profit taking from investors. In this case it is a technical analysis that will enable you to anticipate its movements more precisely.

As you may have noted, it is therefore not always possible to correctly anticipate a technical correction but sometimes it is possible to do so. Due to this fact, using a comprehensive analysis of this asset with technical and fundamental indicators an investor may be able to foresee this correction and adapt their trading accordingly. In fact, certain stock markets tools such as warrants or CFDs enable speculation on the downturn in the price of an asset or the possibility to complete short sales. This is why certain investors actually specialise in trading during technical corrections.

 

What is the difference between a technical correction and a stock market crash?

Let us now pass on to another point you should know regarding technical corrections in order that you do not confuse them with stock market crashes. It should be remembered here that a stock market crash is a major slump in the stock markets which is often caused by the bursting of a speculative bubble. A crash is therefore more severe and volatile than a simple corrective drop and also tends to continue for a longer period of time.

We should also note here that a stock market crash is often followed by a decline in the asset price concerned.

Frequently Asked Questions

Is it possible to trade on a technical correction?

As you may have understood from this article it is possible, using certain trading instruments, to invest in a technical correction which means of course trading on a drop in the price. Among the tools that enable this strategy we notably find the CFDs and warrants. This type of speculation, often also called ‘short selling’ therefore enables you to benefit from falling trends on the market.

How to anticipate a technical correction?

There are of course different methods of predicting and anticipating a technical correction. The first consists of course of examining the charts and completing a technical analysis to identify the signs of a reverse in a trend. The other method relates this time to a fundamental analysis. This analysis is based on signals obtained in particular from publications, announcements and events that could strongly and negatively influence an asset price or group of assets.

72% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money. This is an advert for trading CFDs on Plus500