Given the sharp correction in the Nasdaq over the past two days, this post seems timely…

Based on his own research and market analysis, Chris Gessel noticed something unique about a specific type of market correction. After further study with Justin Nielsen, they found that a significant break of the 50-day and/or 200-day moving averages often lead to a period of under performance, which could include a continued decline, an extended period of volatility and/or failed follow through days.

The break is not a slow, meandering decline through a moving average. The correction involves a quick downturn of an index over the course of one or more days. The correction typically occurs with higher than average volume.

Given the quick vertical drop in the value on an index, Chris coined the term vertical violation.

Vertical Violation Summary

Vertical Violation Example

In the podcast How IBD Called The Stock Market Correction Quickly — And Where It May Go From Here Chris describes how in October 2018 there was a significant break of the 50-day moving average followed four days later by a break of the 200-day, clearly a character change.

Before the vertical violation, notice how there was nothing particularly unusual about the activity on the index. As the index drops through each moving average, there is above average volume in both instances. The gray box highlights low long the correction lasts before returning to the point prior to the first break of a moving average.

More Vertical Violation Examples

The following examples are all from dates mentioned by Justin Nielsen in the article What A Week Of Bearish Reversals Means For Swing Trades.

Notice the similarities in each, including above average volume on the days the index drops through a moving average. In each instance the index remains below the point before for correction for an extended period of time.

Summary

Although each situation is unique, hopefully these historical charts provide some insight on what to look for once you spot a vertical violation.

References

All the information in this post, including the dates for the examples, is derived from the following IBD resources that reference vertical violations: