Here's Why A Pullback Is Healthy for the Market

Ed Ponsi

There's a certain segment of market participants who believe stocks should only go higher and never fall. The truth is, that type of market behavior can lead to a crash.

A healthy market pulls back. It includes enough selling to entice buyers to jump in at lower prices. If no pullbacks occur, the only option for buyers is to pay higher prices.  

nasdaq 1999
Nasdaq 100 weekly chart, 1997-2003 by TradeStation

Case in point: Check out historic Nasdaq rally from 1999. Internet technology made its first major impact on individual U.S. businesses, sparking a buying frenzy. 

The warning sign here is the parabolic curve, in blue. When you see that curve, it's a sign that sellers have been overwhelmed by buyers, who are now in a bidding war for stocks. 

nasdaq 2020
Nasdaq 100 weekly chart 2018-2020 by TradeStation

Why do I bring this up now? Check out the parabolic curve that has currently formed on the Nasdaq 100 weekly chart. At the top of the curve, and you'll see a bearish engulfing candlestick pattern, highlighted in yellow. 

This could be a warning sign that a deeper pullback may be ahead. That's not a bad thing, because in order to keep a rally going, the sellers need to be occasionally rewarded. 

Without sellers to balance the equation, buyers eventually become fully invested. Once that happens, there's nowhere for the market to go but down. If you don't want to see a sharp drop in the market, then you don't want to party like its 1999. 

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Ed Ponsi is the managing director of Barchetta Capital Management, and is the author of three books for publisher Wiley Finance. A dynamic public speaker, Ed has made appearances around the world, in such diverse locations as Singapore, Dubai, London, and New York. For more information about Ed and his work, click here.