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Stocks need a decisive recovery by Friday to avoid tripping a sell signal, said analyst Katie Stockton.
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If some technical indicators were to flash, it would suggest a 10% correction, he wrote.
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Still, seasonal strength could help stocks recover quickly.
Investors are stepping back into the stock market after staging a spectacular retreat on Wednesday, but trouble could still lie ahead.
According to Katie Stockton, the size of the rebound will determine how much risk is still ahead for investors.
“If we don't improve quite dramatically between now and the end of Friday, so just two days, we will see sell signals in our intermediate term metrics,” said the founder and managing partner of Fairlead Strategies. CNBC. “And this will be the first time in months that we have had that.”
In a written commentary, the technical analyst noted that the weekly stochastic indicator – which indicates overbought and oversold conditions in the market – is at risk of an “overbought decline”.
Meanwhile, she wrote that a signal called the moving-average-convergence-divergence indicatoror MACD, could flash its first sell signal since July. The MACD indicator tracks momentum and trends across multiple timeframes and appeals for its clear verdicts, which go one of two ways: buy or sell.
Stockton wrote that once both indicators flash a sell signal for the S&P 500, investors should prepare for a potential correction of 7%-10% in the medium term.
To be sure, it is not considered that this will happen. Although the benchmark index plunged close to 3% on Wednesdays after the Federal Reserve struck a hawkish tone at its meeting, the sell-off occurred just before the market entered a historically strong stretch.
“This actually comes at a pretty interesting time seasonally because we usually have the Santa Claus rally, which is usually the last five days of the year, the first two days of the new year,” Stockton said. “So with snapback, it's possible that it lasts until the end of the year, and maybe a little beyond that.”
Concerned investors, therefore, should wait for intermediate-term sell signals to trigger before hedging exposure, he wrote.
Still, others also see high correction risk. Market veteran Ed Yardeni expects stocks to remain “messy” through January, citing profit-taking, a possible dock strike, and a flurry of executive orders when Donald Trump takes office.
“We cannot rule out a 10% stock market correction, but we would see that as a buying opportunity rather than a reason to panic out of the market as we do not expect a recession or a bear market,” he wrote on Thursday.
Read the original article on Business Insider