What Is a Reaction?
In technical analysis, a reaction is a short-term trend reversal in the movement of a security's price. Reactions are most often associated with a downward movement in the price of a security after a period of upward movement, often in response to news or data released. Reactions are likely to be mild and lead to a slight increase or decrease in price, rather than a large change in value.
- A reaction is a short pause or brief reversal in the price action of a stock or commodity, often to the release of news or data.
- The duration of a reaction is usually only a few consecutive sessions, while a reversal or correction will be deeper and more prolonged.
- Reactions can provide an entry point for traders looking to enter a position when other technical indicators remain bullish.
Reactions are generally considered to be positive for the overall health of the market, since unending price increases can cause inflation or result in an even larger price drop if a company doesn't meet expectations. A reaction is likely to prevent events such as runs or high volume sell-offs at later dates.
When a stock has a downward reaction in price, it is often because of negative news. Negative news will often cause individuals to sell stocks. Negative news can be bad earnings reports, poor corporate governance, economic and political uncertainty, as well as unexpected, unfortunate occurrences will translate to selling pressure and a decrease in stock price.
On the other hand, positive news will normally cause individuals to buy stocks. Positive news might be good earnings reports, increased corporate governance, new products, and acquisitions, as well as positive overall economic and political indicators, translate into buying pressure and an increase in stock price. For example, a hurricane making landfall may cause a drop in utility stocks. Meanwhile, depending on the severity of the storm, insurance stocks could also take a hit on the news.
Reactions and News Reports
Reactions and reversals both involve a security moving off its highs, but reactions are temporary and reversals are longer term. So how can traders distinguish between the two?
Most reversals involve some change in a security’s underlying fundamentals that force the market to reevaluate its value. For example, a company may report disastrous earnings that make investors recalculate a stock’s net present value. Similarly, it could be a negative settlement, a new competitor releasing a product or some other event that will have a long-term impact on the company underlying the stock.
These events, while happening outside of the chart, so to speak, will appear over several sessions and initially will seem much like a reaction. For this reason, traders use moving averages, trendlines, and trading bands to flag when a reaction keeps going and is at risk of entering reversal territory.