The market plunge will trigger dormant sell signals if stocks don't recover 'dramatically,' technical analyst warns

• Stocks need to recover decisively by Friday to avoid tripping a sell signal, analyst Katie Stockton said.
• If certain technical indicators flash, it would hint at a 10% correction, she wrote.
• Yet, seasonal strength could help stocks recover quickly.

Investors are wading back into the stock market after staging a spectacular retreat on Wednesday, but trouble could still lie ahead.

According to Katie Stockton, the magnitude of the rebound will determine how much risk still lies ahead for investors.

"If we don't recover pretty dramatically between now and Friday's close, so just two days, we will see sell signals in our intermediate-term metrics," the Fairlead Strategies founder and managing partner told CNBC. "And this will be for the first time in months that we've had that."

In written commentary, the technical analyst cited that the weekly stochastics indicator — which identifies overbought and oversold conditions in the market — stands at risk of an "overbought downturn."

Meanwhile, she wrote that a signal known as the moving-average-convergence-divergence indicator, or MACD, could flash its first sell signal since July. The MACD indicator tracks momentum and trends across multiple timeframes and is appealing 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 7%-10% correction in the medium term.

To be sure, it isn't a given that this will happen. Though the benchmark index plunged close to 3% on Wednesday after the Federal Reserve struck a hawkish tone at its meeting, the sell-off occurred just before the market is set to enter a historically strong stretch.

"This actually comes at a pretty interesting time seasonally because we have usually that Santa Claus rally, which is the last five days of the year, first two days of the new year, typically," Stockton said. "So with a snapback, it's possible that it does last into year-end, and maybe slightly beyond that."

Concerned investors should, therefore, wait to see intermediate-term sell signals trigger before hedging exposure, she wrote.

Still, others also see elevated correction risk. Market veteran Ed Yardeni expects stocks to remain "sloppy" through January, citing profit-taking, a potential dock strike, and a flurry of executive orders when Donald Trump takes office.

"We can't rule out a 10% stock market correction, but we would view that as a buying opportunity rather than as a reason to panic out of the market since we don't expect a recession or a bear market," he wrote on Thursday.