Where Do We Go From Here?

Click Here For Wyckoff Wave Chart 01-27-12

Last week’s Market Letter anticipated three scenarios as the Wyckoff Wave approached the resistance formed by last May’s highs. The scenarios were:

1. The Wyckoff Wave could rally strongly through the resistance and continue its advance.
2. The Wyckoff Wave could upthrust the resistance.
3. The Wyckoff Wave could react to test the short term uptrend channel or even back to the support/resistance line drawn from K.

This week’s market action eliminated one and possibly two of these scenarios. Since the Wyckoff Wave penetrated the resistance, scenario number three can be illuminated. However, two possibilities still remain.

Last Monday, the Wave rallied on decreased price spread and slowly increased volume. Its high for the day was right at the resistance line. This anticipated supply was present and that the Wave may well begin to react. This anticipation continued through Tuesday’s gap opening to the down side. Then, the Wyckoff Wave spent the rest of the day rallying and closed at the day’s highs. The wider price spread and decreased volume suggested a lack of supply. This opened the door for a second attempt to penetrate the resistance.

And penetrate it did. After a weak opening on Wednesday, the Wyckoff wave rallied strongly and penetrated the resistance. The increased price spread and volume put the strong rally through the resistance and upthrust scenarios in play.

One small clue was the decrease in volume. If the Wyckoff Wave was going to drive through the resistance and continue to rally, it would’ve been helpful if strong demand had been present. While a lack of supply is not a negative, increased spread and volume at this critical juncture would have helped the Wyckoff Trader come to a more positive conclusion.

This made Thursday a very critical day. The Wyckoff Wave experienced a gap opening to the upside and then reacted to close lower and just above the resistance on reduced spread and increased volume. The day’s market action strongly suggested an upthrust. Reduced spread, increased volume and a poor close, as the Wave is trying to leave the resistance area to the upside, are all indications that supply has come into the market.

The Wyckoff Wave was then expected to react and, most probably penetrate the support line drawn through points P & R. It also could easily react back towards the old resistance at point K.

However, the stock market does not make things easy. Instead of increased spread and volume to the down side, Friday brought decreased price spread and slightly increased volume. This would suggest a lack of supply. That is exactly what was not expected. What does that mean and where do we go from here?

It is still appropriate to anticipate the upthrust scenario. This would have allowed aggressive short-term traders to the down side to take a position during the day on Thursday. Despite Friday’s market action, these positions can be maintained. However, stops should be crowded and positions closed if Thursday’s high is taken out.

Intermediate term traders to the upside should have anticipated a reaction and already decided if they were prepared to ride this reaction out or when and if they would close out their trades.

Now, let’s look a little deeper into next week’s potential market action.

The Wyckoff Wave is in an apex. The resistance is the line drawn from point G. The support is the line drawn through points P and R. Wyckoff teaches us that when an index or a stock is in an apex it will depart that apex quickly and decisively. That would suggest our questions will be answered on Monday or at the latest on Tuesday.

An examination of the 12 Wyckoff Wave stocks tell us that eight are in an overbought condition, relative to the Technometer. Four are neutral and none are oversold. In addition, seven of the 12 stocks are weaker than the Wyckoff Wave. Three are stronger and two are the same. This would suggest a bit of a weakness and adds credence to the upthrust scenario.

However, the stock market is a cruel mistress. Friday’s action suggested a lack of supply and made the Wyckoff Wave more vulnerable to advance. While this would be a risky place to take or add to long positions, it is possible that the Wyckoff Wave could put in a strong day on Monday. This is why short term shorts, who have anticipated a downturn, need to be on their toes if the market reverses.

If the Wyckoff Wave does react, there is a strong area of support around the 25,000 level. Not only would any reaction encounter the resistance/support line drawn through point K, but also support line H – P and the long-term supply line drawn through G and S.

If the Wyckoff Wave reacts toward the support, it would also create a helpful Last Point of Support that would set the stage to continue a strong rally to the upside.

While it is logical and acceptable to anticipate that this will happen, it is extremely important to consider all alternatives and make action plans in case the market doesn’t behave as expected.

Situations like this are wonderful opportunities to practice trade. It’s a great time to test your Wyckoff tools, at a critical moment and develop additional market insight.