Absorption at the top of a Trading Range

Click Here For Wyckoff Wave Chart 10-28-11

This week the stock market, as measured by the Wyckoff Wave, jumped its resistance and moved into new high ground, relative to the trading range. This was a most interesting occurrence that, in hindsight, looks fairly reasonable, but confused many Wyckoff students, including myself, as it developed.

I don’t like to “miss one”, but if that happens it is extremely important to review the action and be better prepared the next time.

After the Spring at point H, the Wyckoff Wave rallied and penetrated the first line of resistance drawn at point Y. It then rallied poorly and met supply at point I. Point I is also right at the last level of resistance in the trading range. While it was not unexpected to see supply at this level, what happened next caused concern and uncertainty among many Wyckoff students.

The day after point I, the Wave reacted on reduced spread and volume. This was a lack of supply. In addition, the fairly strong close suggested some support was met at the resistance/support area drawn at point Y. This suggested the Wave may attempt to penetrate the resistance. The next day brought reduced spread and volume which translates to a lack of demand. Patently, the Wave was not prepared to jump the creek. So far, the action suggested the Wave may react to a possible Last Point of Support (LPS) in the area of the halfway point of the rally from point H to point I.

The reaction began the next day on increased spread, but notably decreased volume. This suggested a lack of demand. The day’s action added credence to the LPS theory. This continued briefly on the following day as the Wyckoff Wave opened lower and reacted to point J.

This is when things got a bit confusing. All of a sudden, good demand came in and the Wave rallied strongly (the best day since the spring) back to the resistance line. It seemed that the Wyckoff Wave was again ready to jump the creek. As we saw good support at point J a support line was drawn between points H and J, with a parallel supply line through point I. The Wyckoff Wave was now in a short-term uptrend (Position 1).

The following day, the Wyckoff Wave reacted on reduced spread and volume. Again, we saw a lack of supply, giving the Wave another opportunity to penetrate the resistance and jump the creek. We had also moved horizontally across the short term uptrend channel without making any upside progress. In most cases, when the Wave reaches a resistance point and is unable to penetrate it fairly quickly (Mr. Evans’ “go and go now” observation), it has a tendency to return to the trading range. It appeared that the Wyckoff Wave was exactly in that position.

The next day, the Wyckoff Wave rallied on slightly increased spread and slightly decreased volume. While this suggests a lack of supply, it was not the big demand day that was expected.

Then things got a bit tricky. The Wave penetrated the resistance on decreased spread and increased volume. This suggested supply and was exactly the opposite of what would be expected as the Wave penetrated the resistance. The definition of an upthrust is reduced spread and volume, with the index or stock reacting back to the average level of closes. It would also suggest that there was good overhanging supply from the late spring to early summer trading range. It is shown on the attached chart from points G to U.

When, on October 21st, the expected follow-through to the down side did not occur, other scenarios should be considered. One of these is absorption. Absorption is defined as follows:

“If the market or an individual stock fluctuates within a narrow range for that index or stock, it was probably because the market was called upon to absorb offerings that represented stock purchased by over anxious Bulls”. In this case they got caught in last summer’s markdown, and were anxious to get out even.

Another clue that we experienced absorption is when the market or individual stock reacts on one day, but there is no follow through. Let’s go back and look at the market action to the right of point I. The inability of the Wyckoff Wave to follow-through to the down side is an important clue. It identifying what was really happening as the Wyckoff Wave moved sideways after its rally to point I.

It was also important to review the Technometer. It was overbought on only one day after the move from point I and was very oversold on the day the resistance was penetrated.

On October 24th the Wave traded higher on decreased spread and volume. The next day it reacted on increased spread and decreased volume. The final signal that the absorption was complete was when the Wyckoff Wave was unable to continue to react back into the trading range. Instead it rallied, completed the creek jump and moved into an intermediate term uptrend (Position 2).

Counts on the Point and Figure chart can be taken from point J. In phases they are, J to H, H to F, F to D, D to Z and Z to X. If these counts work out, the maximum objectives will take us back near the 2007 highs.

Before that happens, it is quite probable that the Wyckoff Wave will back up to the creek. If the backup is successful, a more important last point of supply will be established.

The narrow fluctuation as the Wyckoff Wave was at the top of the trading range and the inability to follow through to the down side were important signals that absorption was occurring. It is an important lesson to include in our Wyckoff play book.