Trend Channels Can Deliver Subtle Messages

Click Here For Wyckoff Wave Chart 07-17-2015

This past week, the Wyckoff Wave put in a very poor effort as it continued to rally off the support at point K. So far, it has been unable to reach the short term downtrend channel’s supply line. That gap is marked by a downward red arrow.

The week’s market action reminds me of an old Robert Evans lecture called the Shall Diver’s Tragedy.

In this lecture, the shall diver dives to the bottom of an ocean shelf, picks up a shall, swims to the surface and drops it in his collection basket. He continues this until he develops a slight cramp and is unable to reach the surface. He decides to swim back to the bottom and push off with his good foot, in an attempt to reach the surface.

Sadly, that effort failed and he fell back into the ocean. Unfortunately, the shelf he was on had ended and, now unable to use his legs, the shall diver fell to his doom.

That analogy applies to stocks as they rally and react within trend channels. The surface is the supply line. The shelf, the support line. If a stock or index rallies, but fails to reach the channel’s supply line, it becomes vulnerable to a reaction.

This relative weakness also signals there is a good possibility the stock will react through the support line and weaken the trend channel.

In the Shell Diver’s Tragedy lecture, the emphasis is on distribution and an upthrust that weakens and then breaks the longer term uptrend channel. The result is a reaction and a major change in trend.

I have used that story many times in identifying intermediate and longer term opportunities to the downside, I have also found this important Wyckoff logic applies to just about every trend channel. It can be used on an intra-day, short, intermediate or long term channel. The trend channel can be both up and down.

The analogy doesn’t happen every time. It does happen enough that, when it occurs, it deserves close attention.

Let’s look at this week’s market action, with the shall diver’s story in the back of our mind.

The unsuccessful #3 spring at point G was confirmed by a poor quality secondary test at point I and a reaction to a new low at point K. This allowed the creation of the short term down trend channel that is drawn in red.

The reaction off point J was on relatively wide price spread and good volume. Supply was certainly present and it moved the Wyckoff Wave slightly through the channel’s support line into an over sold position.

The Wyckoff Wave quickly returned to its down trend channel. However, after a strong first day, the rest of the rally off the support line strongly suggested a lack of demand.

Compare the strength of the move from points J to K and points K through Friday’s close.

There was much more supply present on the reaction then demand on the rally. In addition, on Wednesday, Thursday and Friday the Wyckoff Wave begin to “roll over”. While supply has not yet come into the market, this lack of demand is, most certainly, leaving the door open to a reaction next week.

While the Wyckoff Wave may still rally and test, or even penetrate the trend channel’s supply line, it has sent a signal it is ready to react.

Unlike the Shell Diver’s story, this is a short-term analysis. We are not experiencing an upthrust. There is no distribution. The Wyckoff indicators (Optimism – Pessimism Index, Technometer and Force Index) are not sending signals that would suggest a major reaction.

There is also a fairly important support point in the area of the trend channel’s support line.

All these would suggest the Wyckoff Wave is going to make another attempt to Spring the support. Unlike the failed effort at point G, if the spring is successful it could mean the beginning of a new rally in this wonderful bull market.

This week’s market action does not guarantee this. The Wyckoff Wave could simply react and test the support and continue to move sideways.

However, when a clue like this arises it should be watched closely.