Back at Last Week’s Important Support Area. Can the Reverse Use of Trend Lines Give Us Some Answers?

Click Here For Wyckoff Wave Chart 09-06-2013

On Friday, the Wyckoff Wave ended the week in pretty much the same position it was in a week ago. While slightly higher, it appears ready to, once again, test the lows at point Q and the support/resistance area (Creek) drawn from point B on the daily chart.

This week’s discussion will focus on the reverse use of trend lines. While they were briefly mentioned in last week’s post, these “backwards” trend channels can be extremely helpful in monitoring market action.

The reverse use of trend lines is extremely helpful when an index or a stock moves into a substantial oversold or overbought position relative to the original trend channel. When this happens, it becomes difficult to monitor the market action as the related issue is simply out there floating in space. There are no support or supply lines that can provide clues as to what will happen next.

The reverse use of trend lines can be used when a stock or index substantially weakens (strengthens in an up trend)  the trend channel and then rallies back to the support (supply in an up trend). However, it is unable to return to its trend channel.

An example of this on the attached chart is the reaction to point X and the rally to point I. The Wyckoff Wave was unable to return to its short-term down trend channel (drawn in red) and is now “floating in space”.

Now we can establish a new short-term down trend, using the reverse use of trend lines technique. It’s done backwards. In a down trend, instead of drawing the supply line, as was done through points U and W, the support line is drawn first. It is drawn from the original low (point V) and the next low (point X). A parallel supply line is then drawn from the top of the first rally (point W).

In a down trend, the support lines always begin at the same place (point V). When using the reverse use of trend lines technique, the supply line is always drawn from the second high (point W).

This technique enables the Wyckoff student to establish new down trends, using a quantitative set of rules. This avoids the natural tendency to draw the trend channels where they seem to fit. I did that a few times in my younger days and the results were never pretty.

Let’s review the Wyckoff Wave using this new trend channel.

Notice that while the rally to point Y came close, it did not reach the supply line of the new down trend channel. This is a minor bearish indication and some good supply did come in and drive the Wyckoff Wave down the next low at point Z.

On that reaction, demand came into the market before the Wyckoff Wave could penetrate the supply line of the new down trend channel. This and the fact that the Wave was in a fairly significant support area and had met some demand, is a minor bullish indicator.

This week the Wyckoff Wave attempted to rally, but ran out of demand on Thursday, when it experienced an intra-day failure to the upside. There was a large gap opening to the upside on Friday, but the Wave immediately ran into supply and reacted.

However, Friday’s opening and follow through weakened the supply line of the new short-term down trend channel. This is a minor positive indication.

Early next week and perhaps as soon as Monday, the Wyckoff Wave is expected to test the lows at point Z and possibly spring the support at point Q. This would require an initial sharp move to the downside moving through all the support levels.

If the Wyckoff Wave has enough momentum to reach the down trend channels support line, we could be seeing a fall through the ice and the beginning of a reaction that would at least test the halfway point of the rally from point G to point J.

If the Wyckoff Wave is unable to reach this support line, the spring scenario has an excellent chance of coming to fruition.

As several of the Wyckoff tools, that are discussed in the daily Pulse of the Market report, are sending positive signals, the spring scenario appears to have the highest probability of success.

Of course, the Wyckoff Wave could simply test the lows and rally back into the trading range.

Regardless, it is going to be difficult for the Wyckoff Wave to continue to move sideways and we should have some answers to these questions sometime in the coming week.