This past week the Wyckoff Wave tested the support line of the apex formation (drawn in purple) and rallied to the formations supply line. There it moved into a slightly overbought position, before its Friday afternoon reaction back into the apex.
When we draw support and resistance lines to identify the tops and bottoms of the trading range, or trend channels, they are normally identified as support lines and supply lines.
That’s nice, but they are just lines on the chart. What is important is how the index or stock reacts as it approach and possibly penetrate those lines. When that happens to the upside, the stock or index moves into an overbought position. Conversely, it moved into an oversold position on a reaction.
This is when important analysis should take place. It’s not that the line was approached, it is how the index or stock is behaving, especially if it moves into an overbought or oversold position.
In fact, to remind us of this extremely important concept, these lines should really be called overbought lines and oversold lines.
This is when the supply and demand shown on the charts through price printed volume can be joined with the Wyckoff tools, like the O – P Index. Good analysis can uncover some important clues as to what is going to happen next and should new positions be taken or existing ones closed.
The Optimism – Pessimism Index plays an important part in this analysis. The O – P Index is simply an index of volume of the related market index or stock.
Throughout the trading day, like waves in an ocean, market indexes and stocks rally and react. The Wyckoff student calls these intra-day waves. As small rallies are made, intraday waves are created to the upside. Conversely, down intra-day waves are created during small reactions.
While the price determines when a wave is called, the volume during that time. Is associated with the specific wave. If there is an up wave, that volume is added to the O – P Index. If there is a down wave, the volume for that intra-day wave is subtracted. At the end of the day, the final number is posted to the O – P Index line chart. This appears directly below the volume on the attached chart.
The O – P Index represents effort. The Wyckoff Wave represents results. If a great deal of effort goes into a move to the upside, this would cause the O – P Index to noticeably rally. The same is true on a reaction.
By itself that doesn’t tell us a lot. But, when compared to the Wyckoff Wave things become much clearer, especially when compared to previous highs or lows.
For example, at point H the O – P Index was at 70,327. At Thursday’s close, it was at 70,403. On Thursday, the Wyckoff Wave closed at a lower level than at point H.
This means that the effort put in by the O – P Index, represented by the amount of upside volume, was not matched by the Wyckoff Wave. The Wyckoff Wave and the O – P Index are not in harmony. Instead they are diverging. This situation is called a negative divergence.
When the effort does not match the results, it suggests the Wyckoff Wave will have a hard time continuing to rally and there is a good chance it will react back into the apex.
On Friday, after a gap opening to the upside, a brief reaction and a poor quality intra-day rally to test the mornings high, supply came into the market and the Wyckoff Wave reacted back into the apex formation. The supply coming into the market caused the O – P Index to react to 70,304. This eliminated the negative divergence.
The two readings, at points H and on Friday, are now only separated by 23 points. The Wyckoff Wave remains quite a bit lower than it was at point H. This continues to show the effort (O – P Index) is not being matched by the results (Wyckoff Wave).
Although they are technically back in harmony, they are not really in balance with each other. This is called inharmonious action. In this case it is negative inharmonious action. It continues to suggest the Wyckoff Wave will react back into the trading range and possibly test the lows at the apexes oversold line or even the lows at points K and I.
If this happens it will be extremely important to watch the Optimism – Pessimism Index and its relationship with the Wyckoff Wave.
Will we see some positive divergences or inharmonious actions that will give us some clues that a new rally might be in the near offing?