Wyckoff students know that number one Springs (Shakeouts) and number two springs need to be tested. It’s simply a matter of waiting for the test to happen.
This week, it finally appears the Wyckoff Wave is reacting to test the spring at point F. It’s been a long road with a detour or two to get to this point. However, with the weakening of the short term uptrend channel, drawn in blue, enough supply has entered the market to begin to drive the Wyckoff Wave back down towards point F.
Unless Wyckoff investors and traders to the up side entered the market on the spring, they were simply content to wait and enter the market on a successful test of the spring. They were not particularly interested in the minor fluctuations as the Wyckoff Wave rally to point I. They knew that at some point the market would react and then they could use all their Wyckoff tools and take long positions if the test was successful.
Short term Wyckoff traders to the down side paid much more attention to the rally off the spring. They were looking to take short-term positions to the down side and wanted to get in at the highest possible level.
Timing the market is tricky business. The Wyckoff student needs to use all of his Wyckoff tools. While analyzing the price and volume relationships is the most important part of the analysis, the Optimism – Pessimism Index (especially when observing divergences and inharmonious actions), the Technometer and the Force Index can provide valuable confirmation to the initial price and volume analysis.
In a previous Market Letter, we discussed the rally off the spring to point G. It was a very reasonable and expected rally. The final day of the move to point G was on good spread and sustained volume. The next day saw a lack of supply. That was followed by a strong move to the down side, ending at point H. Was this the reaction to test the spring?
On the rally to point G, there wasn’t a drying up of demand. Instead, out of the blue, good supply came into the market. While the Wyckoff student would not eliminate the conclusion that this was the beginning of the test, there were several unanswered questions. This would preclude taking a short term position to the down side.
Volume remained extremely high on the reaction to point H. This was certainly not a drying up of supply, that would be anticipated during a successful test. Nor was the Technometer in an over sold condition.
The market was sending mixed signals and when this happens, the prudent Wyckoff student simply watches and waits.
The market then rallied to point I. Volume continued to reduce on the rally and price spread was mixed. This was not nearly as positive as the rally from point F to point G.
In addition, the Wyckoff Wave moved into a dangerously overbought condition on the Technometer and had developed negative inharmonious action with the Optimism – Pessimism Index, when compared to point G.
The critical day came two days before the high point I. I have marked this with a red arrow. The Wyckoff Wave rallied on decreased spread and volume. In addition it closed near the lows of the day. The Wyckoff Wave continues to be in a dangerously overbought condition, relative to the Technometer.
It is important to note that the Technometer can be a bit of a leading indicator in presenting overbought and oversold conditions a day or two before the actual turning.
At this point, it certainly appeared the reaction to test the spring was ready to begin and short term trades to the down side should be considered.
One of the important Wyckoff rules is that if considering positions to the down side, the Wyckoff student should select stocks that are weaker than the market. This important principle was demonstrated two days later.
On the day marked point I, the Wyckoff Wave put in a nice rally on increased spread and slightly increased volume. It could be considered a rally to catch stop orders.
However, if the Wyckoff students, who took a short position to the down side, had selected a stock or stocks weaker than the market, they were probably protected from this last-ditch rally.
It is also interesting to note that the Wyckoff Wave put in a minor head and shoulders formation before it began to react. On the day following point I, there was a gap opening to the down side. The Wyckoff Wave spent the day attempting to rally on reduced spread and volume. This would suggest demand was withdrawn. That set the stage for Thursday’s and Friday’s reaction which weakened the short term up trend channel.
Where will the reaction stop? Is The first level of support is the resistance line drawn last May through the 2011 highs. That is shown in red on the chart.
The next support area is the bottom of the original trading range, drawn from point Y. It will be interesting to see how the Wyckoff Wave reacts as it approaches these two significant support areas.
However, just because the Wyckoff Wave is reacting to test the spring, does not mean the test will be successful. The good Wyckoff student always looks at every scenario. Prejudging the market is a recipe for disaster.
While the Point & Figure Chart is not really geared to anticipate objectives in a trading range, it is an interesting tool. If we take account from point I, along the 32,000 line, we can see there are two phases in the count. The first is from point I to point E. The second is from point E to point A.
Phase 1 gives us a count of 1,800 points and an objective of between 32,000 and 32,200. This is just below the spring. If the Wyckoff Wave reached this objective and then rallied, we would have a poor quality test of the spring. Poor quality tests need to be re-tested.
If the entire count is reached, this will place the Wyckoff Wave back at the October – December trading range. This would suggest the Wyckoff Wave would enter a new trading range before making a substantial move.
Will the test be successful?. Based on the price spread and volume analysis of the Wyckoff Wave, beginning at point W, the odds favor of a successful test. However, all the scenarios should be examined and studied to ensure when the market is reentered, the risk reward ratio is his lowest possible.