This past Tuesday, the Wyckoff Wave and the rest of the market had their biggest down day in quite some time. This brought numerous conventional wisdom talking heads to your television screen. They all seemed to be forecasting a substantial down move in the market. One large banking and investment company even suggested its clients consider exiting the market.
Tuesday’s market action seemed to be the self fulfilling prophecy concerning the European credit situation and the economic troubles, especially the large deficit, in the United States. While these significant events are certainly the elephant in the room, does that mean the stock market is on the verge of collapse?
To try to discover an answer to this rather significant question, let’s look at the market Wyckoff style.
First, a quick review of earlier market action.
In early February, 2012, the Wyckoff Wave completed a nice four-month rally to point W. It then moved sideways and had a spring at point Z. The rally off the spring penetrated the resistance (jumped the creek), but ended at point A. While the Wave did back up to the top of the trading range at point B, it did so on fairly high-volume. This troubling aspect was confirmed when the Wyckoff Wave was unable to rally into new high ground at point C and then put in a lower bottom at point D and a lower top at point E. It then returned to the original trading range and sprung that range again at point F.
Again, the Wyckoff Wave tried to leave the trading range to the upside and, once again, it failed. There was simply too much overhanging supply that was being dumped on the market as investors were not only taking profits, but since the Wyckoff Wave was at the bottom of the 2008 distribution range, many people who had bought in to the market before the bear market of 2008 – 2009 were trying to get out even. The Wyckoff Wave had a great deal of supply to take in before it could resume its upward move.
This was confirmed as the Wyckoff Wave reacted, on good spread and volume to point J. This was a weak or even fail test of the earlier spring. The poor quality rally two point K was followed by a new low at point L. Point L was also an important objective on the Wyckoff Wave’s 100 Point & Figure chart. The Wyckoff Wave then, for the first time in several months, rallied strongly to point M. That set the stage for last week’s market action.
The rally from point L, which was also at the top of the November – December, 2011 trading range was able to take out the previous high at point K. The rally was also on good spread and volume, suggesting demand was certainly present. More importantly, it penetrated three resistance points. They were: the bottom of the original trading range (line drawn from point V, the 2011 highs (marked in red) and the top of the original trading range (line drawn from point W). However, the coming reaction would provide some important answers to the future direction and strength of the Wyckoff Wave.
On Tuesday, the Wyckoff Wave dropped 687 points. That certainly signaled the beginning of the expected reaction. Now, where do we go from here?
Friday’s market action suggested a strong lack of demand, making the Wyckoff Wave quite vulnerable for a continued reaction on Monday. The Wyckoff Wave is also approaching the halfway point of the rally from points L to M. It would be an extremely positive indication if the Wyckoff Wave held at or above the halfway point and did so on reduced price spread and volume. This would give the Wave an opportunity to break through the February highs and, quite possibly, begin another markup phase. This scenario, while exciting for the bulls, has a low probability of success.
The Wyckoff Wave could continue to react and find support somewhere between the halfway point and the low at point L. This would suggest we are entering another phase of the trading range and can expect some sideways movement until we see some new ending action. This is probably the most plausible scenario.
The Wyckoff Wave could test point L on good spread and volume. The test could hold at or slightly below point L. A poor quality rally would follow taking the Wyckoff Wave back near the bottom of the original trading range. The rally would be on reduced spread and volume and could be considered a Last Point of Supply. This scenario, which melds with the conventional wisdom of the financial gurus, has in my opinion, an extremely low probability of success.
While the Wyckoff Wave still needs to take in overhanging supply, there is much more demand in the market than one would normally find just before a major downturn. In addition, we are beginning to see some positive indications from the Trend Barometer tools.
1. The Optimism – Pessimism Index has been substantially stronger than the Wyckoff Wave. It has been in its up trend channel for almost 7 months. This is consistent with a positive market. In addition, a supply laden move to the down side most likely will quickly create a positive divergence with the Wyckoff Wave, when compared with important support at point L.
2. On Monday, the Technometer will begin the week in an oversold condition. If the Wyckoff Wave reacts strongly to the down side, it will become dangerously oversold. More significantly, it will become more oversold, at a higher level than point L. This is a positive indication.
3. The Force Index is already lower than it was at point L, yet the Wyckoff Wave is substantially higher. This is another positive indication.
The preliminary indications we are seeing from the trend barometer suggest this Wyckoff Wave reaction will most probably hold above point L and possibly even the halfway point of the rally to point M. This would confirm breaking the short term down trend channel (supply line I – K, parallel support line through point J). This would also create a new short-term up trend channel.
However, it is extremely dangerous to stake out a single scenario and eliminate all others. This leads to self-justification and misinterpretation of market activities. That leads to trading losses.
It is extremely important that all the above scenarios be considered in the coming days and weeks. For starters, it will be extremely important to watch the price spread and volume as the Wyckoff Wave approaches the:
1. above-mentioned halfway point.
2. supply line of the short term up trend channel.
3. lows at point L.
Even if one of these support areas are met, the amount of supply present will provide an excellent clue to the quality of the subsequent rally.
There’s an old saying in sports, “let the game come to you”. It also applies to the stock market. Keep your scenarios in mind. Don’t discount any and let the market come to you.