Last week’s Market Letter spent time reviewing the Wyckoff Wave from a longer-term perspective. In doing that, it made a case that the stock market could well be more bullish than bearish.
In addition, I felt we would not be seeing a significant reaction in the near future.
How did last week’s market action measure up to last week’s Market Letter?
On Friday, May 18th, the Wyckoff Wave had closed near the bottom of a narrower price spread on slightly decreased, but relatively high volume. While it was still in a neutral condition, relative to the Technometer, it was right at the beginning of the over sold levels.
Even though the shortened price spread and slightly reduced volume suggested a lack of supply, there was still a good battle going on between supply and demand.
If the Wyckoff Wave was going to continue to react, it was important to see how it would behave when it reached the support line of the short term down trend channel. In addition, on the next rally, the bulls need to see the Wyckoff Wave move out of the short term down trend channel and rally back towards the original trading range. The weakening of the short term down trend channel would be an important positive indication.
This past week got off to a good start. The Wyckoff Wave did not react, but rallied nicely on Monday. It closed at the top of a wider price spread on reduced, but relatively high volume. More importantly, it weakened the short term down trend channel.
It appeared the bulls were going to have a good week. However, the next day brought the first sign of trouble. The Wyckoff Wave rallied and attempted to return to the original trading range. Just as it got to the resistance/support line, drawn from point V, it ran into supply and closed in the lower half of its price spread. The inability to return to the trading range was certainly problematic.
The next day, there was a gap opening to the down side and the Wyckoff Wave reacted. This was not a bullish indication. However, just as it reached the supply line of the short term down trend channel, good demand came in and the Wyckoff Wave rallied to close near the top of a wider price spread. This intra-day failure to the down side suggested demand was still present.
However, so was supply and it certainly seemed the Wyckoff Wave was not going “gentle into this good night”. Instead of continuing to rally and returning to the trading range, the Wyckoff Wave again experienced an intra day failure to the down side. The reduced volume suggested a lack of demand. This was confirmed by a review of the Wyckoff Wave’s intra-day waves. The withdrawal of some demand, right at the resistance/support line is certainly not a positive indication and strongly suggested the Wyckoff Wave would have a difficult time following through, to the upside, on Friday.
Friday (the last day on the attached chart), was also going to be a bit misleading. It was the day before a major holiday weekend and may traders were either not working on Friday. or leaving early. This would most probably have an impact on the volume.
So what happened? Probably the reaction on reduced spread and substantially reduced volume was the best thing that could happen to the bulls. Despite the expected reduction in volume, the substantial drop we saw on Friday suggests that supply was withdrawn. This gave the Wyckoff Wave one more opportunity to attempt to rally back into the trading range.
Will this happen on Tuesday? I simply don’t know. The Wyckoff Wave could rally. It could continue to react on reduced spread and volume and confirm the breaking of the short term down trend channel. I could be totally wrong and the Wyckoff Wave could rally sharply to the down side. In that case, we would’ve seen a Last Point of Supply.
So, back to the original question. Are we seeing a Last Point of Supply?
A Last Point of Supply (LPSY) is when a stock or index rallies on reduced spread and volume after it has experienced a Sign of Weakness (SOW). This rally is intended to confirm that all the demand for the stock or index has been withdrawn and the stock or index is prepared for its markdown phase.
A classic Sign of Weakness is the Fall through the Ice. This is when a stock or index penetrates an important support line on good spread and volume. It then rallies and is unable to return to the trading range (penetrate the support line). Again, the top of this poor quality rally is a Last Point of Supply.
For us to be at a Last Point of Supply, the reaction from point I to point J needs to be a SOW. While the reaction was on good spread and volume, it took 13 trading days. Usually reactions happened quickly and decisively. While this was a decent reaction it was not a standard fall through the ice for a SOW.
In addition, the rally back to the trading range was not a classic rally to a LPSY. This rally should’ve exhibited a drying up of supply. Instead, the battle between supply and demand continued, with strong supply coming in each time the Wyckoff Wave reacted during a trading day. This suggests the forces of demand have not been defeated and are still active players. That was confirmed on Friday when the market reacted on reduced spread and volume, suggesting that supply, not demand, was drying up.
If the market had attempted to rally and the spread and volume was the same to the upside, it would’ve been a very bearish indication. As the market action was to the down side, it suggests, as mentioned earlier, the Wyckoff Wave can certainly make another attempt to return to the trading range.
While a casual view of the attached chart may make it look like a LPSY, the internals say it is simply not ready to react.
There are a couple of significant concerns when considering this scenario. The first is the Wyckoff Wave’s negative divergence with its Optimism – Pessimism Index. Right now there is a negative divergence with all the highs beginning with point A.
The Technometer is also extremely overbought. It has also been overbought for the last four trading days.
The Optimism – Pessimism Index has been in an up trend channel since last November. It is stronger than and leading the Wyckoff Wave. While these divergences suggest problems, it is quite normal for the O – P Index to lead the Wyckoff Wave during bull markets. Despite our attention to the action of the last few months, the Wyckoff Wave has been in a long term uptrend since the end of the 2008 bear market.
While the negative divergences should not be ignored, they need to be analyzed in the above perspective.
The overbought condition of the Technometer suggests the Wyckoff Wave will react. However, it is important to view the Technometer in conjunction with the Force Index. If the Technometer is in an overbought condition and the Force Index is either in positive or mildly negative territory, the expected reaction should be minor.
The Force Index usually reports fairly negative numbers. While the Wyckoff Wave has been in the overbought condition, the Force Index has reported numbers under -100. Friday’s Force Index was only -67. This would suggest any reaction would be minor and short lived.
Even if I am correct, and we won’t know this for a few days, we still need to put in a successful test of the spring at point F. It would be extremely helpful to the bulls if this test was at a higher level than point F. This of course would require a return to the trading range.
Until we see a successful test, it will be difficult for the Wyckoff Wave to put in any kind of the significant rally.
In my view, the answer to the question is no. Despite that, the Wyckoff Wave has some work to do before the bulls can relax.