Are We Seeing An Important Sign Of Weakness?

Click Here For Wyckoff Wave Chart 11-16-12

During the last two months the Wyckoff Wave has lost over 3, 350 points or 10% of its value. The move down from point D, on the daily chart, has been strong and fast. Many traders are forecasting gloom and doom and some have even exited the market. The pending crisis in Washington DC has certainly not helped the situation.

Presently, the Wyckoff Wave is hovering just above an important support line drawn from point L. This line is the bottom of a long sideways movement that began last January. The resistance line is drawn from point A. While other areas of resistance and support have come and gone, these have become the best identifiers of this 11 month trading range.

Before looking at this trading range in more detail, let’s review the Wyckoff Wave’ s weekly chart. The low that is marked as point L on the daily chart is marked as point X on the weekly chart. This has become a very important support point. If the support line is extended to the left of point X, it becomes an important resistance line drawn from point K. Because it is both a resistance and a support line, the Wyckoff Wave should meet demand as it tests the lows at point X.

The weekly chart also shows that the support line is just above the halfway point of the rally from the first point X to point C. The X – H trading range was an important accumulation area that was the cause of the move to the 2012 highs.

I have received several e-mails from Wyckoff students who are calling the move from point D a Sign of Weakness. They may be correct. There conclusions will be vindicated if the Wyckoff Wave penetrates the point L support area on wide price spread and good volume.

However, a few things concern me when reviewing this scenario.

In most cases a Sign of Weakness for a Sign of Strength needs something to “kick it into action”. That something is usually an upthrust or a spring. In addition, a move to the down side is preceded by a sideways trading range that builds the cause for the reaction. Trading ranges, especially when the market is making a major change in direction, usually begin with a Buying Climax.

A review of the Wyckoff Wave’ s trading range, that began in January, does not give us a Buying Climax. While the rally to point A was certainly on high volume, the price spread actually decreased as the Wave approached point A.

Rather than being a Buying Climax, the move to point A appeared simply appeared to be a meeting of supply. The Wyckoff Wave then reacted, but continued to move sideways.  Therefore, it is reasonable to conclude that the Wyckoff Wave did not experience a Buying Climax that could signal the beginning of a distribution style trading range.

Our hunt for ending action, in the form of an upthrust, brings us to point S. Here, the Wyckoff Wave attempted to leave the trading range to the upside. It failed and reacted sharply back to point T. Was this an upthrust?

An upthrust’s characteristics are increased volume, decreased price spread and a poor close. The day before point S we saw increased price spread and volume. The next day saw a decrease in price spread and a poor close. However, the volume was greatly reduced. Instead of supply coming into the market, it was actually withdrawn. While there was a two day reaction to point T, the Wyckoff Wave then spent the next five weeks reacting to point W. This is not how an index or stock reacts after an upthrust. Supply was simply not present.

This long slow reaction on decreased spread and relatively decreased volume is certainly not an indication of distribution.

The Wyckoff Wave then rallied to point X. As it reached the resistance drawn from point S, it experienced some absorption and then jumped the Creek and rally to point X. While point X does exhibit the characteristics of an upthrust, the Wyckoff Wave was too far above the resistance for this to be truly called an upthrust. This was confirmed by the reaction back to point A. This reaction was also long and slow and saw support at the resistance line which marked the top of the trading range. As the Wave approached point A, the price spread narrowed. Again, this is not conducive to how a stock or index would behave if it experienced an upthrust.

Up until now, the indications have been quite bullish. I have written about these in previous articles and there is no need to repeat them again. The Wyckoff Wave was about to experience problems. There was a poor quality rally to point D, a reaction to a lower bottom at point C and an even poorer quality rally to point D. The Wyckoff Wave then fell back into the trading range and has reacted ever since.

As the wonderful Creek Story illustrates, the little boy can certainly fall back into the creek and all his efforts went for naught. This appears to be simply what happened to the Wyckoff Wave. It is reacting, taking in supply and about to meet an important area of support.

However, let’s assume that point X began a distribution phase that ended at point D. It is fair to call the move from point D to E a minor sign of weakness and the rally to point F a minor Last Point of Supply. If we take a count from point D over to point X, on the 100 Point & Figure chart, the objectives are between 29,300 and 28,100. These objectives begin just below the support line and end just above the halfway point of the move from point X to point C, which is shown on the weekly chart.  Presently, it is difficult to forecast any move below these objectives.

Since it is difficult to justify that the trading range that began in January was distribution, what are the possible scenarios?
1. The Wyckoff Wave will react, test the support line, and then rally back into the trading range. This will begin a new phase and we will continue to wait for ending action.
2. The Wyckoff Wave will spring the trading range. If the test of the spring is successful, we will have seen ending action and the opportunity for a significant move to the upside.
3. While this is the least probable of all the scenarios, the Wyckoff Wave could indeed react strongly through the resistance and the halfway point of the last move. While the odds do not favor this, it is important to keep this scenario in mind as the Wyckoff Wave approaches this significant support area.

As we have climactic action (Buying or Selling) or ending action (upthrust and springs), it is reasonable to assume that the Wyckoff Wave has simply moved sideways since January and that we are in a period of re-accumulation.

While the Wyckoff trader certainly has preconceived notions as to the future direction of the market, it is important to keep all scenarios in mind and not dismiss any scenario out of hand. That being said, the bulls may be seeing an excellent buying opportunity in the days or weeks ahead. It’s all about ending action.