Confronting a Difficult Market

Click Here For Wyckoff Wave Chart 12-07-12

As the Wyckoff Wave reacted from the October highs, it formed the down trend channel marked on the daily chart. After returning to its trading range, the Wave appeared headed for the bottom of the trading range, which is marked by a support line drawn from point L.

Then, at point G, the Wyckoff Wave Technometer became dangerously oversold. While the Technometer is presented as a five day moving average, several of the daily readings were at extremely low levels.

The Wyckoff Wave moved into a slightly overbought position, relative to its down trend channel, and then began to rally. As the Wyckoff Wave weakened the supply line, the Technometer moved into an historically high overbought condition.

When the Technometer is overbought, it is helpful to compare it with the Force Index. If the Force Index, which usually has a negative bias, is in positive territory, the expected reaction will probably have a fairly short shelf life and not be particularly deep.

In this case, the Wyckoff Wave continued to rally to point H before we even saw a one-day reaction. That was on Monday. Then, with the exception of Wednesday, the Wyckoff Wave did not produce particularly positive results and basically move sideways.

This week, the Technometer moved back into an oversold condition and on Friday the Wyckoff Wave slightly penetrated the resistance/support line drawn from point W and the halfway point of the reaction from points D to G.

Since point G, the Wyckoff Wave has rallied. The overall quality of the rally has not been terrific, but the results speak for themselves. So far, the expected reaction from point H down to test the lows at point G has not materialized.

So where are we? The Technometer has been dangerously overbought and dangerously oversold. However, it has not had a significant impact on the Wyckoff Wave. The quality of the rally from point G has been poor, but the results have been good. When these conflicting signals arise, as they sometimes do, we need to go back and look at the Wave, from a longer view, and also the individual stocks that make up the Wave.

The weekly chart of the Wyckoff Wave, which is attached to this blog post, shows a support line drawn from point V. If we extend this support line, we see it was penetrated on the reaction to point X, but supported on the next reaction to point Z.

On the November reaction to point D, this support was penetrated. Could this have been a spring and is the Wyckoff Wave rallying off the spring and preparing for a secondary test?

Before attempting to answer that question, let’s look at the 12 individual stocks that make up the Wyckoff Wave. When comparing relative strength and weakness, we find that 6 are stronger, 2 are weaker and 4 are the same as the Wyckoff Wave. During the past two weeks the number of stocks stronger than the Wave has increased by 1 and those weaker than the Wave have decreased by 2. This is a bullish indication.

If we look at how the 12 stocks are trending, we find the following:
Short Term Trend: 9 are in an up trend, 2 are in a down trend and 1 is neutral.
Intermediate Term Trend: 1 is in an up trend, 2 are in down trends and 9 are neutral.
Long Term Trends: 8 are in an up trend, 1 is in a down trend and 3 are neutral.

In addition, 4 of the individual stocks, CAT, IBM, UNP and WMT have all recently had either a #2 spring or a #1 spring (shakeout).

While this does suggest the outlook is certainly more bullish than bearish, how does it relate to the future direction of the market?

It probably adds another scenario to the mix.

One scenario is that the Wyckoff Wave will continue to rally and test the top of the trading range. The positives are that on Friday the Wyckoff Wave slightly penetrated the point W resistance/support line. The negatives are a Technometer that is moving towards an overbought condition and an Optimism – Pessimism Index that is putting in more effort than the Wyckoff Wave is producing results.

The second and third scenarios have the Wyckoff Wave reacting. The difference is the length and strength of the reaction.

The second scenario assumes that point G was a spring and a successful test of the spring would be at or above the support line drawn from point F on the daily chart.

The third scenario has the Wyckoff Wave reacting and probably putting in a spring at the bottom of the trading range (the support line beginning at point L).

How these two scenarios play out will depend on the reaction. If the Wyckoff Wave reacts next week and does so on reduced price spread and volume, scenario number two has the highest probability of success.

If the Wyckoff Wave reacts sharply on good spread and volume, the probability increases that it will test the bottom of the trading range.

If either one of these two scenarios comes to fruition, there will be an excellent buying opportunity to the upside.

Finally, while it is always possible that the Wyckoff Wave will simply continue to move sideways, the Wave’ s behavior does suggest we may be headed for cementing action.

The Wyckoff Wave’s bullish behavior does suggest that it will not strongly penetrate the support at the bottom of the range and “fall through the ice”.

This month will bring us some important and interesting news. Will it be the catalyst that identifies the winning scenario