Finding Turning Points: Sometimes You Win, Sometimes You Lose

Click Here For Wyckoff Wave Chart 06-15-12

This week I had a wonderful conversation with a Wyckoff student. We discussed the market, but more importantly, he shared some of his excellent ideas on how and when to trade.

“I just trade Springs and Up thrusts”, he said. “I find I can get some excellent returns over a few months. It’s a lot easier than trying to time the market.”

This Wyckoff student trades options and is very selective on what he buys and the premium he pays. In the past year, he also has had some very successful trades.

Springs and Up thrusts. I thought a great deal about those important Wyckoff concepts and our conversation as I tried to anticipate a market turning point during the past week. While I used tried and true Wyckoff principles along with the Optimism – Pessimism Index, the Technometer and the Force Index, the Wyckoff Wave decided to ignore everything and continued its rally. It is presently about 400 points higher than my anticipated turning point.

So what happened? First of all, the Wyckoff Strategies & Techniques are not mechanical indicators that automatically tell us when the market is going to change direction. They are simply tools that we can use to improve our trading results. If we stick with the basic concepts of trading ranges, springs, secondary tests, signs of strength and last points of support (up thrusts, secondary tests, signs of weakness and last points of supply) our success percentage, like my telephone friend mentioned above, increased dramatically. Without those key indicators, our success rate does decrease.

Now, let’s look at last week and my, apparently flawed, logic.

A week ago Friday (the day just to the left of point M), the Wyckoff Wave experienced an intra-day failure to the down side. It closed at the top of a wider trading range, in an extremely over bought condition relative to the Technometer. Good demand came into the market and the Wyckoff Wave had an opportunity to return to its original trading range. This was a bullish indication and suggested that the coming reaction would successfully test the lows at point J.

It is important to understand that the Wyckoff Wave has had two lower lows (point J & L) and needs to put in a higher low before the trend can be changed. The farther the Wyckoff Wave could move into the trading range, the higher the probability we would put in a higher low.

Then on Monday (point M) the Wyckoff Wave experienced a large gap opening to the upside. That was the best news of the day for the bulls, as supply came in and the Wyckoff Wave closed, on slightly decreased, but sustained volume, at the bottom of a wider price spread. The Technometer was still in an over bought condition. The day’s action suggested this was the end of the rally and the Wyckoff Wave would react and begin the tests of the lows.

It seemed that additional confirmation of this scenario was received on Tuesday (the day after point M). The Wyckoff Wave rallied on decreased price spread and volume. It also continued in an over bought condition on the Technometer. The price spread and volume suggested a lack of demand. While the relative price spreads were a bit wide, it did not appear that enough demand was present to push the Wyckoff Wave through the second resistance area (the 2011 highs that are marked by a red horizontal line).

Finally, a look at the Optimism – Pessimism Index showed a negative divergence between the O – P Index and the Wyckoff Wave. It also showed a change in character. For the past several months the O – P Index has been leading the Wyckoff Wave. Now, compare the O – P Index with the day before point M. All of a sudden the effort has left the market as the O – P Index is now moving sideways and no longer leading the Wyckoff Wave.
While this is very short term in nature, we are looking for a short-term turning point.

All this would suggest there is a good probability the Wyckoff Wave would begin to react and aggressive, very short-term positions could be taken to the down side.

However, if the above is correct, the Wyckoff Wave needed to react strongly and needed to go and go now. The next day, Wednesday (marked in red), the Wyckoff Wave experienced a gap opening to the down side. It then rallied poorly reacted and closed in the lower half of a narrower trading range. The volume increased slightly. This all suggested the presence of supply. So far, so good. However, the next day needed to see increased spread and volume to the down side.

Thursday did indeed bring increased spread and volume, but it was to the up side. That’s an OOPS. At that point, it became apparent that we were seeing some absorption and the Wyckoff Wave did indeed have the ability to move higher. Hindsight suggests the wider spread is a sign of absorption. However, I would’ve expected the relative volume to be a bit higher.

Needless to say, since the Wyckoff Wave did not go and go now, those aggressive positions to the down side need to be quickly closed. In this situation, one does not wait for a stop order to be executed. When the Wyckoff Wave or your individual trade doesn’t do exactly what you expected and quickly, run, don’t walk to close it out.

Does this mean the Wyckoff Wave is not going to react? There is going to be a reaction, it’s just a matter of when. In addition, the stronger the move to the upside, the higher probability that the reaction will be reasonably short and consist of a drying up of supply. If successful, this will prepare the Wyckoff Wave for the next leg of the bull market. The question is when?

There are a couple of things to keep an eye on. Presently, the Technometer is in an over sold condition. This would suggest the Wyckoff Wave has more room to the upside. The Force Index is also rallying strongly and moving into low negative numbers.

On the other hand, there is still no significant effort shown by the O – P Index. The short term negative divergence is becoming more prominent. This, in itself, suggests we can expect a reaction.

This past week, things looked good for a brief rally to the down side. Patently, that didn’t happen. This is why we have stop orders and why traders should write down their expectations and if the market or their individual trade doesn’t perform exactly as expected, they should, like Elvis, leave the building.