Good News for Bad News? A Spring or a Fall Through The Ice?

Click Here For Wyckoff Wave Chart 07-24-2015

Last week we discussed the wonderful Robert Evans lecture about the Shell Diver. Sadly, for both the diver and the stock market, they were unable to reach the surface (supply line of the short-term downtrend channel) and reacted. This failed effort is marked by point L and the down arrow.

Failing to reach the supply line, the Wyckoff Wave reacted sharply and, as of Friday, had penetrated an important support level. It is marked by the line drawn from point I.

In the shell diver story, the diver, failing to reach the top, dove back down to take one last attempt at reaching the surface. This is what happened during this week’s market.

What will happen to the diver? Will he make it back to the surface or will he fail and fall back into the depths, never to return?

On Friday, the stock market closed in exactly that position. Early next week, one of three things will probably happen.

1. The Wyckoff Wave will be unable to rally and continue to react. Supply would be strong and sustained. This could be the beginning of a significant reaction.

2. The Wyckoff Wave will attempt to rally, but be unable to penetrate the support, now resistance line drawn from point I. The rally would be on poor price spread and volume. If the Wave was unable to return to the trading range it would experience a Last Point of Supply. The reaction described in scenario 1 would then come into play.

3. Good demand will come into the market and the Wyckoff Wave will rally back through the bottom of the trading range. The rally would be on good price spread and strong volume. This would indicate that Friday’s reaction was to beginning of a Spring. Good demand coming into the market on Monday would confirm the spring scenario.

These are the three basic scenarios. One is expected to play out next week.

There is one caveat. The stock market does not always move in such a definitive manner. The answer may not come on Monday. However, if Monday is not provide a definitive answer, it will begin to provide important clues as to which scenario will play out.

In my opinion, the Spring (scenario 3) continues to have a good probability of success. Admittedly, I have been discussing this scenario for several weeks and it has yet to happen. However, there are several reasons why it may be successful.

1. Even though the Wyckoff Wave was unable to reach the supply line at point I, the supply during the reaction has been consistently moderate. Normally, if the Wyckoff Wave was going to react sharply, as the reaction continued, we would see increasing in stronger supply.

2. The Optimism – Pessimism Index has moved into a positive divergence with the Wyckoff Wave when compared to point I. This is a relatively significant intermediate term positive divergence.

While the Wyckoff Wave closed lower on Friday than point I, the O – P Index is quite a bit higher. This suggests that there is not a great deal of effort on this reaction. It also confirms the observations noted in point 1.

On Friday, the Technometer moved into a dangerously oversold condition. It’s readings were at a five-year low. While this does not guarantee an immediate reversal, it is very difficult for a reaction to continue in the face of a dangerously oversold Technometer.

The one negative is the Force Index. It is producing high negative readings. When this happens and the Technometer is oversold, there is a mitigating impact on that reading. It would suggest any rally may not be as strong as expected.

However, it is also important to note that the Force Index is in a slight positive divergence with the Wyckoff Wave, when compared to point K. While the Wyckoff Wave is noticeably lower, the Force Index is slightly higher.

While this is all very nice, what should a Wyckoff trader do?

The key is in the demand. Many Wyckoff students, seeing a reaction through an important support area, automatically assume a Spring is taking place. They rush in prematurely and take new positions should the upside.

Over the years, I have learned to be a bit patient. Wait until demand comes into the market. Analyze the demand. Make sure it is strong and sustained. If it passes the test, new positions can be taken to the upside on the Spring. You may not get the exact low, but taking a position anywhere on the Spring is correct Wyckoff disciplined.

The stock market is at a critical juncture. It may be rising to the top and begin a new leg in this wonderful bull market. Or, like the shell diver, it may be falling to its demise.

I believe we are seeing the former, but I will watch each of these scenarios closely and take the appropriate action when one is confirmed.

While I believe in the Spring scenario, I am not wedded to it and am prepared to make adjustments if another scenario proves correct. Emotions have no place in the stock market.