Market Discipline.  Are We Falling Back Into The Creek?

Click Here For Wyckoff Wave Chart 10-12-12

Back in September, the  stock market, as measured by the Wyckoff Wave, jumped the creek.  It penetrated the July highs at point S on excellent spread and volume. This followed a long slow reaction to a Last Point of Support at point W.

It then seems reasonable to expect the Wyckoff Wave to begin to react back to that old resistance, now support, line drawn from point S.  This is also known as the near bank of the creek.  We would also expect that reaction to be on reduced spread and volume.  Once completed, the Wyckoff Wave would put in an even more important Last Point of Support as it was ready to enter the mark-up phase.

The reaction lasted for 10 trading days.  Reduced spreads and volume suggested good supply was not present.  Although the volume was a bit higher than expected, it was acceptable for this type of reaction.  In addition, the Wyckoff Wave was in an oversold condition relative to its Technometer.  It was also in a positive inharmonious action with its Optimism – Pessimism Index, when compared with point W.  So far, so good.

The Wyckoff Wave then began to rally and move to point B.  Unfortunately, the rally was not of good quality and, although it weakened the short term down trend channel (drawn in red), it was not able to move into new high ground. This suggested all the overhanging supply had not been taken in.

If you read last week’s Market Letter, there was a tremendous amount of pent-up demand during the 2006-07 bull market.  This is probably where the overhanging supply is coming from.

This is a minor change in character, as one would expect the rally to have more demand.

This week, after a reduced spread and volume day on Monday, that can be ascribed to the Columbus Day holiday, supply did come into the market on Tuesday.  This drove the Wyckoff Wave back into the creek.  Tuesday’s market action was similar to that at point Z where the market reacted on wider spread and increased volume.  In fact, the price spread and volume were almost identical.

Unfortunately for the bulls, while the price spread dramatically reduced  after the reaction at point Z, it stayed a bit wider during the last three days of this week.  The comparative volume was basically the same.

In addition, the Wyckoff Wave has penetrated the far bank of the creek (the support line that begins at point S and travels through points U and V).  It has also weakened the intermediate term up trend channel drawn through points L and W.

It appears the market action over the past three trading days has demonstrated a lack of demand rather than the presence of supply.

On the surface, it would seem that the Wyckoff Wave is headed back into the trading range to test the lows at point W.  It would confirm the overhanging supply has not been taken in and we are probably looking at a new phase of this ten-month trading range.

In situations like this, it is extremely important to maintain market discipline and look at all of the Wyckoff strategies and the Wyckoff Tools.  An important question needs to be asked.  Has the market action of the past three days superseded what we have seen over the past several months?

At times like these, it is extremely important to step back and look at the big picture.  Too often we draw intermediate-term conclusions based on short term observations.

We are looking at an intermediate to long-term situation.  The Wyckoff Wave has been in a trading range since January 2012.  We have already seen an important intermediate-term Last Point of Support.  There is still a good possibility that we will see an even more important Last Point of Support that could have long-term consequences to the upside.

To step back and look at the bigger picture it is helpful to study the weekly chart of the Wyckoff Wave, which is the second page of the attached charts.

The Wyckoff Wave’ s long ten-month trading range began at point U.  It is therefore reasonable to draw a resistance line from that point over to the right.  A second resistance line is drawn from point U through point W and Y.  These two lines form the creek.

At the end of July the Wyckoff Wave attempted to leave the trading range to the upside at point A.  This could have been an upthrust.  However, supply never came into the market and we had our S Point of Support at point B.

If we look at the trading range that includes all the market action from January, the Wyckoff Wave has only partially entered the creek.  It is also holding above the support line of the long term up trend channel that is drawn in orange.  The weekly chart places the Wyckoff Wave in a more bullish position than the daily chart.

Now let’s look at the Wyckoff Tools.  The Technometer is in an oversold condition and will open on Monday in a dangerously oversold condition.  This would appear to make it difficult for the Wyckoff Wave to strongly react and some sort of the rally is reasonable to expect.

The Optimism – Pessimism Index is at the same level as it was at point W.  Yet the Wyckoff Wave is substantially higher.  This positive inharmonious action suggests that the overhanging supply coming into the market is still being taken in by stronger hands.  If that was not the case, the Wyckoff Wave would probably be at the same level as point W.

The Force Index rallied this week, even though the Wyckoff Wave reacted.  It is also in a positive divergence with the Wyckoff Wave when compared with point W.  The Force Index is an indication of longer-term investor sentiment into the market future direction.

Looking at the Wyckoff Wave from this perspective suggests the probability of a rally scenario is stronger than a reaction back into the trading range.

The Wyckoff Wave is in a critical position.  Next week it will tell us whether we are going to rally or continue sideways movement with a new phase of the trading range.

While one can always be wrong, a longer-term view often prevails in these types of situations.  For the past several months, the Wyckoff Wave has sent us a consistent message.  In the words of the great sports writer Dan Jenkins, “You dance with who brung you”.