Overhanging supply and the news

Click Here For Wyckoff Wave Chart 12-09-11

No one can dispute that the financial problems plaguing the European Community are not having an impact on the American stock market. It has become a major topic of discussion among investors and traders. Each morning, everyone checks the S&P futures before having their first cup of coffee.

However, Wyckoff traders are taught to ignore the news. They know that news doesn’t change the market’s real destination, it just gets it there quicker. Is this teaching wrong? Have the advances in communication and the 24-hour news cycle changed the market’s from the original Wyckoff perspective? Some think so. Respectfully, I do not.

Perhaps it is not news that is causing some turmoil, but the large gap openings that occur based on a particular development in the European community. These gap openings can cause investors and traders to misread today’s market action.

For example, recently the Wyckoff Wave had a gap opening of over 700 points. The same day the S&P 500 had a gap opening of over 30 points. Both indexes closed near the highs of the day on increased volume. In addition, the price difference between the day’s close and the previous day’s close was almost 1000 points on the Wyckoff Wave and over 35 points on the S&P 500.

A casual look at the day’s action could cause one to conclude strong demand was present and the market was going to continue higher. That was not the case. Gap openings don’t count when analyzing a price spread. What does, is the difference between the actual high price and the actual low price. In this case, on both indexes, the price spread was narrower than the previous day. This suggests that supply came into the market. While everyone else was getting excited, the savvy Wyckoff trader saw problems.

Three days later, with the help of a few more gap opening to the down side, the Wyckoff Wave has reacted and lost over 1500 points. You can see this by looking at the action around point K on the attached chart.

In my opinion, the news impacts markets openings more than it does during the trading day. While this makes it more difficult for the short-term trader to enter and exit the market, it should not impact market analysis.

I would suggest that the amount of overhanging supply, that was discussed in the last market letter, has much more to do with the condition of the market than news from Europe.

How the stock market, as represented by the Wyckoff Wave, handles this overhanging supply will tell us a great deal more about its future direction than the news.
The Wyckoff Wave broke the long-term uptrend channel, that is seen on the left side of the attached chart and reacted strongly to a selling climax at point X. This began a new trading range, which could be easier accumulation or distribution. However the trading range itself can present several clues.

The first significant clue was the spring at point H. This suggests the trading range was accumulation and the market is going to advance.

The market rallied strongly to point I. It then moved sideways for several days. It was unable to rally through the resistance. It was also unable to react back into the trading range. It was experiencing absorption. A portion of the tremendous amount of overhanging supply, not only from earlier this year, but from the bear market of 2008 (people trying to get out almost even or with a small loss). This is a lot of supply and it needs to be placed in strong hands before the market can advance.

The market finally broke through the resistance to the upside. Again, the rally was stopped as more supply came in at point K. At this point, three things could’ve happened:
1. This could’ve been a major upthrust and the Wyckoff Wave could have reacted strongly back into the trading range and beyond. There was a potential for a continuation of the bear market. If one paid attention to the news, that was not an unthinkable scenario.
2. The Wyckoff Wave could have backed up to the creek. The creek, which is drawn in blue shows the near bank at point A and the far bank drawn through point E. A normal backup would be completed on reduced spread and volume.
3. Neither of these would happen and the Wyckoff Wave would simply establish a new trading range and begin to move sideways. This would also be another phase of the trading range that began at point X.

The reaction from point K was on widespread and good volume. Was the upthrust scenario coming to fruition? In fact it wasn’t. The Wyckoff Wave rallied, reacted rallied again and then started the fall back into the creek. In fact it went slightly past the creek and briefly returned to the trading range. It then rallied all the way to point G.

If you look at the chart you will see that a great deal of supply was present. Normally, this amount of supply would drive the Wyckoff Wave at least to the bottom of the trading range. This didn’t happen. This would suggest more and more supplies being dumped, but is being accepted by professional or strong hands. The fact that the supply is being accepted at these levels is, in my opinion, an encouraging sign that this trading range is accumulation. This will be confirmed, one way or the other, by the ending action.

Now the Wyckoff Wave has again rallied to test the highs at point K. As it approached point Q, we saw decreased spread and slightly decreased volume. We also saw the Wave’s inability to penetrate the resistance level on three consecutive days. The reduced spread and slightly reduced volume suggested a general lack of demand and that the Wyckoff Wave would react towards the bottom of the new trading range.

Then, last Thursday and Friday there was a minor change of character. On Thursday, we saw wider spread and increased volume to the down side. Friday brought a complete reversal. Increased spread and volume to the upside. This wider spread and good volume are indications of our old friend absorption. Again, more stock is being dumped by weak hands. It is, however, being taken in. This is one more indication that we are seeing a period of accumulation.

The problem with absorption is that one doesn’t know when it is complete. This makes things tricky, especially for short-term swing traders.

As the market rallied to point Q, the narrower spread suggested there was a short-term opportunity to the down side. Short-term traders were delighted on Thursday. Disappointed on Friday. So, what’s going to happen on Monday?

The Wyckoff Wave could upthrust the resistance. It could react and continue adsorption. It could jump the resistance and move into new high ground. It could react back to the bottom of the new trading range.

In the interest of full disclosure, I am one of those short-term traders that is sitting on a small profit after Friday’s close. To be honest, I haven’t a clue what the market is going to do on Monday. Of the 12 stocks that make up the Wyckoff Wave, 4 look like they are prepared to advance, 4 look like they are prepared to react and 4 look like they are prepared to go sideways. Not much help there.

While I would like to see the market react, it really doesn’t matter. If the market advances, I have established a stop order that will close my position with a small profit. If the market declines I will simply move my stop order. The key is to plan ahead. To anticipate a market move in either direction and established specific plans for each scenario. Then, maintain the necessary discipline to carry out your plan.

For short-term swing traders, it’s never about how much you make, it’s about how much you don’t lose.