Starting a New Phase?

Click Here For Wyckoff Wave Chart 08-26-11

The stock market, as represented by the Wyckoff Wave, appears to be entering a new phase. This week’s market action has appeared to confirm a Selling Climax and weakened the latest short term down trend channel. While those who definitively prejudge the future action and trend of the stock market are often disappointed, if Wyckoff students use their knowledge and the Wyckoff Tools, they often have a leg up on their trading counterparts.

While it is certainly acceptable to identify possible future action, it is equally important to consider other scenarios when analyzing the market. This keeps us from becoming so set in our forecast that we find ways to justify our predetermined objectives even when the market is really going in a different direction. I don’t know about you, but I’ve been there and done that.

With that in mind, let’s revisit the Wyckoff Wave as it experienced a Selling Climax in early August. This was a fairly traditional Selling Climax since the Wyckoff Wave reacted sharply and then rallied on dramatically increased spread and volume. It was in a dangerously oversold condition relative to the Technometer and in an extreme oversold position relative to the downtrend channel.

After the Selling Climax, we can expect an Automatic Rally. That took place, but was on decreasing spread and, even more importantly, decreasing volume. This strongly suggested supply was still present and needed to be worked off.

This weak rally also raised the possibility that we had not seen a Selling Climax, but a fall through the ice. There was still more potential to the down side as shown by the counts on the 100 point figure chart. While this was not an expected scenario, Wyckoff students should always keep every option open. The proof would be in the next reaction. Would it hold above and successfully test the Selling Climax? This was where we left off last week.

While the reaction was on good spread and volume, it only lasted two days. Much of the reaction took place during the gap opening of August 18th. The next day supply dried up a bit, but not substantially and then on Tuesday good demand finally returned. The Wyckoff Wave definitively rallied and completed a successful test of the Selling Climax. We can mark that on our chart as point Z.

Now, the Wave needed to rally and test the top of the automatic rally at point Y. In doing so it would also weaken the short term down trend channel drawn through points W and Y with a parallel support line at point X. That the Wyckoff Wave never approached the support or oversold line strongly suggests the supply line would indeed be weakened on the next raly. This happened on Wednesday, but only slightly. One reason is we are running into an area of fairly strong resistance.
1. We are starting to approach point Y where we can expect to see some supply come into the market.
2. Look at the intermediate-term downtrend channel which was originally drawn through point Y and points capital M with a parallel support line through point J. Just as we are we getting the new short-term down trend channel, we are also trying, for a second time to reenter the now intermediate term downtrend channel. This is one reason why it is important to extend the trend channels, even if we think they are no longer applicable.

Sure enough, on Thursday, the Wyckoff Wave experienced an intra day failure to the upside and reacted. Was this the end of the rally to test point Y or were we experiencing some expected supply that needed to be absorbed? Both of these scenarios needed to be considered and were explored on the daily Pulse of the Market report.

Thursday’s market action came on high-volume suggesting a great deal of supply was still present. While the Technometer was not yet over bought, it was certainly high neutral. The Optimism – Pessimism Index was in a minor negative inharmonious action with point Y. However, the Force Index is becoming stronger suggesting improving investor interest.

Friday’s action was extremely positive. There was an intra day failure to the down side and the Wave closed near the top of a wider range in an overbought condition relative to the Technometer.

One of the scenarios mentioned in yesterday’s Pulse of the Market report was that the “Wyckoff Wave would continue its rally to test the resistance at point Y. This appears to be the case. The overbought condition on the Technometer is even more significant in that the overbought condition is appearing at a lower level than when the Wave became overbought at point Y. This gives more credence to the successful test scenario.” Friday’s report continued:

“Regardless of the Wave’s short term movements as it works through this possible new trading range, it will be important to see the relative volume decrease. Ever since just before the Selling Climax, the volume has been quite high. If this is added to the observation of the rally from X to Y on reduced spread and volume, it can be concluded that strong supply has been present for the past few weeks. This supply needs to be worked off and the action needs to quiet before we can consider the trading range to be one of accumulation. If the volume and the spread remain high, there is a good chance we could be looking at distribution.

Based on today’s action, there is a good chance the wave will continue to rally and test the resistance levels established at point Y. If this test is successful, we can then expect a reaction to test the lows at point X and point Z.

If the test at point Y fails, it would be appropriate to draw a new short-term uptrend with the supply line through point X and point Z. A parallel support line would be drawn through point Y.”

Scenarios for next week

1. The Wyckoff Wave will successfully test the top of the new trading range at point Y and begin to react.

2. The Wyckoff Wave will penetrate the resistance. This will take the form of either a Creek Jump without a spring or, because of the large amount of overhanging supply still present, we could see an upthrust.

If, as expected, the Wyckoff Wave remains in the trading range, it could stay there for quite some time. If we are seeing re-accumulation, we will probably see a dollar market with decreased spread and volume, especially on reactions. Distribution will have wider spreads and higher volume.

What to Do?

In my opinion there are no opportunities to the long side. Short-term traders should anticipate a reaction and look for good short candidates.

We are probably entering an interesting time for shorter-term traders, as the trading range will give them both short and long-term opportunities. Even if you are not a short-term trader, take this time as an opportunity to practice trade and improve your entry and exit decision making process.