Taking a Short Term Position

Click Here For Wyckoff Wave Chart 11-23-12

The Wyckoff Wave finished this holiday shortened trading week with a bit of a surprise. After rallying from point G, the Wave appeared to be running out of steam as it approached support line D – F. Price spread and volume was reduced and the Technometer moved into an overbought condition. In addition, the Optimism – Pessimism Index was in a negative inharmonious action, when compared with the Wyckoff Wave at point D.

It was now expected that the Wyckoff Wave would react and test the previous low at point G and the bottom of the trading range (line drawn from point L).

On Tuesday, subscribers to the Pulse of the Market newsletter were advised to look for short-term opportunities to the downside. The Wyckoff Wave put in an extremely poor performance on Wednesday, which certainly seemed to confirm this recommendation. This recommendation was made at the end of the day marked with the red arrow on your chart.

Then on Friday the Wyckoff Wave rallied strongly through the support line and weakened the short term down trend channel. While volume appeared to be lighter than on Wednesday, this was a bit misleading due to the shortened trading day. In fact, demand was most certainly present.

Does Friday’s performance negate the recommendation? The answer to this question lies in buying strategies.

First, it is important to recognize that the Wyckoff Wave is a leading market indicator. It has proved to be quite reliable in identifying potential turning points. When the Wave identifies a buying (long or short) opportunity, the Wyckoff trader then begins to search his or her list of candidates that appear ready to move to the downside.

These candidates now need to meet specific criteria before a position is taken. Sometimes a candidate will have already begun its move and should not be chased by the short term trader. Sometimes the timing is immediate and a position to the downside can be taken. Sometimes the candidate will not begin its move for a few days after the Wyckoff Wave indicates a reaction is expected.

Since Tuesday evening, I have been reviewing candidates to the downside. None have met my criteria and therefore, no new positions have been taken.

In the Wyckoff Wave world there are no automatic buying or selling signals. There are buying tests and selling tests and specific criteria that needs to be met before a position should be taken.

In short term trading, the following criteria needs to be followed. Remember short-term trends work in days and weeks. Therefore, the analysis for short-term trade should only look at a reasonably short period of history.
1. The activity needs to be bearish. That is volume should increase on reactions and decrease on rallies.
2. The stock should be weaker than the market.
3. The stock should be near or at the supply line of the short term down trend channel.
4. The stock’s Technometer should be in an overbought condition.
5. We should see a negative divergence, or at least strong negative inharmonious action with the stocks Optimism – Pessimism Index on a short-term basis.
6. The estimated profit exceeds the risk (stop order – physical or mental) by the traders predetermined risk/reward ratio. It has been my experience that no short term traders use ratios between 2/1 and 3/1.

Unless a stock is able to satisfy all the above criteria, taking a position is not recommended.

When analyzing your candidates, using the above criteria, it is extremely important to look for anomalies. One of the biggest mistakes the trader can make is to emotionally try to justify the trade. Once a candidate looks qualified, take a few minutes and look for something that is not quite right. Maybe the volume was a little high for the spread was slightly increased, when it should have decreased. The Technometer wasn’t overbought, but everything else looks great.

It is much better to miss an opportunity than be overly aggressive when entering the stock market. Money that is lost in a half thought through trade is capital that is gone forever.

When the market closed on Friday, the Wyckoff Wave’s Technometer had reached a 3 1/2 year high. The Optimism – Pessimism Index was in a very noticeable negative inharmonious action with the Wyckoff Wave. In fact, it was  just a few points away from being a negative divergence,  when compared to point D. It is quite significant when the O – P Index is at the same level and it was at point D and for the Wyckoff Wave to be over 1, 000 points lower.

I have identified candidates for short-term short positions. Presently, not all the criteria described above is being met. If and when it is, I will take short positions. If the criteria is not met, even if the market reacts, I will not take a short position.

Finally, write down exactly what you expect your candidate to do once a position is taken. If that doesn’t happen, exit the position.

Short-term trading is tricky. Let the index identify a changing trend. Select your candidates using specific criteria. Time your trades when all the criteria is met. Make sure you have an acceptable risk/reward ratio.

Above all, and emotional justification of a maintaining trade that doesn’t do what is expected, should never enter the short term traders mind. It’s a great way to pay tuition to the University of Wall Street.