Test of an Upthrust?

Click Here For Wyckoff Wave Chart 09-02-11

The stock market, as measured by the Wyckoff Wave, has up thrusted the new trading range and is reacting. We can expect to see the response to the upthrust, in the form of a test, possibly as soon as next week.

Let’s look at the various scenarios that we could encounter as summer turns to fall.

This week, the Wyckoff Wave rallied and penetrated the resistance at point Y. Point Y was the top of the automatic rally that followed the climactic action at point X. After the first day, this rally was on decreasing spread and volume and the demand that was present early was not sustained. The Wave then reacted to test the Selling Climax at point Z. It is important to note that the bottom of this reaction held above points X.

The Wave then rallied on slightly improved spread and volume. However, the spread and volume decreased near the end of the rally. This showed that demand was being withdrawn. Since the rally penetrated the resistance line and then reacted back into the trading range, the rally to point A needs be called an upthrust. There is also another, more bearish scenario, that will be discussed later in this letter.

After reaching the highs at point A, the Wyckoff Wave reacted. The first day saw an intra-day failure to the upside, which suggested a lack of demand. Yesterday was most interesting. While the markets were down strongly, much of the reaction was on a gap opening. This meant that the actual price spread was narrower than on Thursday. This narrower spread combined with increased volume suggested there was some demand present in the market and the day was not as negative as it first seemed.

In addition, the Technometer became extremely over sold, suggesting we should see a test of point A in the near future. In addition, there is a minor positive divergence with the Optimism – Pessimism Index. While still holding above the low at point Z, the O – P Index has fallen below where it was last Friday, while the Wyckoff Wave is presently above last Friday’s lows.

All this suggests the Wyckoff Wave will test both the intermediate term down trend channel and the short term uptrend channel and then rally to test the upthrust. If this happens, the Wave will have put in a second consecutive higher bottom.

Presently, the Wave is in a short-term uptrend and is testing the supply line of the intermediate term downtrend. The short term down trend channel W – Y, with a supply line through point X was broken and was removed from the chart.

That all being said, when is an upthrust not an upthrust? The automatic rally that follows a selling climax does not necessarily dictate the top of the new trading range. It is certainly possible that the rally to point A is simply establishing a new top for the trading range. The key will be in the reaction following the test. If strong supply, in the form of increasing spread and volume, comes into the market, point A can most certainly be called an upthrust. The following reaction would be a sign of weakness (SOW). We would then see either a continued reaction and fall through the ice, or support at the bottom of the range and a poor rally for a last point of supply (LPSY). As always, the answer is in spread and volume.

Just to complicate matters, it is not uncommon to see a spring following an upthrust. Wyckoff traders need to carefully watch any penetration of the trading range’s support and make sure that all of a sudden good demand does not appear.

If the reaction following the test is on poor spread and volume, especially near the bottom of the range, one can conclude we have seen an expansion of the trading range and we should keep an eye open for ending action.

The Bearish Scenario:

Sometimes we pay so much attention to day to day activity that we miss the perspective of a larger view of the market. Therefore, I have also attached a a weekly chart of the Wyckoff Wave. It is page 2 of the Adobe Acrobat PDF file.

Earlier this week, Fred Keith, an expert Wyckoff student, commented that the Wyckoff Wave was approaching the halfway point of the reaction from point G to point X. Could we have seen a major fall through the ice to point X, instead of a selling climax? Could the following rallies, which have certainly been on reduced spread and volume, be rallies to an important last point of supply (LPSY)? Instead of a trading range, are we in and intermediate term downtrend? Whether we are or whether we are not, the Wyckoff student has to consider every possible scenario. A count on the 100 point and figure chart from point U to point G take the Wave down to at least the 13,400 level. This is the second recession, market collapsing scenario, we hear in the news.

While this certainly can happen, there are several reasons which make me uncomfortable with this scenario.
1. It is not common to see climactic action at the bottom of a major fall through the ice.
2. Bear markets move very quickly. After the fall through the ice, we should expect a brief rally and then a major collapse. That didn’t happen. In fact, the Wyckoff Wave rallied (automatic rally), reacted to a point above the climactic action and then rallied again to a high above the previous top.
3. The O – P Index would be expected to lead the Wyckoff Wave into new low ground. In relation to point X, it is in harmony with the Wyckoff Wave.
4. When compared to the Technometer, the Force Index is stronger. Again, that suggests the significance supply needed to complete this scenario is not yet present.

Based on the above, I am more confident we are continuing to see a developing trading range. It may be accumulation or it may be distribution. Ending action will give us the final answer.

What To Do:

Short-term traders can look for opportunities to the down side and be prepared to enter the market on a successful test of the upthrust. In my opinion, despite the short term uptrend, there are no short-term opportunities to the upside.

Intermediate-term traders can certainly take positions on the upthrust test, but should be extremely careful. They might wish to wait until a sign of weakness followed by a last point of supply gives him a better indication that there will be a sustained down move.

While the Wyckoff student is taught not to pay attention to news, we all need to understand that the situation in Washington, D. C. will, most probably, make itself present in the market. This will be a result of an emotional response to our old friends fear and greed. You may expect to see wider than normal spreads and higher-than-expected volume. Again, this will not alter the direction of the market, but will:
A). Get us to turning points faster than normal and
B). Make it harder for the Wyckoff student to judge the market.

While the headlines cannot be avoided, trading decisions must be made based on Wyckoff philosophy. Stay strong. Avoid fear. Make great trades.