Testing the Spring – Are We Going Up or Down?

Click Here For Wyckoff Wave Chart 04-20-12

This week, the Wyckoff Wave concluded its rally off the spring (shakeout) at point F and began testing reaction. Its success or failure could significantly impact the future direction and objectives of the stock market, as measured by the Wyckoff Wave.

While many Wyckoff students, including myself, have a bullish bias, it is extremely important not to allow this to cloud our judgment. It is always best to analyze multiple scenarios and have action plans in place to take advantage of changes in market direction.

As the Wyckoff Wave reacts to test point F, one of three things will happen.
1. The test will succeed and the Wyckoff Wave can rally again, most probably as a Sign of Strength.
2. The test will fail and the Wyckoff Wave can fall through the ice as a Sign of Weakness.
3. The test will succeed, but its lows will be below point F. This is a test of poor quality and will need to be repeated.

If scenario three happens, we can expect the Wyckoff Wave to continue to move sideways and there will be no immediate change in direction.

However, we need to be prepared for scenarios 1 & 2 as they will give us opportunities to take positions and record profits.

In addition to the Vertical Line Chart, I am also attaching the 100 Point & Figure Chart of the Wyckoff Wave. I have transferred the annotations to the Point & Figure Chart and drawn in phases and objectives.

Before we get to that, let’s quickly review the Wyckoff Wave’s recent action. The Wyckoff Wave appeared to spring the original trading range (defined by a support line drawn from point V and a resistance line drawn from point W). It then rallied to point A, backed up to point B and was expected to begin a nice advance. That didn’t happen. The rally to point C was of poor quality. The reaction back to point D was on good spread and put in a lower low. The final rally to point E, was unable to take out the highs at point C. The Wyckoff Wave then reacted back into and through the original trading range. That brought us to the shakeout (spring) at point F.

This week, the Wyckoff Wave rallied off point F. To judge the nature of the rally, I have drawn a very short, temporary, up trend channel. The support line is drawn through point F and the low of the day as marked with the up arrow. A parallel supply line is drawn through the highs of the day marked with the up arrow. It was interesting to notice how that supply line was respected at point G, as the Wave appears to have reached the end of the rally off the spring.

The Wyckoff Wave then reacted to weaken the temporary short-term uptrend channel and on Friday, put in a weak rally attempt. This may be confirming the break in the temporary short-term uptrend channel. This would allow the Wyckoff Wave to continue to react for this important test.

When the Wyckoff Wave returned to the original trading range, two phases were created on the Point & Figure Chart. The first phase went to point Z. The second phase is from point Z over to point V.

Two important points must be considered when analyzing these phases. First, we do not have a successful test and, therefore, cannot accurately pinpoint the exact count and the price level we can use for the count. Any counts along a price level must be estimated.

More importantly, what if the test fails? Then there is no rally and therefore, no count at that level. Instead we would have to look at the trading range as distribution and point G as a Sign of Weakness.

Both of these scenarios are drawn on the attached Point & Figure Chart.

The bullish scenario is drawn along the 30,700 line. This is only a general area of where the successful test would be completed. This line will change if the test is completed at another level. That is why there is a question mark at the right side of the counter line.

Phase 1 gives us a count of 2,600 points. This gives us a objective of from 33,000 to 133,300. Phase 2 gives us an additional count of 2,500 points. This gives us a total objective of from 35,600 to 35,800.

The maximum objective puts us back into the distribution area of the 2008 highs.

If we see a successful test and a Sign of Strength, the Wyckoff Wave can then react and have a Last Point of Support. This would add to the count and most probably put the Wyckoff Wave into historical new high ground.

If the test fails and the Wyckoff Wave falls through the ice, we could establish a count line along the 31,600 price line. Again, there are two phases. Phase 1, over to point A, from point G, gives us a count of 1,900 points. This presents an objective of from 30,300 to 29,700.

If we combine in phase 2, we have a total count of 5,000 points. Now the objective is from 27,200, down to 26,600. This would take the Wyckoff Wave back to test the November lows.

It can also be argued that there are three phases in this count, with the second phase ending at point W and third phase going from point W to point U. If the test fails and we do see a reaction, I will probably make that adjustment on my Point & Figure Chart.

There is no way a Wyckoff student can predict the success or failure of this important test. The market, and only the market, will provide this answer. Therefore, while we may have logical opinions, we need to prepare for both scenarios so we can act when the time is right.

A final note on trend lines. Trend lines can be extremely helpful in identifying, not only direction, the changes in direction. While the temporary short-term trend channel will probably only be good for a few days, you can see how it gives us an opportunity to see a possible change in direction.

If the reaction continues, it would not be inappropriate to draw a short-term down trend channel with a supply line drawn through points E and G, with a parallel support line drawn through point D. Even if the test succeeds, this downtrend line will give us helpful information.

Hopefully, after several months of moving sideways, we are at a bit of a turning point. It will be fun to see what happens next.