Last Monday, the stock market, as measured by the Wyckoff Wave reached an important high and began to react. Is this normal and expected, are we seeing an important change in character that will negate the positive action of the past three weeks?
Are we experiencing a normal corrective reaction, that in this case is also a backup to the last resistance line (or the Mr. Evans’ creek)? Or, as some have opined, are we seeing an Upthrust after Distribution and is the market beginning an important reaction?
In order to investigate this further, it is important to review and understand, what is known in the Wyckoff world as a change in character. A change in character is nothing more than when the market behaves differently than it did previously. The character of the market (or an individual stock) can be either demand, supply, lack of demand, or lack of supply. Of these, demand and supply are the most important. A stock or index’s character can be demonstrated on either a very short-term basis (one day to the next) or over a longer period of time.
These changes of character, coupled with the Wyckoff tools that include the Optimism – Pessimism Index, Technometer and Force Index, can provide important clues as to the future direction of the market.
To help understand this concept, let’s review the action of the Wyckoff Wave beginning with the spring that took place last October 4th. It is marked as point H on the attached chart.
The day before the Spring, the Wyckoff Wave reacted strongly on increased spread and volume. Supply was definitely present and the Wave was rocketing towards the bottom of the trading range. Based on the day’s action there seem to be an excellent chance that the Wave would break through the support and Fall Through the Ice, for a major Sign of Weakness.
The next day, the Wyckoff Wave opened lower and it appeared that it was going to move through the bottom of the trading range into new low ground. Then, all of a sudden, there was a change in character. If we analyzed the day’s action, we would call it an intra day failure to the down side and a rally on increased spread and volume. Demand came in and point H was a Spring. We went from strong supply to strong demand. This is a change in character. However, it is only a change of character on a very short-term basis and needs to be confirmed.
One easy way to confirm this would be a test of the Spring. This didn’t happen. The Wyckoff Wave rallied directly to the top of the trading range. The rally was on decent spread and slightly decreasing volume. However, while some days demonstrated a lack of demand, supply was not present. The Wave rallied fairly easily to the resistance drawn through point A and, so far the positive character of the Wyckoff Wave remained unchanged.
Then, at point I the Wyckoff Wave rallied on reduced spread and increased volume. It also closed near the low of the day. This suggests supply is coming into the market. This is also a single day change in character.
However, one day does not change a trend. It is simply a flashing light that tells us to be observant. This is also a place where we would expect to see supply.
The next three days suggested a lack of demand. The expected supply was simply not coming into the market. Then, after briefly reacting to point J, strong demand appeared and the Wyckoff Wave rallied on increased spread and volume. While this good demand could help define this area as absorption, the key ingredient was that the expected supply, and therefore a new change of character, did not appear. This would make the Wyckoff Wave vulnerable for a continued rally. And rally it did, up to point K.
The Wyckoff Wave had penetrated the resistance (jump across the creek). When this happens there are three options. The Wave can react and have a successful Last Point of Support. It can Upthrust the trading range and begin a reaction. Finally, it can simply begin a new trading range. In this case, the Wyckoff Wave experienced the third option.
However, it is important to understand that the character of the Wyckoff Wave has not changed since the spring at point H.
The Wyckoff Wave then reacted two point L. It was a three-day reaction. The first day suggested a lack of supply. The second day suggested a lack of demand. On the third day, after a huge gap opening to the down side, on bad news from Europe, the Wyckoff Wave experienced a narrower spread and increased volume. This suggests demand has come into the market. Therefore, despite a fairly significant reaction from point K to point L, the character of the market did not change.
The Wyckoff Wave then moved sideways to point O. While there was one day of good supply on the reaction to point N, it was not sustained and the low at point N was higher than point L.
After rallying to point O, which was basically the same as point M, the Wyckoff Wave reacted to point P. For the first time we are seeing supply come into the market. As the reaction continued, a significant change of character had to be considered. In fact, if we were just using the Wyckoff Wave as our only tool, we would have to say the character of the Wave had changed and supply was now in control. We could certainly expect the Wyckoff Wave to react back into the original trading range and, quite possibly test the old support levels at point H.
However, the Wyckoff trader has a few more tools. One of the most important is the Technometer, which is doubly effective when used with the Force Index.
As supply came in and the Wyckoff Wave reacted through the creek and back into the original trading range, look at the Technometer. There is a huge positive divergence. The Wyckoff Wave is substantially more oversold than it was at point H. When the Wyckoff Wave or and individual stock becomes more oversold on its Technometer, but is higher than a previous low, we should look for a rally. When the Force Index experiences the same positive divergence as the Technometer, this adds even more credibility to this thesis. In addition, the Wyckoff Wave respected the halfway point of the move from point H to point K.
While we have seen a change of character, these Wyckoff tools are telling us things may not be exactly as they seem.
The Wyckoff Wave put in a low at point P and then rallied sharply to point Q. Because the low at point P was put in on the day after Thanksgiving, which was a shortened market day, the low volume was a bit skewed. Even though there was only one strong demand day, the Wyckoff Wave rallied easily to point Q. This would suggest supply was diminished, demand was back in control and the character of the Wyckoff Wave had changed once again.
The Wyckoff Wave reached and slightly up thrusted the new trading range at point G. Once again, we should expect supply to come in and it did. However, was this a change of character. On the surface, it certainly was. If you look at the day’s action on the reaction from point Q to point R there were several days when supply was in total command. However, we need to also look at the results. The reaction from points Q to R lasted for 10 trading days. In that time it reacted less than half the distance of the previous reaction from points O to P. It also respected the halfway point of the rally from point P to point Q. In other words while we can certainly justify supply coming into the market, it appears there were many buyers quite prepared to take in the shares that were being sold. While good supply would suggest a change of character, one needs to see results.
This observation is confirmed when all the lost ground was recovered in three trading days as the Wyckoff Wave rallied smartly from point R.
Again, the Wyckoff Wave reached the top of the new trading range and this was the perfect place for supply to return. Instead, the Wave continued its rally to point S. Interestingly, most of the days suggested a lack of demand. This lack of demand made the Wyckoff Wave extremely vulnerable to supply and an important change of character. However, so far supply has not come into the market. Instead, on the two days following point S we saw supply appearing early in the trading day. It was easily absorbed and followed up with strong demand. This was especially apparent on Thursday as the Wave reacted in the morning and rallied strongly to close near the day’s high. The intra day up waves were primarily responsible for the day’s high-volume. Then on Friday, we saw reduced spread and volume which suggests a lack of supply.
The above suggests that, with a minor exception of the rally from points O to P, which was placed in question by the actions of the Technometer and Force Index, the Wyckoff Wave has maintained a positive character since point H.
The Wyckoff Wave is in a short-term uptrend and may well be reacting back to the resistance line drawn from point K. This lines up with the support line of the short term uptrend channel and the halfway point of the move from R to S.
In addition, if we see supply come into the market, it may well be the situation like the reaction to point P, as the Technometer has a good chance of becoming oversold while the Wyckoff Wave is at a higher level than either points R or P.
It is important to watch the character of an individual stock or index as it develops. In the basic course, it is described as small waves on the ocean. By themselves they don’t seem to be much, but as they develop and experience outside influences, they can grow and become extremely powerful.
One final note: Last weeks Market Letter included a weekly chart of the Wyckoff Wave. Below the chart were charts of the Optimism – Pessimism Index, the Technometer and the Force Index. I should have removed the Technometer and Force Index from the weekly chart. Both of these important Wyckoff tools are daily moving averages and become skewed wave viewed in a weekly or monthly chart. Simply put, the Technometer and Force Index must only be used when viewing a daily chart of the Wyckoff Wave or any of the individual stocks in the charting service.
My sincere thanks to those who brought this to my attention and my apologies for providing this incorrect and unnecessary information.