The Wyckoff Wave and the Optimism – Pessimism Index

Click Here For Wyckoff Wave Chart 07-20-12

Last week the Wyckoff Wave rallied to the top of a new phase of its trading range, met supply and reacted. Two of the Wyckoff tools (the Technometer and the Optimism – Pessimism Index) were extremely helpful to Wyckoff students as they attempted to identify the turning point and take positions to the down side.

As early as Wednesday, the Technometer moved into a dangerously overbought condition, suggesting that it would be difficult for the Wave to strongly push through the resistance at the top of the range.

In addition, the Optimism – Pessimism Index moved into a negative divergence with the Wyckoff Wave.

Finally, on Thursday, the Wyckoff Wave traded higher on decreased spread and increased volume. It reached but was unable to penetrate the resistance. The price spread and volume strongly suggested the presence of supply.

This was the final clue and short-term Wyckoff traders were able to take positions either on Thursday afternoon or Friday morning.

By themselves, these excellent Wyckoff indicators, while helpful, are not nearly as strong as when they are used together in an overall analysis of the market.

One of the most important tools is the Optimism – Pessimism Index. The O – P Index is strictly a volume index. Throughout the trading day the market moves up and down. These price fluctuations create intra-day waves. The Wyckoff tools are all based on these intra-day fluctuations.

When an intra-day wave to the upside occurs, the total volume for that wave is added to the O – P Index for the related index or individual stock. Conversely, when an intra-day wave to the down side occurs, the total volume is subtracted.

The O – P Index indicates the amount of effort being exerted on a particular stock or index. The vertical line chart indicates the result of that effort.

When both are in harmony the resulting move has a good chance of continuing. When they are out of sync, the move may be in trouble

This past week, as the Wyckoff Wave rallied, it was still lower than the highs at points M and O. However, the O – P Index moved into new high ground. This suggested that the strong effort of the O – P Index was not equaling the results as measured by the Wyckoff Wave. This is called a negative divergence. When that is seen, the probability that a stock or index reversed direction increases.

Naturally, the opposite is true when a stock or index moved lower.

Seems fairly simple and straightforward, doesn’t it?

Unfortunately, nothing is ever that easy, especially in the stock market. It is very important to understand that in a bull market the O – P Index usually leads its related index or stock. In a bear market there is a tendency for it to lag behind.

An example of this is happening right before our eyes. Last November, the Wyckoff Wave, after jumping the resistance (Creek) to point K, eventually reacted to a last point of support at point B. It then rallied strongly to point U and began this long, six month trading range.

An up trend channel was created in the O – P Index with a support line through points P and R. A parallel supply line was drawn through point O. Even though the Wyckoff Wave only rallied for a couple of months and then moved sideways, the O – P Index has remained in that up trend channel for a little over eight months. The O – P Index is leading the Wyckoff Wave and this is a positive indication.

Unfortunately, this is a contradiction with what I have written earlier in this article and commented on in several of my daily Pulse of the Market Reports.

This week I received an e-mail from an advanced Wyckoff student who said, in a very nice way, Jim, you can’t have it both ways. He is basically correct. I did a great deal of thinking this week, about how this contradiction is resolved using Wyckoff principles.

I believe it is in how one looks at the Wyckoff Wave.

My long-term view of the market, as measured by the Wyckoff Wave is that we are in a bull market and going through some re-accumulation that will set the stage for higher objectives. That the O – P Index is leading the Wyckoff Wave is an important factor in this conclusion.

However, when I look at the O – P Index within the trading range and am looking for shorter term reversals, the divergences are more significant than the longer-term view.

This allows me to use the valuable Optimism – Pessimism Index using two different and extremely helpful methods.

The Optimism – Pessimism Index and the Technometer are extremely valuable and helpful trading tools. No Wyckoff trader should be without them.