Timing the Market and Turning Points

Click Here For Wyckoff Wave Chart 10-14-11

The stock market, as measured by the Wyckoff Wave turned in a most interesting week. The rally off the spring at point H was, in my opinion, difficult to analyze and in several instances, has not behaved according to expectations. It has caused difficulties for short-term traders, of which I was one, but has reinforced important lessons about how short-term traders deal with turning points in the market.

Before getting to that, let’s go back and review the rally off the spring. On October 4th, the Wyckoff Wave sprung the trading range at point H. Strong demand came into the market. The next day both spread and volume decreased. This is an indication of a lack of demand. The day after that, while the spread increased slightly, volume again decreased. The Wave was starting to approach the upper levels of the trading range and with the exception of the day of the spring we had not seen strong demand.

The next day, the Wyckoff Wave experienced an intra day failure to the upside. It closed in the bottom half of a narrower trading range and, once again, volume decreased. The intra day failure suggests a lack of demand.

This Monday, the Wave penetrated the resistance. The penetration did occur on increased spread, but once again volume decreased. This suggests a lack of supply.

If the Wyckoff Wave was going to jump the creek, we would have expected to see much stronger demand, especially on Monday when the resistance was penetrated.

Two other scenarios would be the potential for an upthrust or, despite slight penetration of the resistance, a reaction back to test the spring. As we had not seen any inklings of supply, the reaction to test the spring seemed the most viable option.

Intermediate term traders to the upside, who have already taken a long position on the spring, are not that concerned. They have already moved stop orders to cover costs and ensure a small profit and are simply waiting for a reaction. Then they can add to their positions on a successful test or, in the case of an upthrust, close their positions with a small profit.

The short term trader, who has taken a long position on the spring, is looking for a top to close the trade. The trader is also looking for opportunities to the down side once the market turns. Finding the top of the rally and timing their next trade requires a more in-depth analysis of the market action at the top of the trading range.

On Tuesday, the Wyckoff Wave rallied on decreased spread and volume. This is a definite sign of a lack of demand. It is also not particularly characteristic of an upthrust. Short-term traders should be ready to close any long positions and identify good candidates to the down side.

On Wednesday, even though the price spread of the Wyckoff Wave was slightly wider than on Tuesday, it was relatively narrow. The volume increased and an analysis of the intra day waves showed strong supply came into the market during the afternoon hours. By all accounts, the market, as measured by the Wyckoff Wave, was finally prepared to react.

Short-term traders to the down side could take positions as early as Wednesday afternoon and certainly Thursday morning. Based on an analysis of the rally off the spring, this looked like an excellent opportunity to the down side.

However, the next day was very disappointing for the bears. The supply that appeared on Wednesday, dried up on Thursday and the Wave actually closed near the high of the day. Spread and volume both decreased, suggesting a drying up of supply. Based on a good Wyckoff analysis, this was not supposed to happen. But the stock market is a hard mistress and often things do not work out as expected. What does a short-term trader to the down side do now?

In my opinion, the answer is one of the most important lessons that anyone who trades intra day or on swings needs to understand and follow religiously. It is this: If a stock does not act the way you expected it to, when you took the position, close the trade immediately.

In this case supply was expected to dominate the market and drive the Wyckoff Wave back into the trading range. During this reaction, the price spread and volume would provide clues as to whether we were reacting, up thrusting the range, or testing a spring. Either way, anyone who took a short term position to the down side expected to see supply and a nice beginning to the reaction.

That didn’t happen. The trader has two choices. The first is to be disciplined and close a position. The second is to hope and pray that their entry point was premature and after a day or so the stock will react as expected. Unfortunately, we all know where that second choice takes short-term traders on a fairly regular basis. I have been there and I have done that. I suspect I also have some company.

In the interests of full disclosure, I also took a short term position to the down side late Wednesday afternoon. I closed that position at the opening on Friday. The fact that I made a small profit is not significant. The fact that I was disciplined enough to avoid a potential loss is.

To me, it doesn’t matter whether the market continues to rally or reacts next week. If I cannot be in control of my trade, I should not maintain a position..

On Friday, the Wyckoff Wave rallied on decreased spread and volume. Again, supply was withdrawn. Again, I will look for short term candidates to the down side. If I take a short position next week and supply does not return strongly to the market, I will again close that position and reevaluate. In the stock market, it’s not how much you make it’s how much you don’t lose.

Finally, based on the action of the Wyckoff Wave, I have added a new resistance point at the old upthrust at point A. I happen to believe that once drawn, trend lines, support and resistance lines should not be changed. It’s too easy to redraw them to justify our expectations. However, the Wave has tested and been turned back at the new resistance line twice in the last three days. If, next week, the Wave reacts, it may be appropriate to re-adjust the resistance line of the trading range.

What to Do?
Short-term traders to the down side should identify candidates and be ready to take short positions. Short-term traders to the upside, who already hold positions, should either close them or aggressively crowd their stops.

There are no intermediate term opportunities in either direction.

The short term trend of the market is still down, although the down trend channel has been weakened. The intermediate term trend of the market is neutral.