Timing When To Take A Position

Click Here For Wyckoff Wave Chart 01-13-12

Last week the stock market, as measured by the Wyckoff Wave, rallied to a high at point S. It then began what some thought would be a reaction to a Last Point of Support. Yours truly was part of that group.

However, a funny thing happened. On the second day of the reaction demand came into the market. That was followed by a day that lacked supply and then a day that lacked demand.

To confuse the situation even more, last Tuesday brought a large gap opening to the upside. However, there was no follow-through and the decreased spread and increased volume indicated supply had again appeared. On Wednesday, Thursday and Friday, the Wyckoff Wave either opened to the down side or experienced an intra-day failure to the down side. This would suggest that supply was taken in and demand was ready to take control of the market.

Does this mean we are at an entry point to the long side? Or, if we have already entered, is this a good place to add to our long positions?

I felt Thursday’s action was quite significant. Not only did we see an intra-day failure to the down side, but an analysis of the Wyckoff Wave’s intra-day waves suggested that supply had really dried up and the Wyckoff Wave was in a position to break out to the upside. In the words of Mr. Bob Evans, “it needed to go and go now”. That didn’t happen. On Friday more supply came into the market. While it was, once again, taken in and demand came back into the market, the day was not as positive as Thursday’s.

Obviously, the Wyckoff Wave did not “go and go now”. This means the breakout scenario was incorrect and everything needs to be reevaluated.

This allows me to introduce, what I think is, an extremely important concept. If the Wyckoff trader comes to a conclusion and takes a position on that conclusion and if the market does not behave as expected, the conclusion should be discarded and the situation completely reevaluated.

Why is this important? Too many traders (and I am one) have lost money by logically creating a scenario and seeing something else transpire. That, by itself, is going to happen. The problem arises when the Wyckoff trader then tries to justify the original scenario. Good Wyckoff logic becomes wishing and hoping and all of a sudden minor losses become significant losses.

For example, let’s pretend that a position was taken in the Wyckoff Wave either late Thursday or early Friday morning. After Thursday’s market action, the Optimism – Pessimism Index was contained in the uptrend channel. The Technometer was neutral and the Force Index was rallying and, on a strong rally, would have reduced the impact of an overbought condition on the Technometer. Again, the most important indicator was the drying up of supply seen on the intra-day waves.

Then on Friday morning the Wyckoff Wave reacted. While it rallied later in the day and closed at the high, it did not perform as expected. This means any long positions are in jeopardy. A new plan needs to be established, which is primarily concerned with setting an exact exit point. If the market rallies next week we are in good shape. If it reacts, we need to make sure we have a definite exit point, regardless of our original stop order.

In this particular case, a great deal of attention should be paid to the support line of the uptrend channel. If the Wyckoff Wave penetrates that support line, the position must be closed. No ifs ands or buts. No emotional justification. Just close the position.

If the reaction continues and there is a definable Last Point of Support, you can reenter the market from a position of strength.

In my opinion, this is a very big deal and a significant reason why traders lose money. I know. I paid a fair amount of tuition to the University of Wall Street before I figured it out.

Now, after Friday’s market action, let’s look at the Optimism – Pessimism Index. It is in a slightly overbought position, relative to its up trend channel. The Technometer is also slightly overbought, but at a lower level. The Force Index reacted very slightly. While none of this is horrible, it is not what was expected a mere 24 hours ago. The Wyckoff Wave is still in a short-term uptrend channel. Supply has not been able to take control of the market and we could simply be seeing more adsorption.

The Wyckoff Wave is holding above the now support/resistance line drawn from point K and the halfway point of the rally from points R to S. In addition, the rally to Thursday’s high can be seen as a weak test of the rally to point S. Weak tests usually require a second test and the Wyckoff Wave may simply be moving sideways to take in more supply.

In my opinion, we are still in a positive situation, but it is always best to prepare for a reversal and have an action plan established before bad things happen.

Trading in the stock market requires preservation of capital. Therefore, it’s often not how much you make, but how much you don’t lose.