When in Doubt, Get Out

Click Here For Wyckoff Wave Chart 08-16-2013

Today’s blog post focuses primarily on short-term (positions lasting from a day to a few weeks) traders. While intermediate and long-term investors should be paying close attention, short-term moves should not impact their trading positions.

The stock market, as measured by the Wyckoff Wave, took a surprising turn this week. Perhaps others anticipated the move to the downside, but it was rather low on my list of probabilities.

When this happens, and it has certainly happened to me in the past, one needs to go back and closely look at the market to see what, if any, Wyckoff principles have been missed.

While, unfortunately, it is easier to see these principles in hindsight, it is also extremely important to make sure they are true Wyckoff principles and not simply used as a justification for an unexplained move.

My journey began at point J. The Wyckoff Wave had moved into an overbought position relative to its intermediate up trend channel and was vulnerable for a reaction. A short-term downtrend channel with a supply line through points J and N and a parallel support line through point M was established.

However, there was no climactic action and the reaction back to point Q could be considered a normal corrective reaction. However, there were two important indications that need to be considered.

1. Support came in at Q right in the area of the old Creek (support/resistance area) drawn from point B.
2. The move down to point Q from point P was on relatively wide price spread and volume. This could be considered somewhat climactic in nature.

These two indicators will become more significant as this study develops.

On the reaction to point Q, the Wyckoff Wave moved into an overbought position relative to its short term down trend channel

The Wyckoff Wave then rallied to point R and reacted to point S. This time the reaction was on reduced price spread and volume. While this is certainly a positive indication, it is important to note that the Wyckoff Wave was still in its short term down trend channel.

In addition, although the Wyckoff Wave was in a positive divergence with the O – P Index, the Technometer was neutral and the Force Index was producing strong negative numbers.

Wyckoff discipline would indicate the trend should not be changed until the short term down trend channel is at least weakened. The Wyckoff Wave then rallied to point T and moved sideways for three days. This was at least a weakening of the downtrend channel and an argument could be made that those three sideways days broke the down trend.

The short-term trend was then changed to up and the Wyckoff Wave rallied to point U. It is also at the supply line of the short term up trend channel and in the upper portion of the intermediate up trend channel. These are all bullish indications.

At point T, the Wyckoff Wave entered into an intra-day trading range that is drawn in light blue on the accompanying chart. In previous blogs I have written about its attempt to leave the trading range to the upside (points U and W) and that the Wyckoff Wave returned to the trading range on reduced price spread and volume.

However, did we miss an upthrust and was it the catalyst for this weeks unexpected move to the downside? The answer is no.

An upthrust is defined as an immediate attempt to rally through the top of a trading range on increased volume with a poor close. The Wyckoff Wave penetrated this intra-day trading range days before point U. In almost every case an upthrust happens as soon as the resistance line is penetrated. In addition, although point U had a poor close, the relative volume was actually decreased. Even in hindsight, point U cannot be called an upthrust. It was simply supply coming into the market in the area of point J and driving the Wyckoff Wave back down into this intra-day, now mini trading range.

What about point W? Was that an upthrust? At point W the Wyckoff Wave rallied on reduced price spread and volume. This suggests a lack of demand. However, it was lower than point U and could be construed as the beginning of a short-term down trend channel.

Once again, the Wyckoff Wave was still in its short-term uptrend channel. In addition, the Technometer was in a neutral condition and the Force Index was producing good low negative numbers. Even though there was a slight negative divergence with the Optimism – Pessimism Index, the short term 100 Point & Figure chart count to the downside was only 1,300 points. This gave us an objective area of between 36,300 & 36,000.

This produced a fairly poor reward/risk ratio and as the Wyckoff Wave still in its short term up trend channel. It made taking a short term position to the downside a high risk opportunity.

The Wyckoff Wave then reacted, weakened and broke the short term up trend channel. It also weakened the intermediate-term uptrend channel and the trend was changed to neutral.

Going into this week it was difficult to justify short-term positions in either direction. The Technometer was moving quickly towards an oversold condition. In addition to leading the Wyckoff Wave, the O – P Index was developing short-term positive divergences with the Wave.

On Monday, the Wyckoff Wave slightly penetrated the support line of this mini trading range for a possible spring. However, a spring needs demand to confirm its existence. Some demand did come into the market on Tuesday. However, it was quickly withdrawn and Wednesday was the beginning of the move to the downside.

Suddenly the Wyckoff Wave was in an oversold position relative to its new short-term down trend channel. The Technometer was oversold. The only negative Wyckoff indicator was a weakening Force Index.

At Tuesday’s market close, the Wyckoff Wave was expected to rally and test the top of the mini trading range. Wednesday’s action was out of character. When this happens and the short-term Wyckoff trader does not have a good feeling for exactly what is happening and why it is happening, there is no excuse for remaining active in the market.

It is very important to simply wait and let the market tell us where it is going. The short-term trader is now out of the market. The intermediate trend is neutral. The long-term trend is up. There are no indications whatsoever that we are looking at the beginning of an immediate decline. There was no buying climax and no ending action.

Therefore, intermediate and long-term traders to the upside should continue to hold positions and let the market develop.

Will the Wyckoff Wave react and test the lows at point Q. If it does, we may want to look at point Q as climactic action and beginning of a trading range.

The Wyckoff Wave rallied back into the short term down trend channel and, if it does will it have the ability to return to the intermediate-term uptrend channel and changed that trend back to up.

I don’t have the answers to any of these questions. I am going to simply wait and let the market do the work. I suggest you do, as well.