Where Do We Go From Here?

Click Here For Wyckoff Wave Chart 12-02-11

In his excellent, but little-known, book “Where Do We Go From Year”, Dr. Martin Luther King Jr. described his blueprint for continuing the civil rights movement after the signing of the 1964 Civil Rights Act. He often referred to the history of the movement and it must be understood as it often repeats itself, although on slightly different ways.

The same is true of the stock market. Sometimes we are so focused on what happened yesterday and may happen tomorrow that we miss the little signs that tell us where the market is really headed.

Wyckoff students can find many of these signs in the Wyckoff tool kit. While the Technometer and Force Indexes are more short-term, the Optimism – Pessimism Index can generate indicators, sometimes months or even years in advance that can warn us of impending market changes.

As many know, Mr. Wyckoff introduced volume studies to technical trading techniques. The Optimism – Pessimism Index is a study of volume and how it compares to the prices you see on the vertical line chart.

Before commenting on today’s market, I would like to review the two previous significant declines. They were, of course, the bear market of 2008 – 2009 and this year’s reaction.

The 2008 – 2009 bear market was the largest in recent history. Many, many people lost a great deal of money and its effects are still impacting today’s stock market.

By early 2011, the market’s rally off the bottom nicely exceeded the halfway point of the bear market. Some investors saw an opportunity to recoup much of their losses and began to do so. Needless to say this helped cause this summer’s reaction. The market then climaxed, began to move sideways and then tried to leave the trading range to the upside.

What is going to happen next? Let’s go back and look at the Wyckoff Wave’s Optimism – Pessimism Index and compare it to the Wyckoff Wave. Perhaps we can learn some lessons from history.

In late 2004, the O – P Index was significantly stronger than the Wyckoff Wave. Over the next four years, the O – P continued to lead the Wave, but its relative strength was decreasing. Wyckoff traders should have been aware of this, but not concerned enough to close positions.

Then things changed. In November of 2007, the Wyckoff Wave reached its high. The Wave then reacted, in what could be considered a normal corrective reaction. In early 2008 the Wave attempted to rally again, but could only reach 35,550. However, the Optimism – Pessimism Index moved into new high ground. The O – P was not leading the Wyckoff Wave, it was presenting a major negative inharmonious action. This was an important change of character. Soon after that the market collapsed and the Wyckoff Wave reacted all the way down to 14,450. Interestingly, a count on the Point and Figure chart from the last point of supply on the rally back to the ice, gave an objective of 15,000. Not only had the Wyckoff Wave anticipated the bear market, it had also provided the correct objective. As the market prepared to decline, the Optimism – Pessimism Index was providing clues to its demise. Unfortunately, this data is not in our database and the numbers were taken from old hand-drawn charts.

Let’s move ahead to this year. A look at the weekly chart of the Wyckoff Wave, which is on page one of the attached file, shows the Wave reached a high at point G. This was in June, 2011. If you go back and look at the Optimism – Pessimism Index and compare it to point E, another change in character is present. Notice that the O – P Index, which was advancing strongly with the Wave, suddenly became weaker. At point E, the O – P was 61,963. At point G, the O – P was only at 61,921. This is a negative divergence. The effort, as represented by the O – P, certainly did not match the results of the Wyckoff Wave as it moved into new high ground. This is a warning sign and it was given three months before the summer’s decline.

There was still more to come. The Wyckoff Wave then reacted to point N and rallied to point S. Notice that S is lower than the highs at point G. Yet the O – P moved into new high ground at 61,980. Not only is this another negative divergence, but it is now what I call a double reversal. There were two important negative divergences. The first presented a weaker O – P. The second presented a weaker Wyckoff Wave. When these appear, believe me, trouble lies ahead.

Of course, it did. The Wyckoff Wave reacted over 20%, climax and began a new trading range.

While history lessons can sometimes be boring, the Optimism – Pessimism Index is an important Wyckoff tool when looking for important changes in direction.

Let’s look forward to today’s market. What does the Optimism – Pessimism Index tell us about the Wyckoff Wave’s future direction. For this, let’s move to the daily chart, which is the second page of the attachment.

After the Selling Climax at point X, the Wyckoff Wave established the top of a new trading range at point A. The O – P Index was at 61,213. A few months later, the Wave jumped the resistance and established a high at point K. The O – P Index was now at 61,852. The O – P Index is in harmony with the Wyckoff Wave and, so far, all is well.

However, the Wyckoff Wave was not ready to begin a new intermediate term uptrend. While it backed up to the resistance at point L, it did so on good supply. The subsequent rally to M was not particularly strong. However, look at the O – P Index. It moved into new high ground at 61,950. This is a short-term negative divergence and a caution sign. Something is happening. It may have longer-term ramifications or it may not. We should, however, pay attention.

After a one-day reaction to point M, the Wyckoff Wave rallied to point L. While points M and O are at basically the same level, the O – P Index again moved higher. Our caution light continues to flash.

The Wave then reacted back down into the trading range (another negative indication) to point P. While the Wave and O–P Index are in harmony when compared to point N, there is a minor positive divergence when compared to point J.

The Wyckoff Wave then rallied back to test the highs at point K. On Friday, it was turned back at the resistance line and closed near the day’s lows. What about the O – P Index?

When compared to point K, everything is basically in harmony. However, when compared to points M and O, we see another double-reversal. All of a sudden, the Wyckoff Wave is higher an the O – P Index is now lower. This negative divergence suggests we are getting more results than effort.

Does this mean we are headed for a new bear market? Candidly, I doubt that is the case. The examples given above were all over longer periods of time. Just like short-term and intermediate term trend channels, there are short-term and intermediate term divergences. As the O – P Index and the Wyckoff Wave are in relative harmony when compared to point K, I would need more intermediate-term evidence before suggesting a major decline is on the horizon. However, we still need to watch the faithful O-P Index for important clues.

It is also important to understand the emotional aspects of the market and the transfer of shares from weak hands to strong hands.

As mentioned earlier, many people lost a great deal of money in the bear market of 2008. There is still a great deal of overhanging supply that needs to be taken back in and acquired by stronger professional hands who are accumulating shares for the next move to the upside. We are right in the middle of the halfway correction of the bear market, which is a classic point for people to get out, but not lose everything.

The short term divergences tell us that while the market may react, it is not yet ready for a major move. Two things can happen. We may see the market react into the trading range and even test the lows at point H.

We may also see a new phase of the trading range with resistance at point K and support at point P. When a stock jumps the resistance (creek) and then is unable to back up for a major Last Point of Supply, it is not uncommon for a new phase of a trading range to develop.

If we are in a period of accumulation, we will need to see the market become duller. That will mean fewer gap openings and more narrower spreads. We will also see more decreased spread and volume on reactions.

While short-term traders may investigate opportunities to the down side, this is probably not a good entry point for intermediate traders to the upside.

The short term trend of the market is still down, but weakened.
The intermediate term trend of the market is neutral.

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