Technical Analysis of Stock Trends, The Wyckoff Wave – Week in Review, November 24, 2011
Don’t Prejudge the Market
Ever since I began writing my Weekly Market Reports, to post on the blog, and my daily Pulse of the Market Reports for charting service subscribers, I have received many e-mails about my comments and observations.
While I sincerely appreciate the kind words, I am most interested and impressed by the observations of other Wyckoff students and their take on recent market action and its future direction.
Many of these students offer, using excellent Wyckoff techniques, their own opinions on the stock market. I have received e-mails justifying why the market is going to advance and why the market is going to decline. Both positions are well laid out and well-documented.
To be honest, all I know is that the market is in a trading range and before we can determine its future intermediate term trend we need to see ending action and a successful test of that ending action.
I worry that students can come to a predetermined conclusion as to the market’s future direction and then look at market action in a way that only justifies their original decision. I would suggest that this is a great opportunity to miss market moves. Even worse, it may cause us to take a short
position, just when the market starts to rally. Or, vice versa. I know, because I’ve been there and done that.
One way to avoid this trap is to always look for opportunities, both to the upside and downside. When the market for an individual stock is rallying, look for both the positives and negatives. The positives are that the rally will continue. The negatives are that we may have a turning point and the market will react. When we look at both, one usually stands out and makes our decision easier. In addition, we don’t become overly bullish or bearish.
There are also a few important rules that successful traders and investors should always follow.
1. Decide if your trade is going to be a short-term (swing) trade or a longer-term intermediate trade.
2. Always, always trade within the trend. The position sheet tells us that Trend 1 is a short-term uptrend. Trend 2 means a long-term uptrend. Trend 3 is a short-term down trend. Trend 4 is a long-term downtrend. Indexes or stocks can also be in a short-term or long-term neutral trends. As long as your trade stays within the trend lines, you are in good shape. When they weaken the trend, the short-term trader should probably close the position. When the trend is broken, the intermediate-term trader should probably close the position.
3. Don’t anticipate a change in the trend. It is better to get in a day or so late and get out a day or so early then to enter a trade and have the trade go against you. Exact turning points are usually only obvious after they happen.
To help clarify this, let’s go back and review the trading range that started in August of this year. The Wyckoff Wave had reacted strongly from its recent highs and we saw a buying climax at point X. There was then an automatic rally to point Y and a successful secondary test at point Z. At that point it is reasonable to conclude the downtrend has stopped and we are going to move sideways for a while. Or our we?
The stock market, as represented by the Wyckoff Wave rallied to point A. By definition, point A is an upthrust. There was a shortening of spread, an increase of volume and the following day the close was back to its recent average range of closes. But was this ending action or was the Wyckoff Wave simply establishing a resistance point at the top of a trading range?
Short-term traders certainly had opportunities to the down side. The Wave had a sharp three-day reaction and then rallied to test the potential upthrust at point C. There was then a brief reaction to D. However, potential trouble was waiting. Notice that demand came in at point D and the Wave closed at the top of the price spread on increased volume. More importantly, it was unable to reach the supply line of the short term downtrend channel. This put the trend in jeopardy and, sure enough, two days later the trend was broken. The short term or swing traders should have closed their trades at the first sign of trouble.
That does not mean that the upthrust was not an upthrust. It only means that it may be tested again and that test will either succeed or fail. The short-term trend is changed to neutral and we let the market tell us what is coming next.
After soundly breaking the trend on wide price spread, the Wyckoff Wave rallies poorly to point E. It ran into good resistance at the line drawn from the top of the automatic rally and did so on reduced spread and volume when compared to the upthrust at point A. This appears to be a more valid test of the upthrust, especially when we see the close at point E. There was reduced spread and volume and the Wave had absolutely no interest in attempting to continue the rally.
Again, the short term traders have another opportunity to the down side. The Wyckoff Wave then reacted sharply to the bottom of the trading range at point F. This is also at the support line of the new short-term down trend channel I have drawn in purple. There is then a three-day rally to point G. Notice that the rally does not reach the supply line. This is considered weakness and an indication that the next reaction could penetrate the bottom of the range for a major Sign Of Weakness (SOW).
However, if we had prejudged that, we would have made a major mistake and missed a nice opportunity to the upside.
The Wyckoff Wave did in fact penetrate the bottom of the trading range. But then, a tremendous amount of demand came into the market. Instead of a Fall Through The Ice (SOW) we had a spring. Just like that the market turned around and rallied strongly. If they were not alert and paying attention, the shorts could’ve lost all or a large portion of their initial profits.
If they were paying attention, the shorts could have closed their positions on the spring and opened new short-term positions to the upside. Buying on a spring is a tried-and-true Wyckoff strategy.
Now we have seen both a spring and upthrust. As it turns out, neither one was the ending action the intermediate-term traders were looking for to take longer-term positions in the market.
The Wyckoff Wave rallied strongly to point I and then moved sideways to point J. It was absorbing supply at the top of the range and we can draw a short-term uptrend channel with a supply line point H – J and a parallel support line through point I.
Have we seen a sign of strength to point I and a last point of support at point J? It is not an unreasonable conclusion. However, that conclusion needed to be confirmed by a strong jump across the creek (the resistance at the top of the range).
Look what happened. The Wyckoff Wave certainly penetrated the resistance and initially did so on good spread and volume. But look at how the Wave moved within the uptrend channel. It was almost immediately weakened and even after the strong rally to point K, it was unable to reach the supply line of the uptrend channel. The strong spread and volume at point K was a very positive indication that the rally might continue. Even though the Technometer was in an overbought condition, the Optimism – Pessimism Index was leading the Wave and things still looked positive to the upside. However, as the uptrend channel had just recently been weakened, the Wyckoff Wave had to “go and go now”. It didn’t do that and two days later again weakened the up trend channel as it reacted two point L.
However, the bulls still had an opportunity. It is not unreasonable to call the move from point H to point K a major sign of strength and to look for a reaction back toward the creek (resistance/support), as drawn in blue on the attached chart. This reaction, if done on reduced spread and volume could become an important Last Point Of Support (LPS).
However, the good Wyckoff student would also be looking at a more bearish scenario. Conclusion should not be drawn, but observations should be made.
The Wyckoff Wave reacted sharply to point L. This was certainly not on reduced spread and volume and one needed to pay great attention to the bearish scenario. However, the Wave saw support right at the top edge of the creek and it was enough to allow a weak rally to point M and a second chance for a successful backup.
The bears should note that point M is a lower than point K and that the rally was of poor quality. We can now draw a new short-term down trend channel with the supply line points K – M and a parallel support line at point L. There was then a one-day reaction back to point N. Even though the reaction was on good spread and volume, it did hold above point L. There was another short rally back to point O. While there was no follow-through, the supply line of the short term downtrend channel was weakened. In addition, the reaction to point N did not reach the support line.
We are now at a most interesting potential turning point. While the bulls can point to the inability of the Wave to reach the support line at point N and the weakening of the supply line at point O, the bears can answer with lower tops and supply on the reactions and rallies of poor quality. In addition, there was no follow-through to the upside at point O.
This would suggest that the Wyckoff Wave will react and it is reasonable for the bears to take short-term positions to the down side. The bulls have one last chance for a reaction on reduced spread and volume for a Last Point of Support.
Both scenarios are plausible and both should be strongly considered. Bulls should have looked for intermediate-term opportunities to the upside, but not taken positions until the LPS was confirmed. Bears could take short-term short positions, but carefully watch the spread and volume.
As it turned out, the Wyckoff Wave fell back into the creek and the trading range should be continuing with a new phase.
This little adventure through the trading range shows us that we need to always consider both sides of the argument and never trade against the trend.
Filed under: The Wyckoff Wave
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