The Market is Reacting.  Are We Seeing a Change in Character?

Last Monday, the stock market, as measured by the Wyckoff Wave reached an important high and began to react.  Is this normal and expected, are we seeing an important change in character that will negate the positive action of the past three weeks?

Are we experiencing a normal corrective reaction, that in this case is also a backup to the last resistance line (or the Mr. Evans’ creek)? Or, as some have opined, are we seeing an Upthrust after Distribution and is the market beginning an important reaction?

In order to investigate this further, it is important to review and understand, what is known in the Wyckoff world as a change in character.  A change in character is nothing more than when the market behaves differently than it did previously.  The character of the market (or an individual stock) can be either demand, supply, lack of demand, or lack of supply.  Of these, demand and supply are the most important. A stock or index’s character can be demonstrated on either a very short-term basis (one day to the next) or over a longer period of time.

These changes of character, coupled with the Wyckoff tools that include the Optimism – Pessimism Index, Technometer and Force Index, can provide important clues as to the future direction of the market.

To help understand this concept, let’s review the action of the Wyckoff Wave beginning with the spring that took place last October 4th.  It is marked as point H on the attached chart.

The day before the Spring, the Wyckoff Wave reacted strongly on increased spread and volume. Supply was definitely present and the Wave was rocketing towards the bottom of the trading range.  Based on the day’s action there seem to be an excellent chance that the Wave would break through the support and Fall Through the Ice, for a major Sign of Weakness.

The next day, the Wyckoff Wave opened lower and it appeared that it was going to move through the bottom of the trading range into new low ground.  Then, all of a sudden, there was a change in character.   If we analyzed the day’s action, we would call it an intra day failure to the down side and a rally on increased spread and volume.  Demand came in and point H was a Spring.  We went from strong supply to strong demand.  This is a change in character.  However, it is only a change of character on a very short-term basis and needs to be confirmed.

One easy way to confirm this would be a test of the Spring.  This didn’t happen.  The Wyckoff Wave rallied directly to the top of the trading range.  The rally was on decent spread and slightly decreasing volume.  However, while some days demonstrated a lack of demand, supply was not present.  The Wave rallied fairly easily to the resistance drawn through point A and, so far the positive character of the Wyckoff Wave remained unchanged.

Then, at point I the Wyckoff Wave rallied on reduced spread and increased volume.  It also closed near the low of the day.  This suggests supply is coming into the market.  This is also a single day change in character.

However, one day does not change a trend.  It is simply a flashing light that tells us to be observant. This is also a place where we would expect to see supply.

The next three days suggested a lack of demand.  The expected supply was simply not coming into the market.  Then, after briefly reacting to point J, strong demand appeared and the Wyckoff Wave rallied on increased spread and volume.  While this good demand could help define this area as absorption, the key ingredient was that the expected supply, and therefore a new change of character, did not appear.  This would make the Wyckoff Wave vulnerable for a continued rally.  And rally it did, up to point K.

The Wyckoff Wave had penetrated the resistance (jump across the creek). When this happens there are three options.  The Wave can react and have a successful Last Point of Support.  It can Upthrust the trading range and begin a reaction.  Finally, it can simply begin a new trading range.  In this case, the Wyckoff  Wave experienced the third option.

However, it is important to understand that the character of the Wyckoff Wave has not changed since the spring at point H.

The Wyckoff Wave then reacted two point L.  It was a three-day reaction.  The first day suggested a lack of supply.  The second day suggested a lack of demand.  On the third day, after a huge gap opening to the down side, on bad news from Europe, the Wyckoff Wave experienced a narrower spread and increased volume.  This suggests demand has come into the market.  Therefore, despite a fairly significant reaction from point K to point L, the character of the market did not change.

The Wyckoff Wave then moved sideways to point O.  While there was one day of good supply on the reaction to point N, it was not sustained and the low at point N was higher than point L.

After rallying to point O, which was basically the same as point M, the Wyckoff Wave reacted to point P.  For the first time we are seeing supply come into the market.  As the reaction continued, a significant change of character had to be considered.  In fact, if we were just using the Wyckoff Wave as our only tool, we would have to say the character of the Wave had changed and supply was now in control.  We could certainly expect the Wyckoff Wave to react back into the original trading range and, quite possibly test the old support levels at point H.

However, the Wyckoff trader has a few more tools.  One of the most important is the Technometer, which is doubly effective when used with the Force Index.

As supply came in and the Wyckoff Wave reacted through the creek and back into the original trading range, look at the Technometer.  There is a huge positive divergence.  The Wyckoff Wave is substantially more oversold than it was at point H.  When the Wyckoff Wave or and individual stock becomes more oversold on its Technometer, but is higher than a previous low, we should look for a rally.  When the Force Index experiences the same positive divergence as the Technometer, this adds even more credibility to this thesis.  In addition, the Wyckoff Wave respected the halfway point of the move from point H to point K.

While we have seen a change of character, these Wyckoff tools are telling us things may not be exactly as they seem.

The Wyckoff Wave put in a low at point P and then rallied sharply to point Q.  Because the low at point P was put in on the day after Thanksgiving, which was a shortened market day, the low volume was a bit skewed.  Even though there was only one strong demand day, the Wyckoff Wave rallied easily to point Q.  This would suggest supply was diminished, demand was back in control and the character of the Wyckoff Wave had changed once again.

The Wyckoff Wave reached and slightly up thrusted the new trading range at point G.  Once again, we should expect supply to come in and it did.  However, was this a change of character.  On the surface, it certainly was.  If you look at the day’s action on the reaction from point Q to point R there were several days when supply was in total command.  However, we need to also look at the results.  The reaction from points Q to R lasted for 10 trading days.  In that time it reacted less than half the distance of the previous reaction from points O to P.  It also respected the halfway point of the rally from point P to point Q.  In other words while we can certainly justify supply coming into the market, it appears there were many buyers quite prepared to take in the shares that were being sold.  While good supply would suggest a change of character, one needs to see results.

This observation is confirmed when all the lost ground was recovered in three trading days as the Wyckoff Wave rallied smartly from point R.

Again, the Wyckoff Wave reached the top of the new trading range and this was the perfect place for supply to return.  Instead, the Wave continued its rally to point S.  Interestingly, most of the days suggested a lack of demand.  This lack of demand made the Wyckoff Wave extremely vulnerable to supply and an important change of character.  However, so far supply has not come into the market.  Instead, on the two days following point S we saw supply appearing early in the trading day.  It was easily absorbed and followed up with strong demand.  This was especially apparent on Thursday as the Wave reacted in the morning and rallied strongly to close near the day’s high.  The intra day up waves were primarily responsible for the day’s high-volume. Then on Friday, we saw reduced spread and volume which suggests a lack of supply.

The above suggests that, with a minor exception of the rally from points O to P, which was placed in question by the actions of the Technometer and Force Index, the Wyckoff Wave has maintained a positive character since point H.

The Wyckoff Wave is in a short-term uptrend and may well be reacting back to the resistance line drawn from point K.  This lines up with the support line of the short term uptrend channel and the halfway point of the move from R to S.

In addition, if we see supply come into the market, it may well be the situation like the reaction to point P, as the Technometer has a good chance of becoming oversold while the Wyckoff Wave is at a higher level than either points R or P.

It is important to watch the character of an individual stock or index as it develops.  In the basic course, it is described as small waves on the ocean.  By themselves they don’t seem to be much, but as they develop and experience outside influences, they can grow and become extremely powerful.

One final note: Last weeks Market Letter included a weekly chart of the Wyckoff Wave. Below the chart were charts of the Optimism – Pessimism Index, the Technometer and the Force Index.  I should have removed the Technometer and Force Index from the weekly chart.  Both of these important Wyckoff tools are daily moving averages and become skewed wave viewed in a weekly or monthly chart.  Simply put, the Technometer and Force Index must only be used when viewing a daily chart of the Wyckoff Wave or any of the individual stocks in the charting service.

My sincere thanks to those who brought this to my attention and my apologies for providing this incorrect and unnecessary information.

Are We Ready to Rock and Roll?

Ask the Technometer

Despite a week of holiday trading doldrums, the stock market as measured by the Wyckoff Wave, sent us an interesting message.  It didn’t go down.

Over the last six trading days, when the Wyckoff Wave penetrated the resistance drawn at point K, supply had an ample opportunity to assert itself as investors and traders either took profits or exited long-held positions.  This phenomena has been present since the Wyckoff Wave rallied off the spring at point H and first encountered this supply at point I.

There was some absorption from point I to point J.  Point J could’ve been marked as a Last Point of Support. Then there was a rally to point K.  This appeared to be a penetration of the resistance and a Jump Across the Creek.  Instead, supply continued to the present and the Wyckoff Wave entered a new trading range.

Now, we have penetrated the new top of the range, but, so far, supply has not appeared. Are we finally ready to leave the two stage trading range that began in early August?  There are a few important signs, especially a Technometer formation, that say 2012 could be a very good year.

Last week, we discussed the supply situation in detail and analyzed the Optimism – Pessimism Index.  This week’s market action has done nothing to change that analysis.  Now, let’s look at a few more positive indications.

After the last three short term rallies, the Wyckoff Wave has respected the halfway points.  If you look at page 1 of the attached charts, you will see that on the reaction to point P, the Wave respected the halfway point of the rally from points H to K.  The same was true of the reaction from points G to R.  Finally, so far, the Wyckoff Wave has held above the halfway point of the R – S rally.  Respecting halfway points is a significant bullish indication.

So far, with the lack of supply at the top of the trading range, we also find the Wyckoff Wave respecting the halfway points of its rallies.  In addition, since the low at point P, we have also seen higher tops and higher bottoms.

Finally, let’s look at the Technometer. The Technometer is a volume based Wyckoff tool that is extremely helpful, when used with other Wyckoff indicators, in identifying important turning points in the stock market or in individual stocks.  Each stock and index in our Pulse of the Market Charting Service has its own individual Technometer readings.

The Stock Market Institute (SMI) courses and lectures tell us that a Technometer reading over 50 consists of an overbought condition and the market or an individual stock may be ready to react.

Conversely, a reading between 42 and 38 suggests an oversold condition and the market or an individual stock may be ready to rally.  I have seen both numbers presented as an oversold condition.  While I have a tendency to use 38 as an oversold condition, when the Technometer falls below 42 I look very closely at other indicators like the Optimism – Pessimism Index and the Force Index to see how they are relating to the Technometer readings.  Any divergences or inharmonious actions can be extremely helpful in confirming market turning points.

One of the most important uses of the Technometer is in comparing readings with previous highs or previous lows.  For example, if the Technometer reaches a new low, when compared to a previous low, but the index or individual stock does not make a new low, this is an important indication that the market should begin to rally.  The Wyckoff Wave gave us an important example of this just before the beginning of the 2010 – 2011 bull market.

Please look at page 2 of the attached charts. Notice the spring at point G and then the Last Point of Support at point M. At point G, the Technometer reading was 38.11.  This is an oversold condition and preceded the expected rally to point H.  The Wyckoff Wave then rallied to point J and fell back into the creek at point K.  It then rallied to point I and reacted through the bottom of the creek at point M.  We can even draw a short-term down trend channel through point J and L, with a parallel support line at point K.  This was not a bullish scenario.  Count to the down side could have certainly been taken from point L to point F and even to point B.  The economic news was terrible.  The country was in a recession and everything was going wrong.  This had to be a continuation of the bear market of 2008.

Except, look at the Technometer.  As the Wyckoff Wave reacted to point M, the Technometer put in a new low.  It registered 35.66.  This is a dangerously oversold condition.

Now compare points G and point M.  M is substantially higher than point G, yet the Technometer is more oversold.  We know, based on our Wyckoff teachings, that this important indication does not suggest we are approaching a bear market.  It suggests we are going up.

Look what happened. Over the next seven months the Wyckoff Wave gained over 8,000 points. This was a 33 1/3% gain and greatly enhanced the portfolios of wise Wyckoff traders.  I would suspect there were an awful lot of “experts” scrambling to cover their shorts.

Let’s move forward to some recent market action.  At point H, the Wyckoff Wave’s Technometer  reading was 38.04.  The Wave then rallied strongly.  After the highs at point K, the Wave moved sideways and then reacted to point P. Its Technometer reading was a dangerously oversold 33.65.  Compare point P with point H.  We have a lower Technometer reading and a more oversold condition at point P. But point P is quite a bit higher than point H.  I would submit there are some substantial conclusions that can be drawn here.

Finally, let’s take a quick look at the Wyckoff Wave’s Point and Figure chart.  The count from point R (which could be a legitimate Last Point of Support) to point P is 30 on the 100 point figure chart. This gives us a count of 3000 points that can be taken from the low at point P and the high at point R.  This objective is from 30,000 31,400.

If this objective is reached we can then use the second phase of the account, which is from point R to point J.  This is a count of 8,800.  These objectives are from 35,800 to 37,200. This takes us back into the distribution area prior to the 2008 bear market.

While it is important to let the initial phases of counsel work out before looking at maximum objectives, if the Wyckoff Wave achieves all of the its count phases to go back to the August selling climax, we would be looking at a monster rally.

Will 2012 be a banner year for the stock market and the Wyckoff Wave?  Honestly, I don’t know for sure.  However, if we believe the Wyckoff analysis of supply and demand and use the tools in our Wyckoff tool kit, the future looks extremely promising.

Crossing the Creek and the Optimism – Pessimism Index

This week, the Wyckoff Wave attempted to cross the creek, marked by the resistance line at point K, and leave the trading range to the upside.  Will this effort be successful or will we have what Mr. Robert Evans called an Oops?

For those who are not familiar with the Oops story, it is when a stock or index tries to leave the trading range to the upside and fails.  It breaks through the resistance.  Everything looks good and then all of a sudden oops.  The stock or index returns to the trading range or, even worse experiences an upthrust.

Are we leaving the creek and beginning a strong rally or is this an oops?  To find some answers, let’s go back and look at the trading range from a longer-term perspective.  Sometimes, and I have found myself to be guilty of this more often than I care to admit, we find ourselves too involved with the short term action of the Wyckoff Wave for the individual stocks we are following.  When we do that, we often miss the major clues that only seem to come to light when it’s too late.

Many of these excellent clues can be found by studying the Optimism – Pessimism Index, the Force Index and the Technometer.  Until the Wyckoff Pulse of the Market Charting Service software was developed, these excellent tools were not available for individual stocks.  This is because all the calculations were manual and, because of the enormous amount of data that need to be calculated, was impossible to complete in a timely manner.  Now, the software programs allow all the complex calculations to be completed just a few hours after the market’s close.

Let’s start with the Optimism – Pessimism Index.  The O – P Index is simply an index of volume.  Throughout the day, the value from up waves is added to the O – P Index.  The volume from down waves is subtracted.  We look at the volume activity as effort.  The price activity is the results.  As long as the results are matching the effort, everything is in harmony and the existing trend is expected to continue.  If this changes, there is a divergence and the reasons need to be closely examined.

In the beginning of October, the Wyckoff Wave experienced a spring.  This is marked by point H.  It then rallied to point I, and then moved sideways with a low at point J.  A short-term uptrend channel can be drawn on both the vertical line chart and the Optimism – Pessimism Index chart.

The Wyckoff Wave rallied to point K.  It then weakened the short term uptrend channel at point L and broke it when the rally to point M failed to return to the short term uptrend channel.  But, look at the O – P Index.  While the Wyckoff Wave broke the up trend channel on the rally to point M, the O – P Index returned to its uptrend channel on the rally to point M.  While this created a short-term negative divergence, which signaled the eventual reaction to point P, it also showed that the O – P Index was trending stronger than the Wyckoff Wave.

In addition, for short-term traders, the O – P Index helped identify a turning point.  While it returned to the short term uptrend channel at point M, the Optimism – Pessimism Index weakened the channel at point N and broke it at point O.  Look what happened.  Short-term traders who entered the market to the down side at point O reaped some excellent profits in less than two weeks.  Keep this action in mind as it will be significant later in this article.

The Wyckoff Wave then reacted to point B.  There it tested the support line of the new short-term down trend channel that I have marked in red.  The Optimism – Pessimism Index was in harmony with the Wyckoff Wave when compared to points H, L and N.

However, look at the Technometer and the Force Index.  At point P, the Technometer was dangerously oversold at 33.  Technometer readings above 50 are considered overbought.  Technometer readings at 38 or below (some believe 42 and below) are considered oversold.  The Technometer has even more credibility when compared with the Wyckoff Wave or its individual stock.  If at the bottom of a reaction the Technometer is more oversold than a previous low, but the Wyckoff Wave or the individual stock remains higher, we can look for a rally.

Look at points P and H.  The Wyckoff Wave was substantially higher at point P, but the Technometer was at its lowest point since just before the Selling Climax at point X.  The same was true for the Force Index.  The Wyckoff Wave immediately rallied to the top of the trading range.  It then slowly reacted back and saw support just above the halfway point of the rally from point P to point Q.  This Week the Wyckoff Wave has rallied and penetrated the resistance drawn along the high at point K.

What is the Optimism – Pessimism Index telling us about this present rally.  Notice how the O – P has stayed in its short-term uptrend channel.  Unlike the rally to point O, it has stayed in the uptrend channel and is in reasonable harmony with the Wyckoff Wave.  In addition, the Technometer is still in a neutral condition.  These are both positive indications that the rally has a good chance of continuing and can put enough distance between itself and the near edge of the creek to allow it a reasonable chance to back up for a major Last Point of Support.

At this time, the only potential negative is the Force Index which is not as strong as we would like.  However, a positive week can alleviate that condition.

Does this guarantee we are seeing the beginning of the next bull market?  Absolutely not.  Only the market will answer that question.  However, the indications that we are seeing seem to indicate a bullish bias.  The Wyckoff Wave can still have an oops.  However, if we do, it’s going to happen in the next trading day or so.

A few final observations:

As it has progressed through both phases of the trading range, the Wyckoff Wave has behaved more like it is in accumulation than distribution.

We have seen a long slow reaction from point Q to point R.  This reaction respected the halfway point of the previous rally and is a reasonable Last Point of Support.

The Technometer and Force Indexes have given us a strong positive signal at point P.

The Wyckoff Wave and the Optimism – Pessimism Index are both respecting their uptrend channels.

While the dreaded oops can always foil our best laid plans, the Wyckoff price and volume signals couples with our Wyckoff trading tools strongly suggest we are headed up.

The short term trend of the market is up.

The intermediate term trend of the market is still neutral, but that may change.

All of us at Wyckoff Stock Market Institute.Com send our very best holiday greetings and wish each of you and your families a joyous and prosperous New Year.

Corrective Reactions and a Discussion about Gap Openings

This past week, the stock market, as measured by the Wyckoff Wave, experienced a bit of a change in character.  The strong supply that had dominated the moves from points K to L, M to N and O to P has been diminished as we watch the reaction from point Q.

The reaction from points K to L lasted three days and saw relatively widespread and increased volume.  The reaction from point M to N lasted one day and was on wider spread and slightly increased volume.

The Wyckoff Wave was then given a third chance to try out supply and complete a successful reaction back to the creek (the resistance level drawn at point A) for an important Last Point of Support.  This didn’t happen.  Instead the Wyckoff Wave reacted from point O back through the entire creek bed and into the original trading range.  This reaction lasted eight days and, with the exception of the last day, (the day after Thanksgiving was a shortened trading day) was done on good spread and relatively good volume.  At this point, one can conclude the Wyckoff Wave could well return to the trading range and continue it’s sideways movement.

Again, that didn’t happen.  This is one reason why it is intentionally disastrous to draw preconceived conclusions of the market’s short-term change in direction.  It’s also why we love stop orders.

The Wyckoff Wave then reacted on, at best, moderate spread and volume to point Q.  In fact, with the exception of a strong demand a on November 30th, the rally was not particularly promising.  In addition, at the top of the rally the narrowing spread and steady or decreasing volume suggested demand was diminishing.  Were we ready for one more strong reaction back into the trading range?

This is where the change of character began to unfold.  The reaction from point O to point P took eight days.  So far, the reaction from point Q to just above the halfway point of the previous rally has also taken eight days. We are also seeing relatively decreasing volume.  However, its never-ending effort to complicate things, good supply did come into the market on Friday.  While we will discuss this later in this Market Letter, notice that the day’s opening was near the highs of the day and the close near the day’s low.

Regardless, until proven otherwise, we have enough evidence to suggest that, overall, supply is finally starting to dry up.

Several days ago, I drew a support line on the chart between points H and P.  I was a bit skeptical when I did this as I was quite uncomfortable with the nature of the reaction to point P and the extremely low volume was  primarily due to the shortened day after Thanksgiving trading day.  However, I was curious to see how the Wyckoff Wave would act as it approached this support line in the future.

The Wyckoff Wave is now approaching three important support levels.
1.  The halfway point of the rally from points P – Q.
2.  The creek or resistance line drawn from point A.
3.  The support line drawn through points H and P.

If the Wyckoff Wave respects these important support levels and does so on reduced spread and volume, we could well see the completion of an important Last Point of Support. In the days to come, the Technometer will most probably send us an important timing clue. As our daily Pulse of the Market Report subscribers already know, the Optimism-Pessimism Index and the Trend Barometer are already dropping some interesting clues.

If it does not, the Wave will most probably return to the trading range and begin a new phase of sideways movement.

A Discussion of Gap Openings

Over the past few weeks, I have received several e-mails inquiring about gap openings.  Many students were not familiar with how they were treated and were curious as to where they could find more information in their course text.

I did not learn about gap openings from the text.  In fact, I honestly don’t know if the subject is included in the basic course.  I learned about gap openings and how they were treated from Craig Schroeder.  Craig, until his untimely passing in 2009 was, with Gary Schuber, the owner of Stock Market Institute (SMI).  Craig began his career with SMI in Chicago, under Mr. Robert Evans.  He read the ticker tape for Mr. Evans and helped compile his charts.  Yes, before computers there actually was a ticker tape machine that spewed out stock prices in a special code and charts were market-up manually.

Although Gap Openings were not nearly as common then as they are today, Mr. Evans was very aware of them and taught Craig how to interpret them.  I am passing along his teachings on this important subject.

When a stock or an index experiences a gap opening, the actual gap is ignored when analyzing the day’s action.  The Wyckoff Student is only interested in the difference between the day’s actual high and its low as shown on the vertical line chart.  If the actual gap is included in the day’s analysis, an incorrect conclusion can be drawn.

When analyzing the market’s action for a particular day, it is helpful to compare it to what happened on the previous day.  Just because a stock or index rallies on a particular day does not mean that demand is always present.  Let’s look at the possibilities when comparing a day’s action to the previous day.
1.  The rally is on increased spread and volume.  That means demand is present.
2.  The rally is on increased spread and decreased volume.  That suggests a lack of supply.
3.  The rally is on decreased spread and volume.  This suggests a lack of demand.
4.  The rally is on decreased spread and increased volume.  This is an indication that supply is coming into the market.

On a reaction, conditions are reversed.
1.  The reaction is on increased spread and volume.  This means supply is present.
2.  The reaction is on increased spread and decreased volume.  This suggests a lack of demand.
3.  The reaction is on decreased spread and volume.  This suggests a lack of supply.
4.  The reaction is on decreased spread and increased volume.  This is an indication of demand is coming into the market.

As you can see, if we include the gap in analyzing a particular day our conclusions could change.  Let’s look at a couple of charts and discuss a few examples.

On the chart of the Wyckoff Wave, I have marked 4 gap openings with blue arrows.  The first is just below point K.  This turned out to be a very important example of how a gap opening can mislead the trader.  The final day of the rally to point K was on increased volume.  In fact, it was the highest since point F.  A cursory look at this would suggest that the Wyckoff Wave had a successful one-day back up the Creek and was quickly leading the trading range to the up side.  However, if we look at the spread between the day’s actual high and low, we will see it was slightly narrower.  Not much, but narrower.  That, coupled with the large increase in volume, suggests supply was more active than demand.  That conclusion was immediately confirmed as the Wyckoff Wave reacted to point L.

The next blue arrow is the day after point P.  The Wyckoff Wave had fallen through the Creek, but then rallied on increased volume. Again, a cursory look would have suggested good demand had come into the market. However, if the gap is removed, we actually see reduced spread and increased volume.  This suggests the presence of supply.  Beginning a rally with some supply still present, suggests the rally will not be either strong or long.  That turned out to be correct as the rally only lasted five days and was unable to penetrate the resistance at point K.

There are some days when the gap opening is irrelevant.  Two days later, we saw a huge gap opening to the upside.  However, notice the actual opening of the Wyckoff Wave.  It was at the top of the day’s price spread.  During the day, the Wave reacted strongly, but did rally and closed at the top of a wider price spread.  While the day’s action must be called decent demand, the actual opening showed us that supply did come into the Wyckoff Wave.  This was the last positive day of the rally. By correctly analyzing the day’s action, we did see that some supply was beginning to come into the market.

The final example is found on last Friday’s action.  Here, there was a large gap opening to the upside and the Wyckoff Wave spent most of the day reacting.  Volume increased. The Wyckoff Wave closed two points lower than it did on Thursday.  The price spread increased.  Two points on an index at 29,000 is an infinitesimal difference.  The Wyckoff Wave easily could have closed two points higher, or 10 points higher, or 50 points higher.  If so, the day’s action could have easily been interpreted as demand (increased spread and volume).  However, if the gap opening is eliminated and we begin the day where the Wave actually opened, it is very easy to see that supply was the dominant force in the day’s action.

Ever since Craig Schroeder shared this bit of information with me, it has helped me to better interpret indexes and individual stocks and reduced my mistakes.  It is important to remember that when comparing the day’s action to the previous day, we are not anticipating an instant change in direction, but getting a better feel for the strength or weakness of a particular trend.

Overhanging supply and the news

No one can dispute that the financial problems plaguing the European Community are not having an impact on the American stock market.  It has become a major topic of discussion among investors and traders.  Each morning, everyone checks the S&P futures before having their first cup of coffee.

However, Wyckoff traders are taught to ignore the news.  They know that news doesn’t change the market’s real destination, it just gets it there quicker. Is this teaching wrong?  Have the advances in communication and the 24-hour news cycle changed the market’s from the original Wyckoff perspective?  Some think so.  Respectfully, I do not.

Perhaps it is not news that is causing some turmoil, but the large gap openings that occur based on a particular development in the European community.  These gap openings can cause investors and traders to misread today’s market action.

For example, recently the Wyckoff Wave had a gap opening of over 700 points.  The same day the S&P 500 had a gap opening of over 30 points.  Both indexes closed near the highs of the day on increased volume. In addition, the price difference between the day’s close and the previous day’s close was almost 1000 points on the Wyckoff Wave and over 35 points on the S&P 500.

A casual look at the day’s action could cause one to conclude strong demand was present and the market was going to continue higher.  That was not the case. Gap openings don’t count when analyzing a price spread.  What does, is the difference between the actual high price and the actual low price.  In this case, on both indexes, the price spread was narrower than the previous day.  This suggests that supply came into the market.  While everyone else was getting excited, the savvy Wyckoff trader saw problems.

Three days later, with the help of a few more gap opening to the down side, the Wyckoff Wave has reacted and lost over 1500 points.  You can see this by looking at the action around point K on the attached chart.

In my opinion, the news impacts markets openings more than it does during the trading day.  While this makes it more difficult for the short-term trader to enter and exit the market, it should not impact market analysis.

I would suggest that the amount of overhanging supply, that was discussed in the last market letter, has much more to do with the condition of the market than news from Europe.

How the stock market, as represented by the Wyckoff Wave, handles this overhanging supply will tell us a great deal more about its future direction than the news.
The Wyckoff Wave broke the long-term uptrend channel, that is seen on the left side of the attached chart and reacted strongly to a selling climax at point X.  This began a new trading range, which could be easier accumulation or distribution.  However the trading range itself can present several clues.

The first significant clue was the spring at point H.  This suggests the trading range was accumulation and the market is going to advance.

The market rallied strongly to point I.  It then moved sideways for several days.  It was unable to rally through the resistance.  It was also unable to react back into the trading range.  It was experiencing absorption.  A portion of the tremendous amount of overhanging supply, not only from earlier this year, but from the bear market of 2008 (people trying to get out almost even or with a small loss).  This is a lot of supply and it needs to be placed in strong hands before the market can advance.

The market finally broke through the resistance to the upside.  Again, the rally was stopped as more supply came in at point K.  At this point, three things could’ve happened:
1.  This could’ve been a major upthrust and the Wyckoff Wave could have reacted strongly back into the trading range and beyond.  There was a potential for a continuation of the bear market.  If one paid attention to the news, that was not an unthinkable scenario.
2.  The Wyckoff Wave could have backed up to the creek.  The creek, which is drawn in blue shows the near bank at point A and the far bank drawn through point E.  A normal backup would be completed on reduced spread and volume.
3.  Neither of these would happen and the Wyckoff Wave would simply establish a new trading range and begin to move sideways.  This would also be another phase of the trading range that began at point X.

The reaction from point K was on widespread and good volume.  Was the upthrust scenario coming to fruition?  In fact it wasn’t.  The Wyckoff Wave rallied, reacted rallied again and then started the fall back into the creek.  In fact it went slightly past the creek and briefly returned to the trading range.  It then rallied all the way to point G.

If you look at the chart you will see that a great deal of supply was present.  Normally, this amount of supply would drive the Wyckoff Wave at least to the bottom of the trading range.  This didn’t happen.  This would suggest more and more supplies being dumped, but is being accepted by professional or strong hands.  The fact that the supply is being accepted at these levels is, in my opinion, an encouraging sign that this trading range is accumulation. This will be confirmed, one way or the other, by the ending action.

Now the Wyckoff Wave has again rallied to test the highs at point K.  As it approached point Q, we saw decreased spread and slightly decreased volume.  We also saw the Wave’s inability to penetrate the resistance level on three consecutive days.  The reduced spread and slightly reduced volume suggested a general lack of demand and that the Wyckoff Wave would react towards the bottom of the new trading range.

Then, last Thursday and Friday there was a minor change of character.  On Thursday, we saw wider spread and increased volume to the down side.  Friday brought a complete reversal.  Increased spread and volume to the upside.  This wider spread and good volume are indications of our old friend absorption.  Again, more stock is being dumped by weak hands.  It is, however, being taken in.  This is one more indication that we are seeing a period of accumulation.

The problem with absorption is that one doesn’t know when it is complete.  This makes things tricky, especially for short-term swing traders.

As the market rallied to point Q, the narrower spread suggested there was a short-term opportunity to the down side.  Short-term traders were delighted on Thursday.  Disappointed on Friday.  So, what’s going to happen on Monday?

The Wyckoff Wave could upthrust the resistance.  It could react and continue adsorption.  It could jump the resistance and move into new high ground.  It could react back to the bottom of the new trading range.

In the interest of full disclosure, I am one of those short-term traders that is sitting on a small profit after Friday’s close.  To be honest, I haven’t a clue what the market is going to do on Monday.  Of the 12 stocks that make up the Wyckoff Wave, 4 look like they are prepared to advance, 4 look like they are prepared to react and 4 look like they are prepared to go sideways. Not much help there.

While I would like to see the market react, it really doesn’t matter. If the market advances, I have established a stop order that will close my position with a small profit.  If the market declines I will simply move my stop order.  The key is to plan ahead.  To anticipate a market move in either direction and established specific plans for each scenario. Then, maintain the necessary discipline to carry out your plan.

For short-term swing traders, it’s never about how much you make, it’s about how much you don’t lose.

Where Do We Go From Here?

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.

When is a test not a test?

A review of the stock market’s action, as represented by the Wyckoff Wave, gives us an opportunity to discuss tests of upthrusts. In this case, what we thought was a test, in fact was not.  We did not see the true test until Tuesday of this week.

To review: The Wyckoff Wave reacted strongly and experienced a selling climax at point X.  The rally to point Y established a new trading range.  This range is presented on the chart with two parallel blue lines.

After the reaction to point Z, the Wave rallied nicely and up thrusted the trading range at point A.  There was then a nice reaction to point B and a two day rally to point C. Even though the rally was brief, the second day was on decreased spread and volume, suggesting a lack of demand.  The Wyckoff Wave then reacted to point D.

Since we had a second rally top (C) that was lower than the first rally top (A), we are entitled to draw a new down trend channel (A – C) with a parallel support line through B.

Until shown differently, C is the test of the upthrust and we should closely watch how the Wave behaves as it moves along the new short-term down trend channel.  We certainly can expect to see support in the area between points Z and X.  What happened?

On September 8th, the Wyckoff Wave experienced an intraday failure to the upside on increased volume.  This suggested supply was present.  The following day, the Wave continued to react on increased spread and volume.  Supply was definitely present and the Wyckoff Wave appeared ready to test the support at the bottom of the trading range.  This is what would be expected after a successful test of the upthrust.

However, things aren’t always as they seem.  After this two day reaction, the Wave experienced an intraday failure to the down side.  It held above point Z.  The intraday failure, on increased volume, indicates demand has returned to the market.  Instead of continuing to react, the Wyckoff Wave began a six day rally that ended at point E.  Let’s investigate this rally on a day to day basis.

On the day following point D, the Wave rallied on decreased spread and volume.  This suggested a lack of demand and opened the possibility of continuing the reaction.  However, that didn’t happen.  The next day, the Wave continued to rally on increased spread and slightly increased volume.  Demand was still present.  However, it was not dominant and the rally was not off to a terrific start.  On the next day, Thursday, September 15th there was dramatically reduced spread and slightly increased volume.  While an argument could be made as to whether today represented the presence of supply or a lack of demand, the bottom line was that the Wyckoff Wave put in another weak performance.

The Wyckoff Wave was now approaching the top of the trading range.  It was either going to jump the creek or react back into the trading range.  The poor quality of the rally suggested the latter.  As expected, on Friday, September 16th, the Wave rose on reduced spread and increased volume.  Again, the day’s action indicated the presence of supply.  This weeklong rally back to the top of the range was of extremely poor quality.  It also put in a top that was higher than point C.  Unlike the short, two day, rally from B to C, this was a more traditional rally to test the upthrust.  It not only dried up the demand, but allowed supply to enter the market.

This Monday, supply came in strongly as the Wave reacted on increased spread and decreased volume.  This lack of demand pretty much confirmed the rally was over. The Wave made one last attempt to rally on Tuesday. The reduced spread and volume coupled with the intraday failure to the upside again suggested a lack of demand.  In addition, an examination of the intraday waves would have shown good supply came in during the afternoon.

This was the real test of the upthrust at point A.  This allowed Wyckoff students to move the short term down trend channel from points A – C (with a parallel support line at B).  The supply line of the new down trend channel is now drawn through points A and C.  The parallel support line is drawn through point D.

On Wednesday, the Wyckoff Wave reacted strongly on increased spread and volume.  It was now headed for the bottom of the trading range, where it would see support, spring the trading range, or fall through the ice. The reaction continued on Thursday, but on decreased spread and increased volume.  This suggested some demand was present.  However, some demand should be expected at the bottom of the trading range.

As I mentioned in Thursday’s Pulse of the Market daily report, we should expect to see a minor rally off the bottom of the trading range.  That began on Friday.  It got off to a poor start as the spread and volume were both less than on Thursday.  This rally should give the Wave a little space before it, again, tests the bottom of the range.

The short term trend of the market, as measured by the Wyckoff Wave, is down.
The intermediate-term trend is neutral.

What to do?

Earlier in the week, traders were advised to look for opportunities to the down side. These positions should be held until a final determination is made as the Wave tests the bottom of the trading range.  No long positions should be considered at this time.

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This was simply because the Wave was calculated manually and combining the volumes of all the individual Wave stocks was cumbersome and extremely time consuming. But, it was tradition and traditions are hard to change.

When Craig Schroeder and I were beginning to develop the online data and charting service we decided to change tradition and designate the volume of the Wyckoff Wave as the total volume of each Wave stock.

Every 5 minutes we take the total, weighted price of each Wyckoff Wave stock and the total volume of all 12 Wave stocks. We use this data to determine or “call” each intra day wave throughout each trading day.

Additional calculations produce the numbers for the Optimism-Pessimism Index was well as the Technometer Force Index.

Craig and I both felt that by using the actual volume for the Wyckoff Wave stocks, this leading indicator index would be even more helpful to Wyckoff traders.

Bob Evans also produced a series of recordings (on reel to reel tape) that offered market commentary using wonderful stories that taught us valuable lessons.  At one time, the tape machine was mailed from student to student so they could listen to the tapes.  My, have times changed.

The fascinating thing about the Wyckoff method is that the principles he developed 80 years ago, work just as well today as they did in the 1920′s and the great depression (when SMI was founded).  On his tapes, Evans may be using a company that no longer exists to make his point, but it doesn’t matter.  It’s the concepts and the lessons that are important and they are timeless.

Probably Bob Evans’ greatest gift was his ability to communicate in a way that you remembered and used the information he presented.  While listening to the tapes was serious business, it was also great fun.  He made over 200 Evans Echoes tapes and many of them are SMI classics.

Gary Schuber and I are working on a project to convert these invaluable tapes into MP3 audio files and, along with the associated charts, are, for the first, time making them available to Wyckoff Students. They can be fouind in the vault section of the web site.  It is a big project and will take some time to update all the Evans Echoes tapes.  If you have a favorite, please leave a comment and we’ll make update it and place it in the vault.