Buying and Selling Waves

Here is a 5 minute bar chart of the e-mini trading during today's day session.

Richard Wycoff wrote what I think is the best single book on tape reading entitled "Tape Reading and Active Trading". Actually, he published it as part of his bigger stock market course which has been out of print for many years.

In any event, the fundamental method that Wycoff advocated was wave chart analysis. In Wycoff's day (1900-1930) there were no computers, so he contructed his wave charts by hand as an average of the prices of 5 actively traded leading stocks of the day. He tracked their prices intraday and calulated the average price at what he thought were the extreme points of intraday swings. Today we can actually trade the averages so our wave chart would be contructed from actual trades in the Spiders or the e-minis.

The way to analyze a wave chart is to compare the length and duration of buying (up) waves and selling (down) waves to one another. This involves a certain degree of artistry and judgement founded on experience because it is sometimes not very obvious where these waves begin and end.

Here is how I think Wycoff might have analyzed today's action thus far. A buying wave lasting about 20 minutes developed from the open and carried the e-minis up 8 1/2 points. Volume was moderate during the upwave compared to previous activity at the same time of day. There followed a 25 minute selling wave which dropped the market 13 1/2 points. This wave occurred on higher volume than the previous buying wave and carried the market down more points than the previous buying wave carried it up. So by 10:15 am ET the wave chart was forecasting a bearish day - at the very least sellers were in control of the market and the tape reader would be inclined to sell rallies.

The next buying wave carried the market up 6 points and did not last as long as the previous buying wave. This confirms that the sellers are in control. But the subsequent selling wave carried the market down only six points while lasting 25 minutes, the same as the previous selling wave. This is an indication that the sellers were pulling back from the market. If the next buying wave can show definite strength by lasting longer and carrying further and either of the two preceding buying waves there is a good chance that the buyers can reassert their control of this market.

I just looked at my 5 minute bar chart and I see that the market has rallied for 30 minutes and has gone up 12 points (not shown on the chart above!). This tells me that the buyers are once again in control of this market and therfore that there was NO supply shock this morning.