From K, a rally begins. If the rally is merely a correction of the oversold condition at K, rather than the beginning of a strong drive to new highs, it should show signs of supply after recovering about one half of the decline from the top, near H.
The arrow marks the one-half recovery point. Note that this price level (150) has taken on unusual significance. It is the level of the initial distribution (D), marked by extreme volume. Subsequently, this level provided resistance and support as the index first rallied then declined. Indeed, this level can be viewed as a kind of axis about which the index pivots for three months. During distribution, the axis is often not only the point of initial distribution but also the final test of supply registered before liquidation begins. Point & figure counts are often best made across such an axis, and important targets are measured from that axis. Similar axes are formed during accumulation as well.
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A normal corrective rally from K returns the price to 150, but volume on the rally is meager. Mounting evidence of technical weakness has put the onus on market bulls to prove they have the firepower once again to take the offensive.
The index does not spend much time trading in the area of K, a sign that little reaccumulation has occurred at that level. The rally back to supply around 150 is quick, and we suspect that, in the absence of reaccumulation, buying is provided by short-covering rather than by traders taking new long positions.
Light volume on the rally indicates that there is little force behind the rally. In the present context of distribution, light volume on the rally tells us that buyers are now exhausted.
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Here is a summary of our reasoning to this point: 1. Distribution by strong hands has been evident since mid-July;2. At I we detected early signs of liquidation; 3. The month-long, persistent decline of prices into the beginning of October is a clear sign of weakness; 4. All previous rallies above 150 have encountered strong selling, and we suspect that any rally attempt much beyond the current level will be slowed or turned back by residual supply; 5. The rebound to 150 in early October shows little indication that buyers have regained control. |
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At L, volume picks up as spread compresses. Sellers are active. This is the setup we have been waiting for. We enter market orders to short.
After we sell short at L, we have only to wait for the index to tell us whether our judgement is correct. Our stops are placed above near-term supply, at a price just over 155.
The index begins to ease downward on only modest volume. Volume must be considered in context, and our interpretation is influenced by months of technical erosion. Light volume here is an indication that the initial decline is encountering little resistance. Bidders are weak. Price gaps down to a test of the early October low, but bargain hunters cannot sustain more than a one-day rally before the index breaks to a new low on increased volume (M). Liquidation has begun in earnest.
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Point and figure analysis shows that the broad band of distribution between 141 and 158 spans 35 columns, from the vertical ascent which terminated with the first point of distribution at D to the last point of supply. Targets may be measured from the high of 158 as well as from the axis, the level at which our count of 35 is taken (149). Our first objective is 124, and our second is 115. Using these measurements, our profit potential for the trade is between 17 and 23 percent. Our risk is 6 points, or just under 5 percent. Our profit potential is four to five times this risk. This is a very favorable risk to reward.
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Selling comes with the force of a Niagara. The first target of 124 offers no support at all. The index gaps down on heavy volume to N. The action is climactic. Shares are being sold at the market by panicky traders. After a two-day automatic rally, the index resumes its decline. Trading is gappy and frantic as prices plunge to new lows. Our second target of 115 is passed with only slight hesitation.
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On the selloff below 110 (O), volume increases, though to a level below the volume highs of the first climactic sell off at N. We suspect that this is a climactic aftershock, and a potential trap for late sellers. Our most ambitious downside target has been exceeded, and we look for any sign that prices are turning up. Any sign of sustainable strength will cause us to cover our short position.
I have not yet identified the index featured in this chapter, though by now you may have guessed the period we have been studying, if not the index. The subject of our study has been the New York Times Industrial Index from early June to late November, 1929.