Selling Short

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.

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.

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.

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.

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