Site icon Rubén Villahermosa | Trading and investing with Wyckoff methodology


Learn how to identify the onset of a lateral market environment

After the appearance of the potential climax, there will be an automatic reaction that will visually leave a large movement in the opposite direction, thus confirming the climatic event.

This movement will be the most important since the market began the previous trend phase. It suggests an aggressive entry of operators in the opposite direction and indicates a change of character.
This ChoCh (Change of Character) has great implications and is that it signals a change in the context of the market; the ChoCh appears to put an end to the previous trend and start an environment of lateralization in the price.

This change in behaviour must be confirmed with the last event of Phase A: the Secondary Test. With its appearance, we can confirm the new environment in which the market will move from that moment on.

The implications of its development

The distance travelled by this movement will be one of the elements we will take into account later on as the structure develops in order to try to determine what the great professional is doing.

We must bear in mind that a short-distance reaction does not have the same implications as a significantly (in comparative terms) larger one.
For example, in a market where the latest upward movements have developed with an average of 50 points; and suddenly you see an Automatic Rally of 100 points, it suggests a stronger bottom.

It will be one of the elements that we will take into account later on as the structure develops in order to try to determine what the great professional is doing.

When we see a movement that is intertwined, does not travel a great distance and without the appearance of a high volume, denotes that there is no great intentionality to push prices that way and suggests to us that the market is not yet in a state of equilibrium. Very possibly the later Secondary Test will be developed relatively soon and may go beyond the limits of the structure, denoting this imbalance.

If we observe this behaviour in a potential accumulation structure, we have to doubt that what is really taking place in the market is an accumulation for a later price increase. With this apparent weakness it will be more sensible to think of a process of redistribution that leads to lower prices.

The same is true for analyses that denote a higher probability of distribution. If we see that the bullish movement is interlaced, that it doesn’t travel a great distance, that we haven’t seen a volume peak and that the Secondary Test ends above the maximum established by the Buying Climax, he suspects that what is happening may be a reaccumulation structure.

The anatomy of the reaction

Generally, the volume at the beginning of the movement will be large, we are at the end of the climatic event and it is normal that this price shift is made with a climatic volume (except for the appearance of Selling/Buying Exhaustion). As the movement progresses, the volume will decrease until it is relatively low in the end. This drying of the volume suggests a lack of interest in continuing to rise and will put an end to the Automatic Rally/Reaction.

With price ranges practically the same thing happens. At the beginning of the movement we will observe wide ranges, good candles/trend bars that will progressively narrow as they approach the end of the event.

Through continued practice you will develop the judgment necessary to know when the narrowing of ranges and the decrease in volume have reached a point at which movement is likely to stop. There are no fixed or mechanical rules, it’s more a matter of judgment.

Reaction Uses

Delimits the limits of the structure

Within the structures of the Wyckoff methodology, it is one of the important elements since its end serves to identify one of the limits of the structure.

Identifies the climate event

The reaction is important as it will sometimes be unclear when the genuine climax has appeared. Therefore, on many occasions we recognize climate action after identifying the character change that follows this reaction.

It provides us with the market context

After observing events 2 (Climax) and 3 (Reaction), we identify the change of character (ChoCh) of the market and we know that the price will test that climate action to develop the Secondary Test. We already have a market map. As we always say, this is very important because it provides us with an operational opportunity.

Opportunity to take benefits

If in an exercise of recklessness you operated on the climatic event seeking precisely that rebound, this position should not be maintained throughout the development of the range, since in principle we cannot know whether it will be a structure of rotation or continuity. The most sensible thing would be to close the position on the Automatic Rally/Reaction obtaining the benefit of a Scalp.

Automatic Rally

The Automatic Rally is an upward movement of the price that develops after the end of the Selling Climax and that appears as the first signal of the buyer interest.
It is an event that is part of the Phase A stop of the previous trend and takes place after the Preliminary Support and the Selling Climax.

Why the Automatic Rally takes place

During the downward trend the price will have moved down a considerable distance and possibly reach a condition of overselling in the development of the Selling Climax where the following actions take place:

Exhaustion of the supply. Aggressive sellers stop entering the market

Short covering. Vendors who would have entered higher close their positions

Appearance of the demand. New buyers enter by observing the climate event

The market has reached uninteresting levels to continue selling, which will lead to a lack of supply. The withdrawal of sellers, both those who stop selling aggressively, as well as those who take profit from their shorts; together with the emergence of new buyers, who may have entered with reversal strategies to the average, will cause an easy push up prices.

The most normal thing is that buyers who have entered the Selling Climax do not intend to maintain their positions, since it is probably Scalp operations (short duration) and take profits during the Automatic Rally, putting an end to its development.

Automatic Reaction

The Automatic Reaction is a significant downward price movement that appears as the first sign of selling interest. It is part of Phase A of the previous trend and develops after the Preliminary Supply and Selling Climax.

Why Automatic Reaction Occurs

The market will have moved upwards enough to produce a series of events that together give rise to the development of Automatic Reaction:

Exhaustion of demand. There are no aggressive buyers willing to keep buying.

Long covering. Buyers who would have entered below close their positions by taking profits.

Appearance of the supply. New vendors enter by observing the previous weather event.

The previous market rally may have reached an overbought condition causing a lack of demand. This withdrawal of buyers, both those who stop buying aggressively, and those who take profit from their lengths; together with the emergence of new sellers will cause an easy push down prices.
Sellers who have entered the Buying Climax are surely speculating looking for a quick downward movement and will take profits during the Automatic Reaction, putting an end to its development. 

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