What is meant by Wyckoff Method?

The Wyckoff method was developed by Richard Wyckoff in the 1930s. It consists of a set of principles and strategies that were originally designed for traders and investors. Wyckoff dedicated a significant part of his life to teaching, and his work greatly influenced modern technical analysis (TA). Although the Wyckoff Method was initially focused on stocks, it can now be applied to all types of financial markets.

Much of Wyckoff's work was inspired by the trading methods of other successful traders (especially Jesse L. Livermore). Today, Wyckoff is as highly regarded as other key figures, such as Charles H. Dow, and Ralph N. Elliott.

Wyckoff conducted in-depth research, which led to the creation of several trading theories and techniques. This article provides an insight into his work. This discussion includes:

• Three fundamental laws;

• Composite Man Concept;

• A methodology for analyzing charts (Wyckoff Scheme);

• A five-step approach to markets.

Wyckoff also developed specific Buying and Selling experiments, along with a unique charting method, based on Point and Figure (P&F) charts. This trial helps traders find better entries. The P&F method is used to determine trading targets. However, this article will not delve into these two topics.

Wyckoff's three laws

Law of Supply and Demand

The first law states that prices rise when demand is greater than supply, and fall when the opposite happens. This is one of the most basic principles of financial markets and Wyckoff's method is no exception. We can explain the first law with three simple equations:

• Demand > Supply = Price increases

• Demand < Supply = Price falls

• Demand = Supply = No significant price changes (low volatility)

In other words, Wyckoff's first law shows that an excess of demand over supply (supply) causes prices to rise because there are more people buying than selling. But, in a situation where there is more selling than buying, supply exceeds demand, causing prices to fall.

Many investors who follow the Wyckoff Method compare price and volume movements as a way to better visualize the relationship between supply and demand. This often provides insight into the next market move.

Law of Cause and Effect

The second law states that the difference between supply and demand is not random. Rather, it appears after a preparatory period, as a result of certain events. In Wyckoff's terms, a period of accumulation (the cause) eventually leads to an uptrend (the effect). Conversely, the distribution period (cause) eventually produces a downtrend (effect).

Wyckoff applied a unique graphing technique to estimate the potential effect of a cause. In other terms, he created a method to define trading targets based on accumulation and distribution periods. This allows him to estimate the possible expansion of the market trend after breaking out of the consolidation zone or trading range (TR).

Business Law vs. Business Law Results

Wyckoff's third law states that changes in asset prices are the result of effort, represented by trading volume. If price movements align with volume, there is a good chance the trend will continue. However, if volume and price differ significantly, the market trend is likely to stop or change direction.

For example, imagine the Bitcoin market starts to consolidate with very high volume after a long bearish trend. High volume indicates great effort, but sideways movement (low volatility) indicates little return. So, there was a lot of Bitcoin changing hands, but no more significant price drops. Such a situation may indicate that the downtrend may be over, and a reversal is imminent.

Composite Party

Wyckoff created the idea of ​​the Composite Man/Party (or Composite Operator) as an imaginary identity of the market. He proposed that investors and traders study the stock market as if one entity controlled it. This will make it easier for them to follow market trends.

In essence, Composite Parties represent the largest players (market makers), such as wealthy individuals and institutional investors. It always acts to ensure it can buy low and sell high.

The Composite Party's behavior is the opposite of the majority of retail investors - who, Wyckoff observed, often lose money. But according to Wyckoff, the Composite uses a somewhat predictable strategy, so investors can learn from it.

Let's use the concept of Composite Parties to describe a simplified market cycle. Such a cycle consists of four main phases: accumulation, uptrend, distribution and downtrend.

Accumulation

Composite Parties accumulate assets before most investors. This phase is usually characterized by sideways movement. Accumulation is done gradually to avoid prices changing significantly.

Uptrend

When the Composite Party holds enough shares, and its selling power is reduced, it begins to push the market. Naturally, emerging trends attract more investors, causing demand to increase.

In particular, there may be several accumulation phases during an uptrend. We can call this the re-accumulation phase, where the larger trend stops and consolidates for a while, before resuming its upward movement.

While the market is moving up, other investors are encouraged to buy. Eventually, even the general public became eager enough to get involved. At this point, demand is much higher than supply.

Distribution

Next, the Composite Party begins to distribute its ownership. He sells his profitable positions to those who enter the market at a late stage. Typically, the distribution phase is characterized by sideways movement that absorbs demand until it is exhausted.

Downtrend

Immediately after the distribution phase, the market begins to reverse downwards. In other words, after the Composite Party finished selling a large amount of its shares, it started to push the market down. Eventually, supply becomes much greater than demand, and a downtrend is formed.

Similar to uptrends, downtrends can also have redistribution phases. It's basically a short-term consolidation during a massive price fall. This can also include Dead Cat Bounces, also known as bull traps, where buyers are trapped, hoping for a trend reversal to occur. When the bearish trend finally ends, a new accumulation phase begins.

Schema Wyckoff

Accumulation and Distribution Schemes are likely the most popular part of Wyckoff's work - at least within the cryptocurrency community. These models divide the Accumulation and Distribution phases into smaller parts. The section is divided into five Phases (A to E), along with several Wyckoff events, which are briefly explained below.

Accumulation Scheme

Phase A

Sales force is declining, and the downtrend is starting to slow. This phase is usually characterized by an increase in trading volume. Preliminary Support (PS) indicates that some buyers are emerging, but it is still not enough to stop the downward movement.

Selling Climax (SC)  is formed by intense selling activity when investors  give up/capitulate. This is often a point of high volatility, where panic selling creates  large candlesticks and wicks. A strong decline quickly turns into a bounce or Automatic Rally (AR), as excess supply is absorbed by buyers. In general, the trading range (TR) of an Accumulation Scheme is determined by the space between SC low and AR high.

As the name suggests,  Secondary Test (ST) occurs when the market falls near the SC region, testing whether the downtrend is truly over or not. At this point, trading volume and market volatility tend to be lower. While ST often forms a higher low in relation to SC, this is not always the case.

Fase B

Based on Wyckoff's Law of Cause and Effect, Phase B can be seen as a Cause that leads to an Effect.

In essence, Phase B is the consolidation stage, where the Composite Party accumulates the highest amount of assets. During this stage, the market tends to test both resistance levels and support levels of the trading range.

There may be some type of Secondary Tests (ST) during Phase B. In some cases, this may create higher highs (bull traps) and lower lows (bear traps) in relation to the SC and AR in Phase A.

Phase C

Phase C accumulation usually consists of what is called a Spring. Often this Spring acts as the last bear trap before the market starts to make a lower low. During Phase C, the Composite Party ensures that there are few lagging offers in the market, for example, lagging offers from people who have already sold previously.

Spring often breaks support levels to stop traders and mislead investors. We can describe it as a last-ditch effort to buy shares at lower prices before an uptrend begins. Bear traps encourage retail investors to dump their holdings.

But in some cases, the support level manages to hold, and Spring does not occur. In other words, there may be an Accumulation Schema that serves all the other elements but not Spring. However, the overall scheme remains valid.

Phase D

Phase D represents the transition between Cause and Effect. This phase is between the Accumulation zone (Phase C) and the breakout of the trading range (Phase E).

Typically, Phase D shows a significant increase in trading volume and volatility. Usually has Last Point Support (LPS), creating a higher low before the market moves higher. LPS often precedes a breakout of a resistance level, which in time creates a higher high. This shows Signs of Strength (SOS), as previous resistance becomes new support.

Although the terminology is somewhat confusing, there may be more than one LPS during Phase D. These LPS often experience increased trading volume when testing new support lines. In some cases, price may create a small consolidation zone before effectively breaking out of the larger trading range and moving into Phase E.

Phase E

Phase E is the final stage of the Accumulation Scheme. It is characterized by a real breakout of the trading range, caused by an increase in market demand. This is when the trading range is effectively broken out, and an uptrend begins.

Distribution Scheme

In essence, Distribution Schemes work as the opposite of Accumulation, but are slightly different in terms.

Phase A

The first phase occurs when an established uptrend begins to slow down due to a decrease in demand. Initial Offer/Preliminary Supply (PSY) indicates that selling power is emerging, although it is still not strong enough to stop the upward movement. Purchasing Climax (BC)  is then formed by intense purchasing activity. This is usually caused by inexperienced traders buying using emotion

Subsequently, a strong upward movement led to an Automatic Reaction (AR), as demand was overwhelmingly absorbed by market makers. In other words, the Composite Party begins to distribute its ownership to the final buyers. Secondary Test (ST)  occurs when the market heads back towards BC territory, and often forms a lower high.

Fase B

Phase B of a Distribution acts as a consolidation zone (Cause) that precedes a downtrend (Effect). During this phase, the Composite Party gradually sells its assets, absorbing and weakening market demand.

Typically, the top and bottom points of a trading range are tested several times, which may form short-term bear traps and bull traps. Sometimes, the market will move above the resistance level created by the BC, resulting in an ST which can also be called an Upthrust (UT).

Phase C

In some cases, the market will form one final bull trap after a period of consolidation. This is called UTAD or Upthrust After Distribution. Basically, it is the opposite of Spring Accumulation.

Phase D

Phase D of a Distribution is exactly like Accumulation. It usually has a Last Point of Supply (LPSY) in the middle of the range, creating a lower high. From this point, a new LPSY is created - either around or below the support zone. A clear Sign of Weakness (SOW) appears when the market breaks below the support line.

Phase E

The final stage of the Distribution marks the beginning of a downtrend, with an apparent break below the trading range, caused by the strong dominance of supply over demand.

Does the Wyckoff Method work?

Naturally, the market does not always follow these models accurately. In practice, Accumulation and Distribution Schemes can occur in various ways. For example, some situations may have a Phase B that lasts longer than expected. Or else, Spring Tests and UTAD may not exist at all.

Nevertheless, Wyckoff's work offers a variety of reliable techniques, which are based on many of his theories and principles. His work is certainly valuable to thousands of investors, traders and analysts around the world. For example, the Accumulation and Distribution scheme may be useful when trying to understand the general cycles of financial markets.

Wyckoff's 5-step approach

Wyckoff also developed a five-step approach to markets, which is based on his principles and techniques. In short, this approach can be seen as a way to put his teachings into practice.

Step 1: Determine the trend.

What are the current trends and where are they headed? What is the relationship between supply and demand?

Step 2: Determine asset strength.

How strong is the asset in relation to the market? Do they move in the same or opposite ways?

Step 3: Find assets with enough “Cause”.

Is there sufficient reason to enter a position? Is the Cause strong enough to make the potential reward (Effect) worth the risk?

Step 4: Determine how it moves.

Is the asset ready to move? Where does it fit in the larger trend? What do prices and volumes suggest? This step often involves using the Wyckoff Buy and Sell Test.

Step 5: Calculate your login time.

The final step is all about timing. It usually involves analyzing a stock and comparing it to the general market.

For example, a trader can compare the price movement of a stock in relation to the S&P 500 index. Depending on their position in the respective Wyckoff Scheme, the analysis can provide insight into the asset's next movement. Finally, this makes it easier for good entries.

This method especially works better with assets that move with the general market or index. In the cryptocurrency market, this correlation does not always exist.

Closing

It has been almost a century since its creation, but the Wyckoff Method is still widely used today. It is definitely more than just a TA indicator, as it covers many trading principles, theories and techniques.

Basically, the Wyckoff Method allows investors to make more logical decisions rather than acting on emotions. Wyckoff's extensive work provides traders and investors with a series of tools to reduce risk and increase their chances of success. However, there is no foolproof technique for investing. One should always be aware of risks, especially in the highly volatile cryptocurrency market.