Table of contents

• What is Wyckoff analysis?

• Wyckoff's Three Laws

  • The Law of Supply and Demand

  • The Law of Cause and Effect

  • The law of quantity-price disharmony

• Market main force

  • accumulation

  • Upward trend

  • Distribution

  • Downward Trend

• Wyckoff's Schematic

  • Cumulative diagram

  • Distribution diagram

• Is Wyckoff analysis effective?

• Wyckoff's Five Steps

• Concluding Thoughts

What is Wyckoff analysis?

Wyckoff analysis was proposed by Richard Wyckoff in the early 1930s. Initially, it consisted of a series of laws and investment strategies designed for traders and investors. Wyckoff devoted a lot of energy to his teaching throughout his life, and his work has influenced many modern technical analysis (TA) methods. Wyckoff analysis was originally mainly applied to the stock market, but now it has been applied to various financial markets.

Many of Wyckoff's work was inspired by the trading methods of other successful traders, especially Jesse L. Livermore. Today, Wyckoff is highly regarded alongside other well-known figures such as Charles H. Dow and Ralph N. Elliott.

Wyckoff conducted extensive research that resulted in the creation of a variety of theories and trading techniques. This article will provide a brief overview of his work. Discussion includes:

• Three basic laws;

• Market leader concept

• How to analyze the chart (Wyckoff's diagram);

• Five steps to enter the market.

Wyckoff also proposed specific buy and sell tests, as well as an original charting method based on Point and Figure (P&F) charts. The tests can help traders discover better entries, while the P&F method is used to define trading targets. However, this article will not delve into these two topics.

Wyckoff's Three Laws

The Law of Supply and Demand

The first law states that when demand exceeds supply, prices rise, and when demand exceeds supply, prices fall. This is one of the most basic principles in financial markets, and it is not unique to Wyckoff analysis. We can illustrate the first law with three simple formulas:

• Demand > Supply = Price Increases

• Demand < Supply = Price Falls

• Demand = Supply = No significant change in price (low volatility)

In other words, Wyckoff's First Law states that demand exceeding supply causes prices to rise because there are more buyers than sellers. However, when there are more sellers than buyers, supply exceeds demand, causing prices to fall.

Many investors who follow Wyckoff analysis will compare price action and volume to better visualize supply and demand. This can often help traders form a trending market.

The Law of Cause and Effect

The second law shows that the differences between supply and demand are not random. Instead, they are due to specific events and are in preparation for a period of time. In Wyckoff's words, a period of accumulation (cause) will eventually produce an upward trend (effect). Conversely, distribution (cause) will eventually produce a downward trend (effect).

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

The law of quantity-price inconsistency

Wyckoff's Third Law states that changes in asset prices are influenced by trading volume. If price movements are consistent with trading volume, there is a high probability that the trend will continue. However, if trading volume and price diverge greatly, the market trend may stop or change.

For example, let's assume that after a long bearish trend, the Bitcoin market begins to consolidate with high volumes. High volumes indicate that market traders are putting a lot of effort into it, but sideways movement (low volatility) indicates that volume has little impact on price outcomes. Therefore, if Bitcoin volume pairs increase but the price does not drop significantly, it may indicate that the downtrend has ended and a price reversal is imminent.

Market main force

Wyckoff envisions "market makers" (or "bankers") as an identity that exists in the market. He suggests that investors and traders should study the stock market as if it were a physical institution. This will make it easier for them to follow market trends.

Essentially, market makers represent the largest participants in the market (market makers), such as individuals and institutional investors who hold large amounts of capital. Their best interest is to ensure that they can buy at low prices and sell at high prices.

Market makers act in the opposite way to most retail investors, and Wyckoff often observes that this is a loss-making situation. But according to Wyckoff, the “market makers” use somewhat predictable strategies that investors can learn from.

We can use the concept of "market force" to briefly explain the market cycle. The market cycle mainly includes four major stages: accumulation, uptrend, distribution and downtrend.

accumulation

The market leader accumulates assets before most investors. The market trend at this stage is usually sideways. The market leader chooses to accumulate gradually to avoid significant price changes.

Upward trend

When the "market makers" hold enough shares and the bearish forces in the market are exhausted, the market makers begin to push the market up. Naturally, this upward trend will attract more investors, leading to increasing demand.

It is worth noting that there may also be multiple accumulation phases in an uptrend. We can call them reaccumulation phases, where the larger uptrend stops and consolidates for a while before continuing its upward movement.

As the market rises, it will encourage other investors to compete to buy. Eventually, more ordinary investors will start to pay attention and participate in it. In this case, demand is much higher than supply.

Distribution

Next, the market leaders start distributing shares. They sell their profitable positions to investors who enter the market later. Usually, the market characteristics of the distribution stage are sideways movement until the market demand is exhausted.

Downward Trend

Soon after the distribution phase ends, the market begins to resume its downward trend. In other words, after the "market maker" sells a large amount of shares, he begins to push the market down. Eventually, the supply becomes much greater than the demand, thus creating a downward trend.

Similar to an uptrend, a downtrend can also have a redistribution phase. This is basically a short period of consolidation during a sharp decline. They can also include "dead cat bounces" or so-called "bull traps" where some buyers get caught up in the hope that the move will not happen. When the bearish trend finally ends, a new accumulation phase will start all over again.

Wyckoff Schematic

The Accumulation and Distribution Schematics are probably the most popular part of the Wyckoff analysis - at least in the cryptocurrency community. These models divide the Accumulation and Distribution phases into smaller sections. Each section is further divided into five phases (from A to E) and multiple Wyckoff events, which are briefly described below.

Cumulative diagram

Phase A

Selling power continues to decline and the downtrend begins to weaken. This phase is usually marked by an increase in trading volume. The initial support (PS) level shows that buyers are increasing, but it is still not enough to stop the downtrend.

When the bears capitulate, the violent sell-off forms a "sell climax" (SC). This is usually a high volatility point, where panic selling produces large candlesticks and wicks. The strong decline quickly rebounds or forms an automatic rebound (AR) because the excess supply is absorbed by buyers. Usually, the trading range (TR) of the accumulation diagram is defined by the space between the SC low and the AR high.

As the name implies, when the market falls near the SC area, a secondary test (ST) will be conducted to test whether the downtrend is really over. At this time, the trading volume and market volatility decrease. Although ST usually forms a higher low relative to SC, it is not always the case.

Phase B

According to Wyckoff's law of causality, stage B can be seen as the cause of the effect.

Phase B is essentially a consolidation phase where the largest amount of assets are accumulated by the market's major players. During this phase, the market tends to test the resistance and support levels of the trading range.

There may be multiple Secondary Tests (STs) within the Phase B range. In some cases, higher highs (bull traps) and lower lows (bear traps) may be produced relative to the SCs and ARs of Phase A.

Phase C

Phase C contains the so-called "bounce". This is also usually the last short trap, which usually occurs before the market starts to make higher lows. In Phase C, the market maker will ensure that there is no supply left in the market, that is, all supply has been absorbed.

A “bounce” often breaks through support levels, serving to deter traders and mislead investors. We can describe it as a last attempt by “market makers” to buy the stock at a lower price before the uptrend begins. A “short trap” tricks retail investors into abandoning the stock they now hold.

However, in some cases, support levels may hold but a bounce may not occur. In other words, the Accumulation Chart may show all the other elements but not a bounce. Nevertheless, the analysis is still valid.

Phase D

Phase D represents the transition between cause and effect. It is between the accumulation zone (Phase C) and the breakout trading zone (Phase E).

Typically, volume and volatility increase significantly during Phase D. There is usually a Last Point of Support (LPS) that sets support at a lower level before the market moves higher. The LPS will usually attempt to make a higher level before breaking through resistance. This is also the Pressure on the Upside (SOS) as the previous resistance forms a new support level.

The above list of terms can be confusing, but it is important to understand that multiple LPS may occur during Phase D. When testing new support levels, there is usually an increase in volume. In some cases, the price may create a small consolidation area before effectively breaking out of the larger trading range and entering Phase E.

Phase E

Phase E is the final phase of the accumulation pattern. Increased market demand leads to a clear breakout of the trading range. This can effectively break the trading range at the beginning of an uptrend.

Distribution diagram

Essentially, the Distribution diagram works exactly the opposite of the Accumulation diagram, with slightly different terminology.

Phase A

The first phase occurs when an established uptrend begins to slow down due to reduced demand. Initial supply (PSY) shows that selling has been occurring, although not enough to stop the upward trend. At this point, a buying craze (BC) forms with intense buying activity. This is usually caused by overbought sentiment from inexperienced traders.

Next, the strong up move triggers an automatic reaction (AR) as excess demand is absorbed by market makers. In other words, the market makers begin to sell their holdings to later buyers. When the market retests the BC area, a lower high is usually formed, leading to a secondary test (ST).

Phase B

Phase B in the distribution diagram is the consolidation zone (volume) preceding the (price) downtrend. In this phase, the market makers gradually sell their assets, absorbing and weakening market demand.

Typically, this phase will test the upper and lower limits of the trading range multiple times, which may include short-term bearish traps and bullish traps. Sometimes, the market will move above the resistance level created by the BC phase, resulting in a secondary test (ST) or Upthrust (UT).

Phase C

In some cases, the market will form one last bull trap after the consolidation period. It is called UTAD or Pull-Up After Distribution. Basically, it is the opposite of the Accumulation Spring.

Phase D

Phase D is almost a mirror image of the accumulation phase. It usually has the last supply point (LPSY) in the middle of the range, which produces a lower high. From this point, a new LPSY will be created around or below the support area. When the market breaks below the support line, it is a clear sign of weakness.

Phase E

The final stage of the distribution marks the beginning of a downtrend, with prices trading below the trading range due to the clear advantage of supply far outstripping demand.

Does Wyckoff analysis work?

Of course, the market does not always follow this type of analysis model exactly. In fact, the Accumulation and Distribution Schematic can appear in different ways. For example, in some cases the duration of Phase B may be longer than expected. Or, there may be a complete absence of a rally and UTAD test.

Nonetheless, Wyckoff analysis provides traders with a variety of reliable techniques based on many of his theories and principles. His analysis has undoubtedly been of great value to thousands of investors, traders, and analysts around the world. For example, the Accumulation and Distribution schematic can come in handy when trying to understand common cycles in financial markets.

Wyckoff's five-step analysis

Wyckoff developed a five-step analytical method based on many of his principles and techniques. In short, this method can be seen as a way to put his theories into practice.

Step one: Identify the trend.

Determine what the current trend is and what the next trend might be? What is the current supply and demand relationship?

Step 2: Determine the strength of the asset.

How strong is the asset relative to the overall market? Is the asset moving in a similar or opposite direction to the market?

Step 3: Find assets with sufficient “reasons” to buy.

Is there enough reason to enter at the current point? Is the reason for entry strong enough to take the risk for the potential reward (effect)?

Step 4: Determine the possibility of further asset appreciation.

Does the asset tend to move? How does the asset move within the larger trend? What is the relationship between price and volume? This step usually involves using Wyckoff to perform buy and sell tests.

Step 5: Confirm your entry time.

The final step is to time your entry. This usually involves analyzing the stock in comparison to the overall market.

For example, traders can compare the stock's price action relative to the S&P 500. Based on their position in their respective Wyckoff diagrams, this analysis can provide insights into where the asset is headed next. Ultimately, this helps establish the right entry point.

It is worth noting that this method works better for assets that move in line with the general market trend or index. However, in the cryptocurrency market, this correlation is not always consistent.

Summarize

It has been nearly a century since the birth of Wyckoff analysis, but Wyckoff analysis is still widely used today. It is widely accepted because it is not just a technical indicator, but also covers many principles, theories and trading techniques.

Essentially, the Wyckoff analysis enables investors to make more logical decisions rather than acting on emotions. The Wyckoff analysis provides traders and investors with a range of tools to reduce risk and increase chances of success. Nevertheless, there is no foolproof technique when it comes to investing. One should always be wary of risks, especially in the highly volatile cryptocurrency market.