According to Wyckoff, a detailed analysis of supply and demand can be done by studying price action, quantity and timing.
Richard DeMille Wyckoff was a pioneer in studying the stock market using technical analysis in the early 20th century and is regarded as one of the five “masters” of technical analysis, along with Dow, Gann, Elliott, and Merrill.
When he was 15, he took a job as a stock runner for a New York brokerage. Later, he started his own firm and founded, wrote and edited Wall Street magazine for nearly two decades.
He devoted his life to instructing and advising young investors on the trading rules for achieving success in the stock market, which he called “the real rules of the game”. He also established a school which later became the Stock Market Institute.
His time-tested insights are still valid today as they were first expressed by him in his book “How I Trade and Invest in Stocks and Bonds”.
Wyckoff followed a five-step approach to the market in which he placed significant emphasis on stock selection and trade entry. Let’s look at each step of his process.
1. Determine the current state of the market and the likely future trend.
Wykoff said investors need to assess the right time to enter the market and whether they should take long or short positions in the current market scenario.
He said that this can be done by finding out whether the market is consolidating or trending and analyzing the direction that the market is likely to take in the near future.
He added that investors can use both bar charts and point and figure charts of major market indices to analyze the trend.
2. Select the stocks in line with the trend. In an uptrend, choose stocks that are stronger than the market
Wyckoff said investors should look for stocks that show a higher percentage increase than the market during rallies and smaller decreases during recessions.
In a downtrend, investors should reverse and choose stocks that are weaker than the market, he added.
“If you’re not sure about a specific issue, skip it and move on to the next one,” he said.
According to Wyckoff investors can use bar charts of individual stocks to compare them with the most relevant market indices to perform the above analysis.
3. Select the “reasonable” stock that equals or exceeds the minimum objective
Wyckoff was famous for identifying price targets using Point and Figure (P&F) projections for both long and short trades.
According to Wyckoff’s fundamental law of “cause and effect”, the horizontal P&F count within a trading range represents the cause, while the subsequent price movement represents the effect.
Wyckoff said that if investors are planning to take long positions they should choose stocks that are subject to accumulation or re-accumulation and have created sufficient reason to serve their objective.
He added that investors can use point and figure charts of different stocks to accomplish this objective.
4. Determine the Movement of Shares
Wyckoff said investors should do some technical tests to buy or sell a stock to gauge its readiness to move.
Wykoff said investors should examine the price and volume of their stock and the behavior of the overall market and ensure that their findings are valid and that the stock is a good option before taking a position.
“For example, in a trading range following a long rally, is there evidence from nine sell tests that significant supply is entering the market and a short position can be warranted? Or a clear accumulation in the trading range. , Nine buy tests indicate that the supply has been successfully absorbed, as evidenced further by a low volume spring and one low volume test of that spring?,” he said.
According to Wyckoff, investors should use bar charts and point and figure charts of individual stocks to perform this analysis.
5. Fulfill your commitment with stock market index changes
Wyckoff said that investors should buy the stock they choose if their analysis shows that the market will reverse and rally and similarly they should sell the stock if their analysis indicates that the market will fall.
According to Wyckoff, investors should use bar and point and figure charts to perform this analysis.
Wyckoff’s “The Whole Man”
Wyckoff suggested a heuristic tool for understanding price movements in individual stocks and markets, which he called the “holistic man”.
“All the fluctuations in the market and in all the different stocks should be studied as if they were the result of the operations of one man. Let us call him the Composite Man, who, in theory, sits behind the scenes and accounts for your losses. Manipulates stocks to his advantage if you don’t understand the game as he plays it; and to his great advantage if you understand it,” he said.
Wyckoff advised traders to try to play the market game as the overall man played it.
Based on his years of observation of market movements, Wyckoff concluded that:
- The Composite Man carefully plans, executes and concludes his trades.
- The Composite Man attracts traders to buy stocks in which he has already accumulated a large number of shares by including a large number of stocks, actually advertising his stock by creating a “broad market” appearance. .
- Investors should study individual stock charts for the purpose of identifying the behavior of the stock and the motives of the larger operators that dominate it.
- With study and practice, investors can gain the ability to explain the motives behind the action that a chart portrays.
Wykoff believed that if investors could understand the market behavior of the Composite Man, they could identify many trading and investment opportunities in order to profit from them.
three wyckoff laws
Wyckoff used a chart-based method to conduct his investment analysis that was based on three fundamental “laws”.
These laws helped determine the current and potential future directional bias of the market and stocks. In addition, these laws can be used to select the best stock to trade, identify a stock’s readiness to leave a trading range, and price targets in a trend from the stock’s behavior in a trading range. to present.
1. The law of supply and demand determines the direction of price.
According to Wyckoff when demand exceeds supply, prices rise, and when supply exceeds demand, prices fall and so investors study the balance between supply and demand by comparing price and volume bars over time. should do.
According to Wyckoff, this law sounds simple, but it takes a lot of practice to learn to accurately evaluate supply and demand on a bar chart, as well as understand the implications of supply and demand patterns.
2. The law of cause and effect helps the trader to determine price objectives by estimating the likely extent of the trend to emerge from the trading range.
According to Wyckoff “cause” can be measured by horizontal point counts in a point and figure chart, while “effect” is the distance value corresponding to the point count.
The operation of this law can be seen as the force of accumulation within a trading range, as well as how this force acts up or down in a subsequent trend or movement.
3. The law of effort versus result provides early warning of a possible change in trend in the near future.
Wyckoff noted that the difference between quantity and price often indicates a change in the direction of a price trend.
Therefore, when a substantial rally is followed by several high-volume but narrow-range price bars, the price fails to make a new high, suggesting that larger interests are offloading shares in anticipation of a change in trend.
What is the Wyckoff method used for?
The Wyckoff method is used by traders to determine market trends, selected investments, and timing of trade placements.
This can help them identify the times when the big players are accumulating or distributing positions in the stock. It can also help investors find trades with high-profit potential.
The advantage of following this method is that it is a straightforward analytical approach that helps investors enter and exit the market without sentiment which can cloud the decision.
What are the 4 stages of the Wyckoff cycle?
The four phases of the Wyckoff cycle are accumulation, markup, distribution and markdown. They represent trading behavior and price action. Once the final markdown phase of the Wyckoff cycle is completed, a new accumulation phase begins a new cycle.
Most professional traders use Wyckoff’s methodology, but unfortunately, his approach is still not widely spread and followed among retail or new traders.
Although Wyckoff’s teachings were supposed to make investors aware of the “real rules of the game”, his methods require smart practice and are well worth the effort for rookies and young traders to succeed in the long run. .
(Disclaimer: This article is based on Richard Wyckoff’s book “How I Trade and Invest in Stocks and Bonds”)