The Most Comprehensive Content to Improve Context Analysis by Studying Price Action
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Wyckoff and the first readers of the tape understood that the movements of the price do not develop in periods of time of equal duration, but that they do it in waves of different sizes, for this reason they studied the relation between the upward and downward waves.
The price does not move between two points in a straight line; it does so in a wave pattern. At first glance they seem to be random movements, but this is not the case at all. The price is shifted up and down by fluctuations.
Waves have a fractal nature and interrelate with each other; lower grade waves are part of intermediate grade waves, and these in turn are part of higher grade waves.
Each uptrend and downtrend is made up of numerous minor uptrend and downtrend waves. When one wave ends, another wave starts in the opposite direction. By studying and comparing the relationship between waves; their duration, velocity and range, we will be able to determine the nature of the trend.
Wave analysis provides a clear picture of the relative changes between supply and demand and helps us judge the relative strength or weakness of buyers and sellers as price movement progresses.
Through judicious wave analysis, the ability to determine the end of waves in one direction and the beginning in the opposite direction will gradually develop
The Price Cycle
In the basic structure of the market there are only two types of training:
▶ Trends. These can be bullish if they go up, or bearish if they go down.
▶ Ranges. They can be of accumulation if they are at the beginning of the cycle, or of distribution if they are in the high part of the cycle.
During the accumulation phase, professional operators buy all the stock that is available for sale on the market. When they are assured by various manoeuvres that there is no longer any floating bid, they begin the upward trend phase. This trend phase is about the path of least resistance. Professionals have already verified that they will not encounter too much resistance (supply) that would prevent the price from reaching higher levels. This concept is very important because until they prove that the road is free (absence of sellers), they will not initiate the upward movement; they will carry out test maneuvers again and again. In case the offer is overwhelming, the path of least resistance will be down and the price at that point can only fall.
During the uptrend, buyers’ demand is more aggressive than sellers’ supply. At this stage there is the participation of large operators who are less well informed and the general public whose demand shifts the price upwards. The movement will continue until buyers and sellers consider the price to have reached an interesting level; buyers will see it as valuable to close their positions; and sellers will see it as valuable to start taking short positions.
The market has entered the distribution phase. A market ceiling will be formed and it is said that the big operators are finishing distributing (selling) the stock they previously bought. There is the entry of the last greedy buyers as well as the entry for sale of well-informed operators.
When they find that the path of least resistance is now down, they begin the downtrend phase. If they see that demand is present and with no intention of giving up, this resistance to lower prices will only leave a viable path: upward. If you continue to climb after a pause, this structure will be identified as a reaccumulation phase. The same is true for the bearish case: if the price comes in a bearish trend and there is a pause before continuing the fall, that lateral movement will be identified as a redistribution phase.
During the downtrend sellers’ supply is more aggressive than buyers’ demand so only lower prices can be expected.
Being able to determine at what stage of the price cycle the market is at is a significant advantage. Knowing the general context helps us avoid entering the wrong side of the market. This means that if the market is in a bullish phase after accumulation we will avoid trading short and if it is in a bearish phase after distribution we will avoid trading long. You may not know how to take advantage of the trend movement; but with this premise in mind, you will surely avoid having a loss by not attempting to trade against the trend.
When the price is in phases of accumulation or uptrend it is said to be in a buying position, and when it is in phases of distribution or downtrend it is said to be in a selling position. When there is no interest, that no campaign has been carried out, it is said to be in neutral position.
A cycle is considered to be complete when all stages of the cycle are observed: accumulation, uptrend, distribution, and downtrend. These complete cycles occur in all temporalities. This is why it is important to take into account all the time frames; because each of them can be at different stages. It is necessary to contextualize the market from this point of view in order to carry out a correct analysis of it.
Once you learn to correctly identify the four price phases and assume a totally impartial viewpoint, away from news, rumors, opinions and your own prejudices, taking advantage of your operative will be relatively easier
Prices change and the waves resulting from those price changes generate trends. The price is moved by a series of waves in the direction of the trend (impulses), which are separated by a series of waves in the opposite direction (reversals).
The trend is simply the line of least resistance as the price moves from one point to another because it follows the path of least resistance; therefore, the trader’s job is to identify the trend and trade in harmony with it.
When a market is rising and encounters resistance (sales), either exceeds that resistance or the price will turn; the same happens when the price is falling and encounters resistance; either exceeds those purchases or the price will turn. These pivot points are critical moments and provide excellent locations to operate.
Depending on the direction of movement, we can differentiate three types of trends: bullish, bearish and lateral. The most objective description of an uptrend is when the price makes a series of rising impulses and falls, where highs and lows are increasing all the time. Similarly, we identify a bearish trend when highs and lows are decreasing, leaving a series of decreasing impulses and regressions. Finally, we determine a sideways environment when highs and lows remain fluctuating within a price range.
Trends are divided by their duration into three different categories; long, medium and short term. Since there are no strict rules for classifying them according to the timeframe, they can be categorized according to how they fit into the top. That is, the short term trend will be observed within the medium term trend, which in turn will be within the long term trend.
Las tendencias se dividen por su duración en tres categorías diferentes; largo, medio y corto plazo. Como no hay reglas estrictas para clasificarlas según el marco temporal, se pueden categorizar según éstas encajan dentro de la superior. Es decir, la tendencia de corto plazo se observará dentro de la tendencia de medio plazo, la cual a su vez estará dentro de la tendencia de largo plazo.
Types of trends
Note that all three trends may not move in the same direction. This can present potential problems for the operator. In order to be effective, doubts must be eliminated as much as possible and the way to do this is to identify in advance the type of trading to be carried out.
A very important condition to take into account when selecting the type of trading is the Timing (input calibration). Success in any kind of operative mainly requires a good Timing; but success in short term trading requires a perfect Timing. Because of this, a beginner should start with long-term trading until he achieves consistent success.
Because trends may be different depending on the time frame, it is possible but difficult to have buy and sell positions at the same time. If the medium-term trend is bullish, you can take a buy position with the expectation of holding it for a few weeks or months; and if in the meantime a short term bearish trend appears, you can take a short sell position and hold the buy trade at the same time.
Although theoretically possible, it is extremely difficult to maintain the discipline necessary to maintain both positions at the same time. Only experienced operators should do this. For the initiate it is best to operate in harmony with the trend and not to operate on both sides simultaneously until consistently profitable.
You must learn and understand the motives, behavior patterns, and emotions that control the market. A bull market is driven by greed, while a bear market is driven by fear. These are the main emotions that drive the markets. Greed leads to paying higher prices until it leads to what is known as an overbought condition. On the other hand, the panic caused by falls leads to wanting to get rid of positions and sell, adding more momentum to the collapse until over-selling conditions are reached.
Having these emotions is not a negative thing, as long as they know how to move towards a positive aspect and it is very clear that what is really important is the protection of capital.
This interaction between supply and demand as a trend develops will leave clues in the conformation of the price action. We have different tools to help us assess trends.
Judiciously assessing the trend is key to determining your health. It allows us to detect if any force gives symptoms of weakness or if the opposing force is gaining strength. Our job is to go for strength and against weakness.
When the price is in trend, we expect greater strength from the pushing side. We have to see it as a battle between buyers and sellers where we will try to analyze the strength or weakness of both. The best way to assess current strength/weakness is to compare it with previously developed movements.
A weakness in the price does not imply a change of trend, it is simply a sign of loss of strength and tells us that we must be prepared for future movements.
There are several ways to analyze market strength/weakness. The key is comparison. Absolute values are not sought. It is a question of comparing the current movements with the previous ones.
Speed refers to the angle at which the price moves; so if the price is moving faster than in the past, there is strength. If on the other hand it is moving slower than in the past, it suggests weakness.
With this tool we evaluate the distance that the impulses travel and compare them with the previous ones to determine if the strength has increased or decreased.
For a trend to remain alive, each impulse must surpass the previous impulse. If an impulse is not able to make new progress in the direction of the trend, it is an alert that the movement may be nearing its end.
With depth analysis we evaluate the distance travelled by trend reversals to determine whether weakness has increased or decreased.
As with projection analysis, we can evaluate depth using two measurements: the total distance of the recoil from its origin to its end; and the distance the price travels from the previous end to the new end.
The lines delimit the ranges and define the angle of advance of a trend. They are of great visual aid for the analyses, being very useful to evaluate the health of the movement; so much to identify when the price reaches a condition of exhaustion, as to value a possible turn in the market.
In general they help us to foresee levels of support and resistance at which to wait for the price. At the same time, an approach or touch of those lines suggests the search for additional signs to look for a turn, offering diverse operative opportunities.
The more touches a line has, the more validity the level for the analysis will have. You must be careful not to draw lines indiscriminately, especially on every minor movement. The correct handling of lines requires good judgment; otherwise it will cause confusion in your reasoning.
When the price penetrates a line we must remain more alert and be prepared to act. Depending on the position where the break occurs, as well as the action itself, we can suggest different scenarios. A thorough understanding of price and volume action is needed to determine the most likely scenarios.
▶ Horizontal Lines
A horizontal line identifies an old zone of imbalance between supply and demand. When it connects at least two lows it identifies a support. This is an area where buyers appeared in the past to outdo sellers and stop the price drop. On that area it is expected that buyers will appear again when it is visited again.
A horizontal line connecting at least two highs identifies a resistance and is an area where supply outpaced demand by stopping a price hike; that is why sellers
When a line serves both as support and resistance, it is known as a pivot line. Prices tend to revolve around those axis lines. Those price levels are constantly changing roles; a broken resistor becomes a support, and a broken support becomes a resistor.
▶ Trend Lines
After identifying the nature of the trend, the next step is to build a guideline in order to take advantage of the movement. It is the simple connection between two or more price points.
In a bearish trend, the trend line is drawn by connecting two decreasing highs. This line is called the bid line because it is assumed that the sellers will appear on it.
In an uptrend, the trendline is drawn by connecting two rising lows. This line is called a demand line because it marks the point where buyers are supposed to appear.
We can continuously readjust the trend lines in order to adjust the one that best suits the price action and therefore generated the most touches. The more times the line has been respected, the
stronger we will be able to interpret it when it is played again in the future.
Note that a line with too much slope will be broken too soon, so it will not be drawn correctly.
As long as the price remains within the established levels, it is said that the movement is healthy and it is appropriate to consider maintaining or adding positions.
When the price approaches a trend line there is a threat of breakage and this may mean that the strength of the trend is being exhausted, suggesting a change in the speed of the trend or a definite danger of reversal of the trend.
Breaking a trend line by itself is not a conclusive symptom of anything, as it may be a true or false break. What is significant is how the line is broken, the conditions under which it happens, and the behavior that precedes it.
After a movement of a certain distance, the price may find resistance to continue and this will cause the trend to change its speed and rest. During the break (lateral movement or range) the force that originally drove the trend may be renewed or even strengthened, resulting in a continuation of the trend with greater momentum than before.
Under these conditions, it is necessary to reposition the trend lines to conform to the new set angle. For this reason it should not be accepted that the mere fact of breaking the trend line is a reversal of the same.
The ideal channel will have several touch points and should capture most of the price within its limits.
When the bullish trend line or demand line is dragged towards the opposite end and anchored parallel to the maximum that lies between the two minimums used to create it, the overbought line is created; and together they define an upward trend channel. This channel identifies a rising price.
The operator should be aware of overbought conditions. These conditions are created when the price exceeds the high end of the bullish channel. Due to too rapid an acceleration, the price reaches a point at which it is highly sensitive to long coverage and generally to the withdrawal of more experienced buyers, suggesting a weakening of the uptrend. They usually guide the price to a downward corrective action.
Human beings seem to be inclined towards extremes. In the financial markets this trend is revealed in the form of greed. Prices are pushed higher and higher until the public swells with stocks that are generally overvalued. When this happens, an overbought condition is said to exist.
When the bearish trend line or supply line is dragged towards the opposite end and anchored parallel to the minimum that is located between the two maximums used for its creation, the oversold line is created; and together they define a bearish trend channel. This channel identifies a falling price.
The operator should be aware of oversold conditions. These conditions are created when the price exceeds the low end of the downstream channel. Due to too fast a bearish movement, the price reaches a point at which it is highly sensitive to short coverage (profit taking) and a general withdrawal of experienced traders who were sold; suggesting a weakening of the bearish trend. They usually guide the price to an upward corrective action.
In a bear market there is another extreme that takes control; fear. As the price falls, traders become alarmed. The lower they go, the more frightened they get. Fear reaches a level that weak hands can’t stand and sell their shares. This selling panic generates an overselling condition.
Those periods of overbought or overbought that lead to the stop of the movements can be seen in any temporality.
▶ Inverted Lines
In high-speed conditions where a clear trend has not yet been established, inverted lines are a good way to try to structure at least initially the price movement.
It is a question of first creating the line of supply in an upward trend to generate from it the line of demand; and of first creating the line of demand in a downward trend to generate from it the line of supply.
At the beginning of a bullish advance, in case the price has made two important upward thrusts without leaving any significant bearish retreat, one can estimate at what point to expect the price to retreat by first creating the supply line in order to drag it and create the bullish trend line; and in the same way, first draw the demand line in order to create from it the bearish trend line.
▶ Converging Lines
There will be times when you will notice that overbought and oversold lines created from their trendlines do not work effectively. The price may never reach these lines as you will probably be following a different movement dynamic.
The way to solve this deficiency is to create these lines independently, without taking into account the trend line.
In this way, an overbought line would be created by connecting two maxima and the overbought line by connecting two minima. The objective is to try to find the structural logic to the movements in order to take advantage of them.
Note that in the case of an upward movement, not being able to even reach the original overbought line denotes a symptom of weakness and alerts us to a possible downward turn. Similarly, the fact that the original overbooking line cannot be reached in the case of the bear movement denotes a symptom of background strength and alerts us to a possible upward turn.
Visually they are observed as exhaustion patterns.
The market spends most of its time in this type of condition, so they are extremely important.
Ranks are places where previous movement has been stopped and there is a relative balance between supply and demand. It is within the range where accumulation or distribution campaigns are developed in preparation for an upward or downward trend. It is this force of accumulation or distribution that builds the cause that develops the subsequent movement.
The ranges within it present optimum trading opportunities with a very favourable risk/reward potential; however, large operations are those in which you correctly manage to position yourself within the range to take advantage of the trend movement.
In the operative in trend, as the price is already in movement, part of its path will have been lost. By taking advantage of opportunities within the range, there is a chance to catch a bigger move.
To be correctly positioned at the beginning of the trend, you must be able to analyze price action and volume during range development. Fortunately, the Wyckoff methodology offers unique guidelines with which the operator can successfully perform this task. The identification of events and the analysis of phases become indispensable tools for the correct reading of the range.
If you don’t see a clearly defined trend, the price is most likely in a range context. This neutral or lateral trend may have three main interests behind it: it is accumulating, in preparation for an upward movement; it is distributing, in preparation for a downward movement; or it is oscillating up and down without any defined interest.
Random fluctuations should be ignored as there is probably no professional interest behind that market. It is important to understand that in not all ranks there is professional interest; and that therefore, if these interests are not involved in a security, the price simply fluctuates because it is in equilibrium and movements in one direction are neutralized with movements in the opposite direction.
On the basis of the law of cause and effect, it is necessary for the price to consume time within the range in preparation for the subsequent movement. And that movement will be directly proportional to the time spent in the range. This means that shorter ranges will generate shorter movements and that longer ranges will generate movements that will travel longer distances.
To define a range two points are required to build the channel. As long as the price remains within the range, no major movement will occur. The key is in the extremes. When these are broken, they can offer excellent trading opportunities.
Be clear that the decisive move to break the range and start the trend phase cannot occur until a clear imbalance between supply and demand has been generated. At that point, the market must be in the control of the professionals and they must have confirmed that the direction in which they will direct the price movement is the path of least resistance.
This means that if they have accumulated with the intention of launching prices upwards, they will first verify that they will not find resistance (sales) to stop that rise. When they see that the road is clear, they will initiate movement. Similarly, if they have been distributing (selling) with the intention of lowering prices, they need to make sure that the floating demand (buyer interest) is relatively low.