Learn the most logical approach to Investing in the Stock Market
Richard Wyckoff (1873-1934) became a Wall Street celebrity.
He was a forerunner in the investment world as he started as a stockbroker at the age of 15 and by the age of 25 already owned his own brokerage firm.
The method he developed of technical analysis and speculation arose from his observation and communication skills.
Working as a Broker, Wyckoff saw the game of the big operators and began to observe through the tape and the graphics the manipulations they carried out and with which they obtained high profits.
He stated that it was possible to judge the future course of the market by its own actions since the price action reflects the plans and purposes of those who dominated it.
Wyckoff carried out its investment methods achieving a high return. As time passed his altruism grew until he redirected his attention and passion to education.
He wrote several books as well as the publication of a popular magazine of the time “Magazine of Wall Street”.
He felt compelled to compile the ideas he had gathered during his 40 years of Wall Street experience and bring them to the attention of the general public. I wanted to offer a set of principles and procedures about what it takes to win on Wall Street.
These rules were embodied in the 1931 course “The Richard D. Wyckoff Method of Trading and Investing Stocks. A course of Instruction in Stock Market Science and Technique” becoming the well known Wyckoff method.
The Wyckoff Method
Many of Wyckoff’s basic principles have become basic foundations of technical analysis. The three fundamental laws: Supply and Demand, Cause and Effect and Effort and Result; the concepts of Accumulation/Distribution and the supremacy of Price and Volume when determining price movements are some examples.
The Wyckoff method has passed the test of time. More than 100 years of continuous development and use have proven the value of the method to trade all kinds of financial instruments.
This achievement should not come as a surprise as it relies on the analysis of price and volume action to judge how it reacts to the battle between the real forces that govern all price changes: supply and demand.
Wyckoff Methodology Structures
Financial markets are a living thing, they are constantly changing due to their continuous interaction between buyers and sellers. This is why it would be a mistake to use fixed patterns or schemes to try to read the context of the market.
Aware that it is practically impossible for price to develop two identical structures, the trading approach proposed by the Wyckoff methodology is flexible when analysing the market.
The price can develop different types of structures depending on the conditions in which it is found. This is why we need an approach that gives some flexibility to price movements but at the same time is governed by certain fixed elements that provide as much objectivity as possible to the reading.
These fixed aspects of the methodology are the events and phases that make up the development of the structures. Below we present two basic schemes of accumulation and distribution to provide a very general idea of the dynamics in which price moves under the premises of the Wyckoff methodology.
As we have just said, these schemes can be considered as ideals. The important thing to keep in mind is that the market will not always present them this way.
Basic scheme of accumulation #1
Accumulation. The process by which large operators absorb available stock from the market. This is a transfer from retail traders or “weak hands” to strong traders or “strong hands”.
Creek. Resistance level for accumulation or reaccumulation structures. It is established by the maximum generated by the Automatic Rally and by the maximums that can be developed during Phase B.
CHoCH. Change of Character. Change of character. It indicates the environment in which the price will move soon. The first CHoCH is established in Phase A where the price moves from a downward trend to a consolidation environment. The second CHoCH is set from the minimum of Phase C to the maximum of SOS in which the price moves from a consolidation environment to an upward trend environment.
Phase A. Stopping the previous bearish trend.
- PS Preliminary Support. Preliminary support. It’s the first attempt to stop the downward movement that will always fail.
- SC Selling Climax. Sales climax. Climate action that stops the downward movement.
- AR Automatic Rally. Bullish reaction. An upward movement that sets the maximum range.
- ST Secondary Test. Test of the level of supply in relation to climate action. Establishes the end of Phase A and the beginning of Phase B.
Phase B. Construction of the cause.
- UA. Upthrust Action. Temporary breakage of the resistance and re-entry into the range. This is a test at the maximum generated by the AR.
- ST as SOW. Secondary Test as Sign Of Weakness. Sample of weakness in test function. Temporary break of the support and re-entry to the range. This is a test at the minimum generated by the SC.
Phase C. Test
- SP Spring Shaking bassist. It is a test in the form of breakage of the minimums of Phases A and B. There are three different types of Springs.
- Test Spring. Downward movement towards lows of the range in order to check the commitment of the sellers.
- LPS. Last Point of Support. Last level of offer support. Test in the form of a bearish movement that fails to reach the minimum range.
- TSO. Terminal Shakeout or Shakeout. Final shake. Abrupt movement of minimum breakage that produce a deep penetration of the level of support and a fast recovery.
Phase D. Bullish trend within the range.
- SOS. Sign of Strength. Sign of strength. Bullish movement generated after the Phase C Test event that manages to reach the top of the range. Also called JAC. Jump Across the Creek. Creek jump.
- LPS. Last Point of Support. Last level of offer support. These are the rising troughs we find in the upward movement towards resistance.
- BU. Back Up. This is the last big reaction before the bull market starts. Also called BUEC. Back Up to the Edge of the Creek. Back to the creek.
Phase E. Bullish trend out of range. Succession of SOS and LPS generating a dynamic of rising highs and lows.
Basic scheme of accumulation #2
Second variant of the methodology in which the test event in Phase C fails to reach the minimums of the structure.
It usually occurs because current market conditions denote background strength.
The objective of the price is to visit this liquidity zone but the big operators support the market entering aggressively in purchase. They don’t let the price go any lower so no one else can buy any lower.
This type of ranks are more complicated to identify because by not being able to assess that jolt action, the bullish approach loses a point of confidence.
The primary trading zone is in the Spring potential; then, when buying in a possible LPS we will always be in doubt if, as is most likely, the price will visit that minimum zone first to develop the Spring.
In addition to this, that first sign of bullish strength that produces range breakage is usually lost.
Therefore, the only viable purchase opportunity in this type of structure can be found in the BUEC. This is where we must pay more attention to look for entry in lengths.
Basic scheme of distribution #1
Distribution. The process by which large operators distribute (sell) stock. This is a transfer from the strong operators or “strong hands” to the retail operators or “weak hands”.
ICE. Level of support for distribution or redistribution structures. It is established by the minimum generated by the Automatic Reaction and by the minimums that can be developed during Phase B.
CHoCH. Change of Character. Change of character. It indicates the environment in which the price will move soon. The first CHoCH is established in Phase A where the price moves from an upward trend environment to a consolidation environment. The second CHoCH is set from the maximum of Phase C to the minimum of the SOW in which the price moves from a consolidating environment to a downward trend environment.
Phase A. Stop the previous trend.
- PSY. Preliminary Supply. Preliminary resistance. It’s the first attempt to stop the climb that will always fail.
- BC Buying Climax. Shopping climax. Climate action that stops the upward movement.
- AR Automatic Reaction. Bearish reaction. Bearish movement that sets the minimum range.
- ST Secondary Test. Test of the level of demand in relation to climate action. Establishes the end of Phase A and the beginning of Phase B.
Phase B. Construction of the cause.
- UT. Upthrust. Same event as accumulation UA. Temporary breakage of the resistance and re-entry into the range. This is a test at the maximum generated by the BC.
- mSOW. Minor Sign of Weakness. Sample of minor weakness. Same event as ST as SOW of accumulation. Temporary break of the support and re-entry to the range. This is a test at the minimum generated by the AR.
Phase C. Test
- UTAD. Upthrust After Distribution. Bullish shake. It is a test in the form of breakage of the maximums of Phases A and B.
- UTAD test. An upward movement that goes up to check the level of commitment of the buyers.
Phase D. Bearish Trend Within Range.
- MSOW. Major Sign of Weakness. Sample of major weakness. Bearish movement originated after the Phase C Test event that manages to reach the bottom of the range generating a character change.
- LPSY. Last Point of Supply. Last level of demand support. These are the decreasing highs we find in the bearish movement towards support.
Phase E. Bearish trend out of range. Succession of SOW and LPSY generating a dynamic of diminishing maximums and minimums.
Basic scheme of distribution #2
Second variant of the methodology in which the test event in Phase C fails to reach the maximums of the structure.
Inverse reasoning than for the example of cumulative scheme #2.
Denotes a greater weakness in the background.
The price tries to reach the liquidity that there are in maximums but the big traders that are already short positioned prevent it,
Structures with a loss of confidence due to the absence of shaking. When going short on the possible LPSY we will always be in doubt as to whether the price will shake to highs before falling.
The sign of weakness (SOW) that breaks the structure is lost. Unique opportunity to the breakage test (LPSY).