The Simplified Guide To Trading
With The Wyckoff Method
Using the Wyckoff Method
and trading strategy in the 21st century
Richard Wyckoff was an American investor and stock market trader active from the late 1800s until 1934.
A genius technical analyst, his unique Wyckoff Method and Wyckoff accumulation remains relevant decades later.
Even back then, Richard Wyckoff wanted to teach ordinary traders about ‘the real rules of the game’ and the imaginary ‘Composite Operator.’
In this article, I’ll go into the Wyckoff Method with in-depth detail.
After reading this, you’ll get a better understanding of market structure, and overall market feel, helping you make better trading decisions.
It can be quite technical at times. That was just his nature.
Stick with it because I think it will give you a good understanding of the market structure.
Whether you trade forex, stocks, futures, on any timeframe.
So, let’s get started…
Table of Contents
What is the Wyckoff Trading Method?
The Wyckoff Method is a framework that explains the many elements of trend developments through market cycles of so-called Wyckoff accumulation and distribution.
It also has fundamental laws, the ‘Composite Man’ concept, and a five-step approach to technical analysis.
While Wyckoff created the theory for stocks, it works across any freely traded market and time frame.
Learning about the laws before getting into the nitty-gritty of complex price cycles is best.
Let’s start there.
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Wyckoff's three fundamental laws
Law of supply and demand in the financial markets
Supply and demand is a concept from economic trade but exists in any financial market.
An asset’s price goes up because the buyers are more aggressive than sellers or demand exceeds supply.
(A quick note. Be careful not to fall into the trap of thinking there are more buyers than sellers in an upward price trend. For a trade to take place, we need to have a buyer and a seller. It’s the side that is more aggressive that ultimately moves the price.)
On the flip side, the price of an asset goes down with selling pressure, supply overpowers demand and prices fall.
And then, there is a third scenario.
Supply and demand are more or less equal, resulting in a sideways market or horizontal trading range.
The trading range represents almost a stalemate situation.
- Price rise = demand > supply
- Price drop = supply > demand
- Range = supply and demand are equal
Traders and investors are non-committal.
Of course, something has to drive these supply and demand dynamics.
Enter Richard Wyckoff and his aptly named Wyckoff method.
He believes price moves are never random, bringing us to his law of cause and effect.
Law of cause and effect
Wyckoff theorised that every price change happens because of certain factors that prepare it.
We know that markets don’t move in a straight line but in steps.
This is where the accumulation and distribution stages come into play.
An uptrend (the effect) begins from an accumulation phase (the cause).
On the other hand, a downward trend (the effect) happens after a distribution phase (the cause).
Don’t worry about the terminology too much, just keep those in your mind for now. We’ll go into these in more detail pretty soon.
Law of effort and result
Richard Wyckoff reasserted that any market’s price changes come from an effort represented in the trading volume.
This leads to that asset moving in a certain direction, which is the result.
Volume will be stronger on one side than another, whether uptrend or downtrend.
Sometimes, the volume is high but almost equal on either side, producing sideways movement or a small result in price movements.
Hence the law of effort.
The Composite Man
The ‘Composite Man’ (or ‘Composite Operator’) isn’t a law but an abstract concept.
I liken it to the modern label of ‘smart money’
Richard Wyckoff states that any market is controlled by a large imaginary entity whose behaviour contradicts what your average retail trader does.
But, at times, Wyckoff asserts that the smart money moves are somewhat predictable.
In less figurative terms, he simply meant the biggest players, like institutional investors and so-called market makers.
These entities exist whether the financial asset is forex, crypto, stocks, or commodities.
In the words of the man himself,
“…all the fluctuations in the market and in all the various stocks should be studied as if they were the result of one man’s operations. Let us call him the Composite Man, who, in theory, sits behind the scenes and manipulates the stocks to your disadvantage if you do not understand the game as he plays it; and to your great profit if you do understand it.“
Knowing the three fundamental laws and about the Composite Man or in more modern terms, ‘smart money’ helps when it comes to the price cycles.
This is the most complex yet intriguing part of the Wyckoff Method.
Wyckoff Market Price Cycles
Price cycles form the bulk of the Wyckoff Method, describing Wyckoff’s observations of supply and demand.
The trader once worked as a broker, giving him a vantage point to observe how powerful entities traded using bar and figure charts.
His extensive research led to the conclusion that any market moves in four distinct stages.
Let’s go through each of them here.
This represents the first part of Wyckoff’s market cycle.
After a downtrend, the ‘smart money’ accumulates or builds their buying positions.
This phase is a broad trading range or sideways market, a common trait when the price has moved in one direction for an extended period.
Wyckoff divided the accumulation stage into little sub-phases, the price movements are each telling a different story.
The End of The Downtrend – Phase A
Here, the selling pressure decreases, eventually forming the Preliminary Support (PS), the second-to-last low before the range that persists in Phases B and C.
The Selling Climax (SC) is that final low, which forms after panic selling.
Then, the price retraces to create the Automatic Rally (AR).
Notably, this push is a bit longer than the previous retracement legs. This suggests both the closing of short positions and early signs of institutional buying demand, which lead to the Secondary Test (ST).
ST doesn’t exceed SC and eclipses AR slightly, indicating that more bulls are coming in.
The labels Richard Wyckoff used are not so important, but his technical analysis approach is.
How he saw trapped retail traders, the meaning behind the price cycle, market trends and his prediction of subsequent price movement helped him ask the question ‘why?’.
Why should price move this way?
Who is trapped and who is in control?
He treated his Wyckoff analysis almost like a stock market science.
Building the Cause – Phase B
This phase is where the cause-and-effect law begins.
Here, the price is in consolidation, where Wyckoff says that the larger players build most of their positions. Traders should expect traps or fake breakouts between the SC, ST, and AR points before the market moves into Phase C.
The Spring – Phase C
The Spring is the last bear trap before the market starts to trend higher.
Wyckoff affirms that the Composite Man ensures little supply or sellers remain. It offers the perfect opportunity for anyone to buy at lower prices.
In rare cases, the Spring does get broken, but this doesn’t invalidate the cycle.
This is often where you might see the low break fake trade setting up too.
The Effect – Phase D
This is where we see the transition from cause to effect.
There is a noticeable increase in volume and volatility, consisting of one or many Last Point of Support (LPS) points.
Here, the price simply has one or more higher lows.
Phase D comes with a break of the range from Phase B until the price SOS (Signs of Strength), meaning prior resistance becomes support.
Bulls Take Over – Phase E
This is what any Wyckoffian analyst rejoices for – the last accumulation stage.
It’s clear as day that we are now in an uptrend. In reference to the earlier law, supply has exceeded demand.
Higher highs, solid buying.
You’ll still get small pullbacks and flags but ignition bars are commonplace, and shorts are scrambling for cover.
The mark-up is the next phase in the Wyckoff trading cycle after accumulation. As expected, the price action at this point is bullish.
Wyckoff noted three patterns here: the upside breakout, ‘jump the creek,’ and re-accumulation.
Distribution – Trading Range
Needless to say, the distribution portion of Wyckoff’s trading cycle is the opposite of the accumulation portion.
The big players distribute or build their short positions after the uptrend.
As with the accumulation phase, we expect sideways movement.
Again, Mr. Wyckoff created little segments for distribution, except that the wording for a few terms differs.
The End of The Uptrend – Phase A
The buying pressure starts to fade to form the Preliminary Supply (PSY). This is one of the last highs that shows some life of bulls who suddenly bring the price up, reaching the Buying Climax (BC).
The market falls to form the Automatic Reaction (AR), where the big players distribute their holdings to late buyers.
A Secondary Test (ST) happens, a lower high next to the BC.
Building the Cause – Phase B
As with accumulation, the cause-and-effect law comes into play here. The market will trade sideways, making it the best time for the ‘big boys’ to increase their selling power.
A Secondary Test (ST) happens, a lower high next to the BC. We should anticipate several fakeouts at the SOW (signs of weakness) and UT (upthrust) points.
The Test – Phase C
The ‘Test’ serves the same but opposite function as the ‘Spring’ in the accumulation phase: the bull trap before the downtrend.
While this level does get broken, it doesn’t change the picture of the cycle.
The Effect – Phase D
Phase D in this distribution phase is a mirror image of Phase D in the accumulation cycle. There is a considerable surge in volume and volatility, comprising one or more Last Point of Supply (LPSY) points. A Sign of Weakness (SOW) level happens, the final indication that the bears will soon take centre stage.
Bears Take Over – Phase E
This stage is when the sellers are in full force, meaning the demand has surpassed the supply and down we go…
The markdown marks the final part of Wyckoff’s entire trading cycle. It represents the strongest leg of the downtrend formed from the distribution stage.
As with the markup, Wyckoff created three patterns that can happen here: the downside breakout, ‘break the ice,’ and re-distribution.
The Wyckoff Trading Method in Action
The final piece of the puzzle is the five-step approach that Wyckoff created for traders to use with his method.
- What is the trend?
- Determining the asset’s strength
- Looking for an asset with sufficient cause
- Determining an asset’s readiness to move
- Timing your entry
Some traders can get bogged down with the terminology in the different cycles.
Yet, it’s more important to know the overall stage instead of nitpicking each sub-phase.
Markets don’t always move exactly according to the theory.
So, it should serve as a guide, not the be-all and end-all.
The key thing is to know which cycle the market is likely in.
Recognizing range-bound activity is always the first point of reference. During these formations, the fakeouts (the ‘Test’ or ‘Spring’) are significant in Wyckoff’s cycles.
Some traders may decide to enter the market using classic price action patterns that complement them.
But some consider it risky as the market could break the range.
An alternative is to enter once the accumulation or distribution stage is in Phase E.
Some traders may enter during the markup or markdown periods once the trend is in full force. Here, they would use mean-reverting strategies to take advantage of the pullbacks.
So, there are many parts to explore in Wyckoff once you understand where you are and overall market conditions.
Let us look at the complete Wyckoff market cycle with real chart examples across three different financial markets, starting with Bitcoin (BTC).
Above is the daily chart for Bitcoin showing the complete Wyckoff market cycle phases.
Notice all the familiar elements, like the typical consolidation in the Wyckoff accumulation /distribution periods and the fakeouts before the price trended.
The next example is on the 4HR chart of EUR/USD. Regardless of the time frame, Wyckoff reigns supreme with the classic elements of accumulation/distribution ranges and the Test/Spring points.
Finally, for you swing traders, good ‘ol gold on the weekly chart.
You’ll notice that the distribution range had two test points.
As Wyckoff stated, the first of these can get broken, but this wouldn’t make the cycle invalid. It’s also possible to have several attempts of a fakeout, as in the chart below.
Mix Wyckoff’s analysis with the price action, the time frame, and other market dynamics to get a good feel.
One mistake some traders commit is regarding Wyckoff as a strategy.
It’s a skeleton, a technical analysis theory like Dow, Gann, or Elliott. The key is to build a strategy around it, not that it’s a strategy itself.
Regardless, Wyckoff as a concept has stood the test of time.
Markets do move based on the Wyckoff Method in many cases. But, as with any market theory, it should only be one element among many others used when traders create trading ideas.
Common questions about the Wyckoff Method and other resources
How does the Wyckoff Trading strategy backtest?
The guys over at quantified strategies addressed this in a post about Wyckoff.
They argued it’s a difficult strategy to backtest.
I agree, it’s a concept and overall view of the market, rather than a binary flow chart. It would be very difficult to backtest his rules and theory.
What are the three Wyckoff laws?
The Wyckoff method focuses on 3 laws.
- The law of supply and demand
- The law of cause and effect
- The law of effort and result
What is the best timeframe to trade Wyckoff?
In theory, Wyckoff’s methods are more effective at longer timeframes.
So a daily or weekly chart would make sense.
But, using the Wyckoff patterns on the lower time frames can also be useful in identifying the accumulation phase and forecasting potential future trends when day trading.
Is the Wyckoff Method effective?
I think like any trading concept it’s how you interpret and deploy it.
Wyckoff trading strategy is all about defining the current price cycle.
As a trader, your job is to then deploy the right trading strategy for the conditions.
Other Wyckoff method resources
Wyckoff trading course on YouTube
Richard Wyckoff’s book – How I Trade and Invest in Stocks and Bonds
He also wrote a book on tape reading, but used a nom de plume ‘Rollo Tape’ Studies In Tape Reading
So there you have it!
The Wyckoff method.
How can you implement Wyckoff in your trading?
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