The Wyckoff Theory
Updated: Aug 30
We will be going to look into the famous Wyckoff Theory from the eyes of Bob Evans who was a great teacher of the Wyckoff Theory.
First Determine the present position and probable future trend of the market.
What is the market doing at the time you’re looking at the charts?
This is a good question to ask yourself
This assessment should help you decide whether to be in the market at all, The use of bar charts, Point & Figure charts or even Candle Stick charts.
Pick a stock that’s in line with the current trend
If the trend is up, pairs that are stronger than the market will have a good indication that the market is buying, just looking at structure if price is making Higher Highs or Lower Lows.
Pick stocks for trading that have the potential to exceed or equal the minimum objectives
A method called Point and Figure (P&F) for both long and short trades. In 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. Therefore, if you are planning to take long positions, choose stocks that are under accumulation or re-accumulation
Pick stocks that are ready to move
Look for what is going on in that stock is the market buying or is the market already selling? or is the market in a range ready to buy or sell.
A systematic approach of the selling steps, these are to be explained down below.
Wyckoff’s Composite Man
This was the idea that was made to create an imaginary identity for the market, it was made to help traders understand a pair or stock's price movement and the overall market. Wyckoff suggested that all traders should study the fluctuations of the market along with price movements.
Wyckoff always wanted retail investors to trade just like the Composite Man, however, what he found was that the behaviour of retail traders was always the opposite of the Composite Man, he iterated that the strategy of the Composite Man is somewhat predictable, and retail traders can learn from that strategy.
The strategy of a Composite Man can be analysed by using the four price cycles, which make up our next topic.
The Wyckoff Price Cycles
According to Richard Wyckoff, the market can be understood and anticipated through a detailed outlook of Supply and Demand.
As a broker himself, he was able to observe the doings of highly successful individuals, via the use of what he called vertical (Bar) and figure (Point and Figure) charts he was able to decipher the future intentions of those interests.
The time to enter long orders is towards the end of the preparation for a price mark-up or bull market (accumulation of large lines of stock), while the time to initiate short positions is at the end of the preparation for price markdown.
In simpler words, the time for selling was at over brought distribution areas and vice versa for sells, over sold accumulation areas.
The Foundations of the Wyckoff Method
The Wyckoff method of trading or Wyckoff theory relies on two main rules or concepts:
These are the two important pillars of the Wyckoff method:
The price action never follows the same course as it did in the past. This means the market never will behave in the same way or manner
As every move of the price action and market is unique, its analytical importance relies on its comparison to past behaviour.
Analysing Trading Ranges
Improving market timing when establishing a position is one of the objectives when analysing trading ranges.
These are places where there is a favourable reward/risk ratio which exists within the trading range.
Trading ranges (TR) are places where the previous trend (up or down) has been halted and there is relative equilibrium between supply and demand.
For one to say they’ve mastered Wyckoff they must be able to anticipate and correctly judge the direction and magnitude of the move out of a trading range (TR), These concepts are illustrated in the following two schematics; two depicting common variants of accumulation TR, followed by examples of distribution TR.
PS - Preliminary Support
The spread widens, Volume increases, this shows that the selling pressure might be depleting
SC - Selling Climax
At this point selling pressure is at its highest with high volume and wide spreads
AR - Automatic Rally
Automatic Rallies come after a SC which marks exactly where demand comes in to stop price falling further
ST - Secondary Test
A secondary test will be testing the range either high or low of the range. testing supply and demand orders Spring/Shakeout
A spring or shake out, shakes out any weak hands that brought early, known as a stop loss hit
LPS - Last Point of Support
The lowest point of a reaction after a spring/shakeout action, showing the last point before the breaks the range
SoS - Sign of Strength
Price advances with increased volume, this usually takes place from the spring forming a LPS
BU - Back up
The common structural element preceding a more substantial price mark up. Usually includes a variety of forms, including a simple pull-back, or a new TR creating a fractal reaccumulation
The stopping of the down trend, during this phase supply has been dominant
The spread widens, followed by a volume deficit so the intense selling pressure is relieved
If the ST goes lower than SC, a prolonged consolidation can be expected
The rules of the SC & ST along with the high of the AR set the boundaries of the TR
After the selling pressure, it's preferable to see the PS, SC AR, and the ST forming.
During the accumulation TR, the points PS, SC, and ST are not evident.
Also known as "building a cause"
In phase B, institutions are accumulating the low-priced inventory
Usually, multiple ST according to phase B accompanied by an rally to the upper end of the TR.
Price swings are usually accompanied by high volume, as the professionals absorb the orders
At this stage the instrument is ready for phase C
The spring is a method that was introduced to trap traders to take short positions for the price to quickly reverse back to the TR
This means the instrument is ready to make a move up
The appearance of a SC validates the move; this is a good time to initiate a partial long position
In this phase price usually moves to the top of the TR
At this time, it's good to add to any profitable positions usually at LPS or the SoS with a BU action in hand
The pair leaves TR & demand is in full control along with the mark-up
PSY - Preliminary Supply
Volume increases indicating the change in price direction
BC - Buying Climax
Buying force is at its peak
A BC coincides with a great earnings report or any other positive news.
AR - Automatic Reaction
With intense buying diminished after the BC, AR takes place
The low of the sell-off helps define the low boundary of the distribution trading range
ST - Secondary Test
Price revisits the area of the BC to test the demand/ supply
Volume and spread decrease as price approaches the resistance area of the BC
mSoW - Minor Sign Of Weakness
A downward move can be observed to the lower boundary or slightly past the AR
The initial SoW shows a change in market direction, supply will now be dominant
This shows a break in the lower TR showing weakness in the range
UT - Upthrust
An upthrust is similar to a spring where it breaks out the upper range
Can be seen as a stop loss hit for any sellers selling early
Is also known as it testing hold volume areas mostly the BC
UTAD - Upthrust After Distribution
This is the distributional counterpart to the spring and terminal shakeout
This happens at the later stages of the TR
The UTAD is not a required element
The move will be sharp and happens after an upthrust
LPSY - Last Point Of Supply
After testing the SoW the market may slow down, and start showing difficulty advancing
This is caused by a weak demand
This is the last point in which you will see higher prices before breaking the TR
MSoW - Major Sign Of Weakness
A downward move can be observed to the lower boundary breaking out the TR
The initial SoW shows a change in market direction, supply will now be dominant and overcoming demand
This phase marks the stoppage of the prior, this event usually follows on AR and a ST of the BC
The function of this Phase is to build a cause in preparation for a downtrend. In this phase, institutions will be closing their long trades
in this case, large interests are net sellers of shares as the TR evolves, to exhaust as much of the remaining demand as possible
This phase may avail its self via push up to the UT or UTAD that quickly reverses and close back in the TR
This is a move that's meant to induce break-out traders then later pinch them out of their over-leveraged positions, thus surrendering their stake to the big guys, often demand is weak in a distribution TR.
Usually, the price doesn't reach the level of the BC or initial ST
Phase C's test of demand may be represented by a UT of a lower high with the TR
The evidence that supply is dominant increases being signalled by price travelling through or to the TR support
There are often multiple weak rallies within this phase
These LPSY represent excellent opportunities to initiate or add onto profitable positions
This phase depicts an unfolding downtrend.
Price leaves the TR, supply will now be in full swing.
Once TR support is broken on a major SoW, the breakdown is often tested with a rally that fails at or near the support this shows a high probability of price selling off
Recommended charts to Analyse for Wyckoff
Wyckoff Buying Tests for Accumulation
Downside price objective accomplished – P&F chart
Preliminary support, selling climax, secondary test - Bar and P&F charts
Activity bullish (volume increases on rallies and diminishes during reactions) – Bar chart
Downward stride broke (that is, supply line or downtrend line penetrated) - Bar or P&F chart
Higher lows - Bar or P&F chart
Higher highs - Bar or P&F chart
Stock stronger than the market (that is, stock more responsive on rallies and more resistant to reactions than the market index) - Bar chart
Base forming (horizontal price line) – Bar or P&F chart
The estimated upside profit potential is at least three times the loss if the initial stop-loss were hit – P&F or Bar charts
Wyckoff Selling Tests for Distribution
Upside objective accomplished - P&F chart
Activity bearish (volume decreases on rallies and increases on reactions) - Bar and P&F charts
Preliminary supply, buying climax - Bar and P&F charts
Stock weaker than the market (that is, more responsive than the market on reactions and sluggish on rallies) - Bar chart
Upward stride broke (that is, support line or uptrend line penetrated) - Bar or P&F chart
Lower highs - Bar or P&F chart
Lower lows - Bar or P&F chart
Crown forming (lateral movement) - P&F chart
The estimated downside profit potential is at least three times the risk for if the initial stop-order were hit - P&F and bar charts
The work of Wyckoff's method was centred around the realization that the stock and the forex market were driven by large operators who manipulate the price in their favour.
This then leads to traders favouring the Wyckoff method.
His method has withstood the test of time, this method was systemized for identifying high probability trades, which has given traders an edge over the market.
To get the full in-depth teaching of Wyckoff, One Percent Trading Group is the perfect place to start.
Offering you step by step guide that'll hold your hand throughout the learning curve