Price action analysis using the Wyckoff method

Introduction

Richard D. Wyckoff was a very famous stock market trader. He is considered one of the five titans of technical analysis along with Dow, Gann, Elliott and Merrill. Wyckoff proposed a method to help traders understand price movements in markets. This method is called the Wyckoff method. Wycoff advised traders to try to understand the market and play the market game as the Composite man.

The fluctuations in the market 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 

 ~R.D Wyckoff 

 A composite man is a highly skilled and better informed investor who has the ability to shape the market and control the price. He carefully plans, executes and concludes his campaigns. His aim is to gather as many stocks as possible at the lowest price then attracts the public to buy a stock in which he has already accumulated a sizeable line of shares.

The Wyckoff Price Cycle

Wyckoff developed a price action market theory that states that price moves in cycles and a cycle is made up of 4 phases:

1. Accumulation Phase
2. Markup Phase
3. Distribution Phase
4. Markdown Phase

The Accumulation and Distribution phase are the market consolidation phases. Markup and Mark down phases are the long term variations of the uptrend and downtrend respectively. These patterns can be identified in all time frames.

• Accumulation Phase

This is whereby the market is moving sideways or ranging. It occurs after a major downtrend. The accumulation phase has six distinct paths which have different functions. The accumulation stage is due to an increase in institutional demand. Buyers are gaining power and the price is pushed higher marking the beginning of a new trend. However, this is not the best time for retail investors to buy as capital will be tied up and the retail investor may lose a large amount of capital at this stage. It is sometimes useful to add an indicator to help identify non-trending conditions. 

For further reading on trend analysis visit this article

• Markup Phase

The Accumulation phase is succeeded by the Mark up phase. This is the stage where price moves into a long term uptrend comprising of higher highs and higher lows breaking out of the Accumulation phase. The markup phase is the most profitable stage to own an asset or stock.

You may also find this article helpful: Introduction to the Elliott Wave theory

Distribution Phase

The distribution phases occurs after the mark up phase. It is the opposite of the accumulation phase. It occurs after a major uptrend where sellers want to maintain a higher price until the shares are sold.

There are patterns that represent price consolidation. These patterns can form during the accumulation and the distribution phase. 

This article on "Analysis of Trend Continuation and Trend Reversal Chart Patterns" can help you understand the chart patterns and what they represent.

Markdown Phase

The markdown stage occurs when price makes successive lower highs and lower lows forming a downtrend.

The complete Wyckoff Cycle will look like this on a chart

Each phase in the Wyckoff Cycle has its own phases that have identifiable characteristics and all are governed by Wycoff`s three laws:

• Supply and Demand

This law determines the price direction. Price rises when demand is greater than supply and prices fall when supply is greater than demand. The balance between supply and demand can be studied by comparing price and volume bars over time.

• Cause and Effect

This law tells us that for an effect to be there, there must be a cause that originates it. The effect realized by the cause is directly proportional to that cause. This law helps traders estimate the potential extent of a trend emerging based on the length of the price consolidation. The cause occurs during the accumulation and distribution phases and the effect occurs during the mark up and mark down phases. 

• Effort vs Result

This law tells us that every effort should lead to a result. Effort is represented by the volume and result is represented by the price. In other words, if the price movement is in harmony with volume then the trend is likely to continue, however, if the price movement is not in harmony with volume then the trend is likely to change.