wyckoff: Richard Wyckoff’s tips to study market trends for super stock selection

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Legendary technical analyst Richard Wyckoff believed stock prices are determined solely by supply and demand and has little to do with rumors, stock tips, news items, financial reports and a host of other sources of information.

According to Wyckoff, the detailed analysis of supply and demand can be done by studying price action, volume and time.

Richard Demille Wyckoff was a pioneer in studying the stock market using technical analysis in the early 20th-century and is regarded as one of the five “gurus” of technical analysis, along with Dow, Gann, Elliott and Merrill.

When he was 15, he took a job as a stock runner for a New York brokerage. Later, he started his own firm and also founded, wrote, and edited The Magazine of Wall Street for nearly two decades.

He dedicated his life to instructing and advising young investors on the trading rules they should follow to achieve success in the stock market which he termed as the “real rules of the game”. He also founded a school which later became the Stock Market Institute.

His time-tested insights are valid even today as they were when first articulated by him in his book “How I Trade and Invest in Stocks and Bonds”

Wyckoff followed a five-step approach to the market in which he gave significant emphasis to stock selection and trade entry. Let’s look at each of the steps of his process.

1. Determine the present position and probable future trend of the market.
Wyckoff said investors need to assess the right time to enter the market and whether they should take long or short positions in that current market scenario.

This he said could be done by finding out whether the market is consolidating or trending and analysing the direction that the market is likely to take in the near future.

He said investors could use both bar charts and point and figure charts of the major market indices to do this trend analysis.

2. Select stocks in harmony with the trend. In an uptrend, select stocks that are stronger than the market

Wyckoff said investors should look for stocks that show greater percentage increases than the market during rallies and smaller decreases during slumps.

He said in a downtrend, investors should do the reverse and choose stocks that are weaker than the market.

“If you are not sure about a specific issue, drop it and move on to the next one,” he said.

According to Wyckoff investors can use bar charts of individual stocks to compare with those of the most relevant market index to do the above analysis.

3. Select stocks with a “cause” that equals or exceeds the minimum objective

Wyckoff was famous for identifying price targets using Point and Figure (P&F) projections for both long and short trades.

According to 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.

Wyckoff said if investors are planning to take long positions they should choose stocks that are under accumulation or re-accumulation and have built a sufficient cause to satisfy their objective.

He said investors could use the Point and Figure charts of individual stocks to fulfill this objective.

4. Determine the stocks’ readiness to move
Wyckoff said investors should conduct some technical tests for buying or selling to find out a stock’s readiness to move.

Wyckoff said investors should examine the price and volume of their stock and the behavior of the overall market and make sure that their conclusions are valid and the stock is a good choice before taking a position.

“For instance, in a trading range after a prolonged rally, does the evidence from the nine selling tests suggest that significant supply is entering the market and that a short position may be warranted? Or in an apparent accumulation trading range, do the nine buying tests indicate that supply has been successfully absorbed, as evidenced further by a low-volume spring and an even lower-volume test of that spring?,” he said.

According to Wyckoff, investors should use bar charts and Point and Figure charts of individual stocks to conduct this analysis.

5. Time your commitment with a turn in the stock market index
Wyckoff said investors should buy a stock they’ve selected if their analysis shows that the market will reverse and rally and similarly they should sell a stock if their analysis indicates that the market will fall.

According to Wyckoff, investors should use bar and Point and Figure charts to conduct this analysis.

Wyckoff’s “Composite Man”
Wyckoff suggested a heuristic device in order to understand price movements in individual stocks and the market, which he termed the “Composite Man.”

“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,” he said.

Wyckoff advised traders to try to play the market game as the Composite Man played it.

Based on his years of observations of the market activities, Wyckoff concluded that:

  1. The Composite Man carefully plans, executes and concludes his trades.
  2. The Composite Man attracts traders to buy stocks in which he has already accumulated a sizable number of shares by making many transactions involving a large number of shares, in effect advertising his stock by creating the appearance of a “broad market.”
  3. Investors must study individual stock charts with the purpose of judging the behavior of the stock and the motives of those large operators who dominate it.
  4. With study and practice, investors can acquire the ability to interpret the motives behind the action that a chart portrays.

Wyckoff believed that if investors could understand the market behavior of the Composite Man, they could identify many trading and investment opportunities early enough to profit from them.

Three Wyckoff Laws
Wyckoff used a chart-based methodology to conduct his investment analysis which was based on three fundamental “laws”.

These laws helped in determining the market’s and stocks’ current and potential future directional bias. Also, these laws could be used for selecting the best stocks to trade, identifying the readiness of a stock to leave a trading range and projecting price targets in a trend from a stock’s behavior in a trading range.

1. The law of supply and demand determines the price direction.
According to Wyckoff when demand is greater than supply, prices rise, and when supply is greater than demand, prices fall and hence investors should study the balance between supply and demand by comparing price and volume bars over time.

According to Wyckoff, this law seems simple, but learning to accurately evaluate supply and demand on bar charts, as well as understanding the implications of supply and demand patterns, takes considerable practice.

2. The law of cause and effect helps the trader set price objectives by gauging the potential extent of a trend emerging from a trading range.
According to Wyckoff “cause” can be measured by the horizontal point count in a Point and Figure chart, while the “effect” is the distance price moves corresponding to the point count.

This law’s operation can be seen as the force of accumulation within a trading range, as well as how this force works itself out in a subsequent trend or movement up or down.

3. The law of effort versus result provides an early warning of a possible change in trend in the near future.
Wyckoff said divergences between volume and price often signal a change in the direction of a price trend.

Hence, when there are several high-volume but narrow-range price bars after a substantial rally, with the price failing to make a new high, this suggests that big interests are unloading shares in anticipation of a change in trend.

What is the Wyckoff method used for?
The Wyckoff Method is used by traders to determine market trends, select investments, and time the placement of trades.

It can help them identify the times at which big players are accumulating or distributing positions in a stock. It can also help investors to find trades with high-profit potential.

The advantage of following this method is that it is a straightforward analytical approach which helps investors enter and exit the market without emotion that can cloud judgment.

What are the 4 phases of the Wyckoff Cycle?

The four phases of the Wyckoff cycle are accumulation, markup, distribution, and markdown. They represent trading behavior and price action. Once the final markdown phase of the Wyckoff cycle is complete, a new accumulation phase kicks off a new cycle.

Most professional traders use Wyckoff’s methodology, but unfortunately, his approach is still not widely spread and followed among retail or new traders.

Although Wyckoff ‘s teachings were thought to make investors aware of the “real rules of the game”, his methods need smart practice and are well worth the effort for rookie and young traders to become successful in the long run.

(Disclaimer: This article is based on Richard Wyckoff’s book “How I Trade and Invest in Stocks and Bonds”)



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