What is the Wyckoff Method?

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BITSTAMP:BTCUSD   Bitcoin / U.S. Dollar
Accumulation schematic #1 Wyckoff Event and Phases

The Wyckoff Method was developed by Richard Wyckoff in the early 1930s. It consists of a series of principles and strategies initially designed for traders and investors. Wyckoff dedicated a significant part of his life teaching, and his work impacts much of modern technical analysis (TA). While the Wyckoff Method was originally focused on stocks, it is now applied to all sorts of financial markets.

The three laws of Wyckoff

The Law of Supply and Demand

The first law states that prices rise when demand is greater than supply, and drop when the opposite is true. This is one of the most basic principles of financial markets and is certainly not exclusive to Wyckoff’s work. We may represent the first law with three simple equations:

Demand > Supply = Price rises

Demand < Supply = Price drops

Demand = Supply = No significant price change (low volatility )

In other words, the first Wyckoff law suggests that an excess of demand over supply causes prices to go up because more people are buying than selling. But, in a situation where there is more selling than buying, the supply exceeds demand, causing the price to drop.

Many investors who follow the Wyckoff Method compare price action and volume bars as a way to better visualize the relation between supply and demand . This often provides insights into the next market movements.

The Law of Cause and Effect

The second law states that the differences between supply and demand are not random. Instead, they come after periods of preparation, as a result of specific events. In Wyckoff's terms, a period of accumulation (cause) eventually leads to an uptrend (effect). In contrast, a period of distribution (cause) eventually results in a downtrend (effect).

Wyckoff applied a unique charting technique to estimate the potential effects of a cause. In other terms, he created methods of defining trading targets based on the periods of accumulation and distribution. This allowed him to estimate the probable extension of a market trend after breaking out of a consolidation zone or trading range (TR).

The Law of Effort vs. Result

The third Wyckoff law states that the changes in an asset’s price are a result of an effort, which is represented by the trading volume . If the price action is in harmony with the volume , there is a good chance the trend will continue. But, if the volume and price diverge significantly, the market trend is likely to stop or change direction.

For instance, imagine that the Bitcoin market starts to consolidate with a very high volume after a long bearish trend . The high volume indicates a big effort, but the sideways movement (low volatility ) suggests a small result. So, there is a lot of Bitcoins changing hands, but no more significant price drops. Such a situation could indicate that the downtrend may be over, and a reversal is near.

Wyckoff’s Schematics
The Accumulation and Distribution Schematics are likely the most popular part of Wyckoff’s work - at least within the cryptocurrency community. These models break down the Accumulation and Distribution phases into smaller sections. The sections are divided into five Phases (A to E), along with multiple Wyckoff Events, which are briefly described below.

Accumulation Schematic
Wyckoff method accumulation schematic

Phase A
The selling force decreases, and the downtrend starts to slow down. This phase is usually marked by an increase in trading volume . The Preliminary Support (PS) indicates that some buyers are showing up, but still not enough to stop the downward move.

The Selling Climax ( SC ) is formed by an intense selling activity as investors capitulate. This is often a point of high volatility , where panic selling creates big candlesticks and wicks. The strong drop quickly reverts into a bounce or Automatic Rally (AR), as the excess supply is absorbed by the buyers. In general, the trading range (TR) of an Accumulation Schematic is defined by the space between the SC low and the AR high.

As the name suggests, the Secondary Test (ST) happens when the market drops near the SC region, testing whether the downtrend is really over or not. At this point, the trading volume and market volatility tend to be lower. While the ST often forms a higher low in relation to the SC , that may not always be the case.

Phase B
Based on Wyckoff’s Law of Cause and Effect, Phase B may be seen as the Cause that leads to an Effect.

Essentially, Phase B is the consolidation stage, in which the Composite Man accumulates the highest number of assets. During this stage, the market tends to test both resistance and support levels of the trading range.

There may be numerous Secondary Tests (ST) during Phase B. In some cases, they may produce higher highs (bull traps) and lower lows (bear traps) in relation to the SC and AR of Phase A.

Phase C
A typical Accumulation Phase C contains what is called a Spring . It often acts as the last bear trap before the market starts making higher lows. During Phase C, the Composite Man ensures that there is little supply left in the market, i.e., the ones that were to sell already did.

The Spring often breaks the support levels to stop out traders and mislead investors. We may describe it as a final attempt to buy shares at a lower price before the uptrend starts. The bear trap induces retail investors to give up their holdings.

In some cases, however, the support levels manage to hold, and the Spring simply does not occur. In other words, there may be Accumulation Schematics that present all other elements but not the Spring . Still, the overall scheme continues to be valid.

Phase D
Phase D represents the transition between Cause and Effect. It stands between the Accumulation zone (Phase C) and the breakout of the trading range (Phase E).

Typically, Phase D shows a significant increase in trading volume and volatility . It usually has a Last Point Support ( LPS ), making a higher low before the market moves higher. The LPS often precedes a breakout of the resistance levels, which in turn creates higher highs. This indicates Signs of Strength (SOS), as previous resistances become brand new supports.

Despite the somewhat confusing terminology, there may be more than one LPS during Phase D. They often have increased trading volume while testing the new support lines. In some cases, the price may create a small consolidation zone before effectively breaking the bigger trading range and moving to Phase E.

Phase E
Phase E is the last stage of an Accumulation Schematic. It is marked by an evident breakout of the trading range, caused by increased market demand. This is when the trading range is effectively broken, and the uptrend starts.

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