swing trading

Richard Wyckoff Trading Method

Wall Street has seen its fair share of legendary traders and investors. In this light, the Wyckoff Method has been described as the “de facto guide of technical analysis”. Richard D. Wyckoff was not merely graced with the crown of legend for the wyckoff method; he earned it. The true value of Wyckoff’s giftedness as a trader was his willingness to educate others and to contribute his methodologies to future generations of research in regard to market theory; which extended beyond the humanistic motives of profit and wealth. This paper will present a historical portrait of the financial theories and logic of Richard D. Wyckoff; an overview of the Wyckoff Laws and Rules; and how his theories apply to today’s markets.

Introduction

The Wyckoff stock trading method evolved from an early start in a life that became completely engaged in the world of stock market trading. At fifteen years of age, Wyckoff was a Wall Street stock runner; and by 25 years of age, he had opened his own stock brokerage firm. Born in 1873, Wyckoff was influenced by traders such as J.P. Morgan, Charles Dow, Jay Gould, Andrew Carnegie and Jesse Livermore and eventually interviewed many of the famous traders. As a student of great mentors, Wyckoff learned about stock accumulation and distribution identification of large operators and other insights, which he eventually integrated into his own methodologies. For nearly 20 years, Wyckoff blessed the Wall Street community through his insightful publications in The Magazine of Wall Street

(Pruden, 2011) described Wyckoff as an early 20th century trader, broker, and publisher that codified best practices from legendary traders into laws, tenets and techniques of mental discipline, money management, and technical stock trading methodologies. Wyckoff defined the mental qualifications of the professional trader as the ability to define trends and the ability to take a loss. Of his many simplistic, yet profound theories, Wyckoff contributed that the successful trader is the outcome of “absolute focus upon the subject; painstaking effort; and an absolute devotion of attention and time toward the reading of the tape”. In 1910, Wyckoff Published Studies in Tape Reading; and in 1924 he published How I Invest in Stocks and Bonds. At his forte, Wyckoff founded a school that became the Wyckoff Stock Market Institute in 1930, and published the book, The Richard Wyckoff Method of Trading and Investing in Stocks - A Course of Instruction in Stock Market Science and Techniques in 1931; which has become a financial bible to hedge fund managers.

Wyckoff Method

Over the span of his lifetime, Wyckoff produced several theories that were characterized by concepts of the Composite Man, buying and selling climaxes, jump across the creek, upthrusts, and springs that are still in use today. The fundamental components of his method consisted of observations of the movements of price and volume. Fortunately, a significant percentage of Wyckoff’s work was published either through his own publications or through renowned book publishers and have since been recycled and refined.The most noted contributions from Wyckoff’s many trading philosophies include the Wyckoff 3 Laws; the Nine tests for buying and selling; and the 5 Step Approach to the Market.

Wyckoff 3 Laws

The Wyckoff method reflected Wyckoff’s repertoire of trading and investment philosophies that supported the economic tenets of supply and demand were reflected in the movement behaviors of price and volume; which in turn, could be used to project future movements. The price movements were regarded as significant based upon daily, weekly, monthly and annual comparisons. The 3 Laws of the Wyckoff Method consist of (1) the Law of Supply and Demand; (2) the Law of Effort versus Results; and (3) the Law of Cause and Effect, and are summarized in table 1:

Wyckoff 3 Laws

1. Law of Supply and Demand - When market demand is greater than the supply; the market prices will rise. When the market supply is greater than the demand, the market prices will fall.

2. Law of Effort versus Results - The disharmonies and divergencies between price and volume will often serve as indicators of changes in the direction of price trends.

3. Law of Cause and Effect - Effect requires a cause; and the effect will an outcome that is proportional to the cause.

Table 1. Wyckoff’s 3 Laws 

Market behavior was expected to fluctuate according to basic patterns that continuously became modified. Based upon the Law of Supply and Demand, scarcity increases the price and supply will increase to meet demand. The Law of Effort versus Results and the Law of Cause and Effect support that the fluctuations in the market price action are proportional, as in each action produces an equal or proportionate reaction. In combination, the Law of Supply and Demand and the Law of Effort versus Result produce powerful revelations of the modern bull market.

Wyckoff 9 Buying and Selling Tests

Wyckoff presented nine buying tests in order to diagnose reversal formations and nine selling tests in order to define new bull trends that were exhibited in bar charts and point-and-figure chart illustrations. The nine buying tests are summarized as follows in table 2:

Wyckoff Buying Tests

Wyckoff Selling Tests

1 Downside price objective accomplishment

1 Upside objective accomplishment

2 Preliminary support, secondary test, selling climax

2 Activity bearish

3 Activity bullish

3 Preliminary supply and buying climax

4 Downward stride is broken

4 Stock weaker than the market

5 Higher lows

5 Upward stride is broken

6 Higher highs

6 Lower highs

7 Stock stronger than the market

7 Lower lows

8 Base forming

8. Crown forming

9 Estimates of upside profit potential 3x loss if initial stop-loss is hit

9 Estimates of downside profit 3x risk if initial stop-order is hit

Table 2. Nine Classic Buying Tests and Selling Tests            

The buying and selling tests serve to guide entry into a trade; to distinguish when the trade range is closing; and to distinguish when a new upward or downward trend is beginning.

5 Step Approach to the Market

The investor is required to discern whether or not to enter the market, and upon entry, what position to take based upon the current and projected market position. The selection of stocks are then based upon interpretations of the current market trends. The Wyckoff 5 Step Approach to the Market provides a guide to trade entry and the selection of stocks, as shown intable 3:

Wyckoff 5 Step Approach to the Market

1. Determine present position and probable future market trends - consideration for market consolidation or trending, direction and timing.

2. Stock selection in harmony with trends - In uptrends, choose stocks that are stronger than the current market.

3. Stock selection: with “cause” equal to above minimum objectives - identification of price targets using point and figure based upon Law of Cause and Effect.

4. Determination of stock readiness to move - application of 9 steps for buying and 9 steps for selling.

5. Commitment timing according to stock market index - anticipation of potential market returns such as change of price action character.

Table 3. Wyckoff 5 Step Approach to the Market

The approach addresses the questions of present and future market position and trends. The selection of stocks is based upon the strength of the market and the direction of the trends. Price targets are identified with projections that are drawn from point-and-figure charts for short and long trades. The stocks’ readiness to move is determined by the application of the 9 steps to buying and to selling. The stop-loss is placed and then trailed until the position is closed.

The Wyckoffian logic was comprised of the climaxes, trends, rallies, and the causes and effects on price and volume. Figure 1 shows a chart of the “Wyckoffian Logic”:


Figure 1. Wyckoff’s Phases and Events (RTT, 2010)

A primary trading strategy for Wyckoff was the price markup/down phase, in which the price has broken out of a base pattern and a four stage market cycle. The cause and effect are exhibited Wyckoff’s phases and events were based upon the assumption that tape-reading could significantly support determinations of future market price movements prior to the price change. Ultimately, the primary focus of the logic was price action.

Relevance in Today’s Markets

After studying the wisdom of legendary traders of his day, Wyckoff himself became a legend. Modern market analysts confirm that Wyckoff’s method is certain and relevant for both short and long term trading and investment decisions (Burgess, 2016; Hutson, Schroeder & Weiss, 1991). Four key components of the Wyckoff method that are still relevant today are the reversal patterns, trend identification, trend positions, and price projections. The position and direction of trends are still analyzed based upon Wyckoff’s school of thought in regard to technical market analysis. Wyckoff’s method aids less sophisticated investors who otherwise are ravaged by large operators who capitalized upon the wrong responses to market price movements. 

Real-time tests of the Wyckoff stock trading method against the Dow Jones Industrial Average have continued to validate the method (Pruden, 2011). The practicality of the method in today’s markets, such as its application to today’s SP500, SP100, Russell 2000, NY Composite and the Nasdaq, lies in that it serves as a reliable guide for market trend analysis; market timing based decision making; price action and as a reliable indicator for when traders should be in or out of the markets. (Pruden, 2011) supported that the Wyckoff method “empowers trader-analysts with a whole-brained, balanced approach to decision making in regard to technical analyses”. In regard to his own works, Wyckoff submitted that “herein lies the outcomes of a lifetime of tape reading studies. A pursuit that is profitable; not for the weak hearted or the slow minded…but for the resolute; the strong willed and disciplined; the focused, studious and of calm disposition”.

References 

Burgess, R. Upthrusts & climaxes: Wyckoff analysis & the dollar index. Futures, 2016.

Hutson, J. Schroeder, C. Weiss, D. 1991. Charting the Stock Market: The Wyckoff Method. Technical Analysis of Stocks and Commodities.

Pruden, H. The Wyckoff Method Applied in 2009: A Case Study of the US Stock Market. IFTA Journal, 2011.

RTT. 2010.  Richard Wyckoff Method. Indicator Library. Read the Ticker. Retrieved from http://www.readtheticker.com/Pages/IndLibrary.aspx?65tf=84_richard-wyckoff-method

Wyckoff, R. 1919. The Day Trader’s Bible. Ticker Publishing. 

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