The Wyckoff Method

Explained
Advanced

What is the Wyckoff Method?

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.
A lot of Wyckoff’s work was inspired by the trading methods of
other successful traders (especially Jesse L. Livermore). Today,
Wyckoff is held in the same high regard as other key figures,
such as Charles H. Dow, and Ralph N. Elliott.

Wyckoff did extensive research, which led to the creation of

several theories and trading techniques. This article gives an
overview of his work. The discussion includes:

• Three fundamental laws;

• The Composite Man concept;

•A methodology for analyzing charts (Wyckoff’s

Schematics);

•A five-step approach to the market.

Wyckoff also developed specific Buying and Selling Tests, as
well as a unique charting method based on Point and Figure
(P&F) charts. While the tests help traders spot better entries, the
P&F method is used to define trading targets. However, this
article won’t dive into these two topics.

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 there are
more people 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.

The Composite Man

Wyckoff created the idea of the Composite Man (or Composite
Operator) as an imaginary identity of the market. He proposed
that investors and traders should study the stock market as if a
single entity was controlling it. This would make it easier for them
to go along the market trends.

In essence, the Composite Man represents the biggest players

(market makers), such as wealthy individuals and institutional
investors. It always acts in his own best interest to ensure he can
buy low and sell high.

The Composite Man’s behavior is the opposite of the majority of

retail investors, which Wyckoff often observed losing money. But
according to Wyckoff, the Composite Man uses a somewhat
predictable strategy, from which investors can learn from.

Let’s use the Composite Man concept to illustrate a simplified

market cycle. Such a cycle consists of four main phases:
accumulation, uptrend, distribution, and downtrend.

Accumulation

The Composite Man accumulates assets before most investors.

This phase is usually marked by a sideways movement. The
accumulation is done gradually to avoid the price from changing
significantly.

Uptrend

When the Composite Man is holding enough shares, and the

selling force is depleted, he starts pushing the market up.
Naturally, the emerging trend attracts more investors, causing
demand to increase.

Notably, there may be multiple phases of accumulation during an

uptrend. We may call them re-accumulation phases, where the
bigger trend stops and consolidates for a while, before
continuing its upward movement.

As the market moves up, other investors are encouraged to buy.

Eventually, even the general public become excited enough to
get involved. At this point, demand is excessively higher than
supply.

Distribution

Next, the Composite Man starts distributing his holdings. He sells

his profitable positions to those entering the market at a late
stage. Typically, the distribution phase is marked by a sideways
movement that absorbs demand until it gets exhausted.

Downtrend

Soon after the distribution phase, the market starts reverting to

the downside. In other words, after the Composite Man is done
selling a good amount of his shares, he starts pushing the
market down. Eventually, the supply becomes much greater than
demand, and the downtrend is established.

Similar to the uptrend, the downtrend may also have re-

distribution phases. These are basically short-term consolidation
between big price drops. They may also include Dead Cat
Bounces or the so-called bull traps, where some buyers get
trapped, hoping for a trend reversal that doesn’t happen. When
the bearish trend is finally over, a new accumulation phase
begins.

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
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 excessive 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 the 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

The Phase D represents the transition between the Cause and

Effect. It stands between the Accumulation zone (Phase C) and
the breakout of the trading range (Phase E).
Typically, the 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

The 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.

Distribution Schematic

In essence, the Distribution Schematics works in the opposite

way of the Accumulation, but with slightly different terminology.
Phase A

The first phase occurs when an established uptrend starts to

slow down due to decreasing demand. The Preliminary Supply
(PSY) suggests that the selling force is showing up, although still
not strong enough to stop the upward movement. The Buying
Climax (BC) is then formed by an intense buying activity. This is
usually caused by inexperienced traders that buy out of
emotions.

Next, the strong move up causes an Automatic Reaction (AR),

as the excessive demand is absorbed by the market makers. In
other words, the Composite Man starts distributing his holdings
to the late buyers. The Secondary Test (ST) occurs when the
market revisits the BC region, often forming a lower high.

Phase B

The Phase B of a Distribution acts as the consolidation zone

(Cause) that precedes a downtrend (Effect). During this phase,
the Composite Man gradually sells his assets, absorbing and
weakening market demand.

Usually, the upper and lower bands of the trading range are
tested multiple times, which may include short-term bear and bull
traps. Sometimes, the market will move above the resistance
level created by the BC, resulting in an ST that can also be
called an Upthrust (UT).

Phase C

In some cases, the market will present one last bull trap after the
consolidation period. It’s called UTAD or Upthrust After
Distribution. It is, basically, the opposite of an Accumulation
Spring.

Phase D

The Phase D of a Distribution is pretty much a mirror image of

the Accumulation one. It usually has a Last Point of Supply
(LPSY) in the middle of the range, creating a lower high. From
this point, new LPSYs are created - either around or below the
support zone. An evident Sign of Weakness (SOW) appears
when the market breaks below the support lines.

Phase E

The last stage of a Distribution marks the beginning of a

downtrend, with an evident break below the trading range,
caused by a strong dominance of supply over demand.
Does the Wyckoff Method work?
Naturally, the market doesn’t always follow these models
accurately. In practice, the Accumulation and Distribution
Schematics can occur in varying ways. For example, some
situations may have a Phase B lasting much longer than
expected. Or else, the Spring and UTAD Tests may be totally
absent.

Still, Wyckoff’s work offers a wide range of reliable techniques,

which are based on his many theories and principles. His work is
certainly valuable to thousands of investors, traders, and
analysts worldwide. For instance, the Accumulation and
Distribution schematics may come handy when trying to
understand the common cycles of financial markets.

Wyckoff’s five-step approach

Wyckoff also developed a five-step approach to the market,
which was based on his many principles and techniques. In
short, this approach may be seen as a way to put his teaching
into practice.

Step 1: Determine the trend.

What is the current trend and where it is likely to go? How is the
relation between supply and demand?

Step 2: Determine the asset’s strength.

How strong is the asset in relation to the market? Are they
moving in a similar or opposite fashion?

Step 3: Look for assets with sufficient Cause.

Are there enough reasons to enter a position? Is the Cause
strong enough that makes the potential rewards (Effect) worth
the risks?

Step 4: Determine how likely is the move.

Is the asset ready to move? What is its position within the bigger
trend? What do the price and volume suggest? This step often
involves the use of Wyckoff’s Buying and Selling Tests.

Step 5: Time your entry.

The last step is all about timing. It usually involves analyzing a
stock in comparison to the general market.

For example, a trader can compare the price action of a stock in

relation to the S&P 500 index. Depending on their position within
their individual Wyckoff Schematic, such an analysis may
provide insights into the next movements of the asset.
Eventually, this facilitates the establishment of a good entry.

Notably, this method works better with assets that move together
with the general market or index. In cryptocurrency markets,
though, this correlation isn’t always present.

Closing thoughts
It’s been almost a century since its creation, but the Wyckoff
Method is still in widespread use today. It is certainly much more
than a TA indicator, as it encompasses many principles,
theories, and trading techniques.

In essence, the Wyckoff Method allows investors to make

more logical decisions rather than acting out of emotions. The
extensive work of Wyckoff provides traders and investors a
series of tools for reducing risks and increasing their chances of
success. Still, there is no foolproof technique when it comes to
investing. One should always be wary of the risks, especially
within the highly-volatile cryptocurrency markets.