Wyckoff Theory: How to Trade Wyckoff Distribution
As a professional trader, you should have a vast knowledge of the main theories of the market system and circles. The most common market theories include the Elliott Wave Principle and the Dow Theory. However, in this text, we will focus on an additional important market theory known as the Wyckoff theory. We will broadly discuss the Wyckoff Accumulation and the Wyckoff theory. We will look at the trading methodology based on its price action.
What is a Wyckoff theory?
This article will provide a clear understanding of Wyckoff’s theoretical approach to the market in general, and similarly tactical for determining trade prospects when opening long and short positions. It will also include the analysis of the accumulation and distribution cycle. And also explain Wyckoff’s market trading strategies. The article focuses on the general market application of the Wyckoff theory. These cover a range of financial markets, including Stocks, Forex, Bonds, Commodities, etc.
To get right into the article let’s start by talking about the founder of the theory.
Who Is Richard Wyckoff?
Richard Wyckoff is a legendary technician that wrote about the financial markets in the early 20th century. He operated around the same time as some renowned market analysts like Charles Dow, and Jesse Livermore. His first strategy in technical analysis is known as the Wyckoff Method. This theory has survived the years and made it into Modern war. The theory helps traders to pick the best stocks, the best entry and exit strategy, and also the most efficient risk management strategy.
Wyckoff’s statement on price action gave birth to the present market cycle known as the Wyckoff theory. This theory defines the main components in price trend expansion that are reflected by periods of accumulation, markup, distribution, and markdown. Richard also laid out rules to use together with these phases. These rules help traders to know the location and importance of price within the wide range of bullish trends, bearish trends, and sideways markets.
These rules are gotten from Wyckoff’s analyses and understanding of trading the stock market.
The Wyckoff theory is established mainly on the price movement and the various cycle phases the market upholds. It is important to know the two most significant rules mentioned in his book named “Charting the Stock Market ”.
The Two Main Rules Of Wyckoff Theory
The market and individual trades do not create the same pattern twice. This means that no trade has the same outcome. There are variations in some areas such as size, detail, and extension. This means that even if the trade had some similarities with previous trades there will be some variations in terms of the area mentioned above. Experienced traders refer to this as a shape-shifting phenomenon that has to do with profit-seeking.
The importance of price trends shows itself only when related to past historic price trends. That means, the financial market solely relies on context. The best method to analyze the current price trend is to relate it to the previous price trends of say last year, week, month, or day.
This rule states that basing price analysis based on a single day’s price trend will lead to incorrect results.
The two rules mentioned above are very important details for our next subtopic.
Wyckoff Market Cycle
A professional Wyckoff market analyst must have the ability to predict and affirm the direction and momentum of the move out of a TR. Thankfully, Wyckoff provides top-notch guidelines for specifying and outlining the phases and conditions within the TF, which then offers the ground for evaluating price targets in the following trend. These theories are depicted in the following four cycles. The two cycles show common conditions of accumulation TRs, with the subsequent two instances of distribution TRs.
The concept of the Wyckoff market promotes the Wyckoff strategy. It interprets the reason why stocks and other securities move. This is based on Wyckoff’s theory of supply and demand, and the price of financial assets moves in a cycle in four different phases. Traders make use of this market cycle to determine the market trend and also note any potential price reversals. It also helps traders to know the time of a trade, which is the Wyckoff accumulation and distribution/sell-off stage.
The cycle phases are namely: accumulation, markup, distribution, and markdown. These phases represent the nature of the traders and can also help to determine the trend of a trade or a potential price move.
The Wyckoff accumulation stage is the stage where institutional traders boost their buying and increase their assets. As the demand increases the trading range forms higher lows and prices start to move higher. When buyers begin to gain more momentum in the market, prices begin to break out through the top level of the trading range. When it gets to the Markup stage the chart shows a consistent bullish trend, the trend is consistently moving upwards.
The distribution phase, this phase illustrates that sellers are taking control of the market. The horizontal side of this chart shows low Price highs and a shortage of higher bottoms. The markdown phase is the period of increased selling. It confirms the bearish trend when prices break below the already formed lows. When the fourth and final stage of the Wyckoff cycle is reached, the whole cycle starts again.
PS – preliminary support, this is where the buyer starts to offer evident support after a long bearish trend. The volume of trade shows a significant increase and the price starts to increase. It indicates the end of the bearish trend.
This is where substantial buying begins to provide pronounced support after a prolonged down-move. Volume increases and price spread widens, signaling that the down-move may be approaching its end.
SC – selling climax, this shows the increase in the bullish trend and the end of the bearish trend. Prices close at SC, indicating an increase in buying power.
AR – automatic rally, this happens when the selling intensity has drastically decreased. The market is controlled by the buyers and the other is a continuous bullish trend. Price rallies define the upper boundary of an accumulation TR.
ST – secondary test, this is the phase where price retouched the level of the SC to test the level of supply and demand at this phase. If a low is confirmed, the volume and price will drastically reduce as the market lives towards support in the area of the SC. After SC it is normal to give various STs.
In the Wyckoff accumulation stage, a new phase begins forming a trading range. The structure gives rise to a bearish point or a spring that reaches its selling peak, before the rise of a strong trend that ultimately retreats to the opposite side of the trade. The final fall is when the price falls below the key support and activates a selling spree. After this, the price starts to pick up and begins to move back over support.
This phase signifies the end of the initial bearish trend. Before this stage, supply has been controlling the market. The gradual halt of supply is confirmed by the preliminary support (PS) and the selling climax (SC). These conditions can be seen on a bar chart, where expanding spread and high volume indicate the selling of high numbers of stocks from the public to big professional bodies.
Once the high selling strength reaches its climax, an automatic rally (AR), made up of all types of traders begins. A profitable secondary test (ST) close to the DC area will illustrate lower selling strength than prior and a reduced spread with a low volume will be seen. This stops at or moves over the same price as SC. If the ST undercuts the SC, it indicates a potential new low or a long-term price consolidation. The TR levels are formed by the highs of AR, and the lows of SC and ST.
Wyckoff analysis, Phase B shows the process of a new bullish trend. In layman’s terms causes and effect. This shows the banks, and institutional bodies accumulating stocks while waiting for the next markup. This process generally takes a long time; it could prolong up to a year or more. It involves the buying of stocks at a lower price with quick sales. Lots of STs spring up during phase B, and also a rise is noticed at the top end of the TR.
During the early stage of phase B, the price volatility is wide and is followed by big volume. Experienced traders usurp this opportunity to a word supply. However, in the bearish trend with the TR, the volume tends to decline. This is when supply had reached its climax, indicating the stock is ready for Phase C.
This stage shows the stock going through its final test of the lingering supply, this gives the banks and the institutions the final lap to indicate if the stock price is ready to reverse. As earlier stated, spring is when a price undercuts the support level of the TR and quickly picks up and crosses back to the TR.
In the trading world, it is referred to as a bear-trap; indicating a brief period of a bearish run, but in all indications it is the beginning of the bullish trend, thereby hooking the late seller. According to Wyckoff’s theory, a successful test of supply is illustrated by a spring. A spring with low volume indicates that the price of the stock is about to reverse. Traders are advised to initiate a temporary long position.
The trend is confirmed when SOS appears briefly after spring. However, this is not always the case, as supply can be tested at the upper area of the TR without the event of a spring.
Phase D shows a continual dominance of demand over supply in the market. This is shown by the structure of increased prices and high volume. During this phase, the price moves to the upper part of the TR.
In this phase, the price moves away from TR, showing demand in full control of the market. At this stage the markup is evident. Insignificant reversals such as shakeouts are short-lived. The phase gives rise to new TR levels. New highs are formed accompanied by high volume.
Accumulation / Distribution Price Spring
According to our Wyckoff market cycle image, you can see where the price moved below the Accumulation channel and moved above the distribution level. This action occurred before the real price breakout occurred. This is known as the Wyckoff spring, which is known as a false breakout. This is another clear indication that the price trend adheres to the Wyckoff market cycle.
Note: Springs occur late in a TR and it enables the stock’s main players to make a concise test of accessible supply before markup takes place. A false breakout takes the price below the low of the TR; this event gives rise to the public being misled, giving the main players more room for price bargains. Sometimes spring can occur after markup, this is to make retail traders sell off their stocks giving banks and institutions the upper hand.
PSY – This is the preliminary supply, where institutional traders begin to sell off shares after a long period of an uptrend. Volume increases and price spread increases. This implies a possible reversal in trend.
BC – This is the opposite of SC. This is the buying climax. During this point, volumes and price spreads are increased. The intensity of buying hits its apex, with a high volume of buying occurring close to the top. This buying intensity is fueled by big institutions and banks. A Buying climax is accompanied by a good earnings report and good tidings. The company needs to sell off sticks without having to reduce the stock price.
AR – This is known as an Automatic reaction. At this point the intense buying is gradually reduced after the Buying Climax and heavy supply proceeding, it gives rise to an AR. The low of the selloff formed helps traders distinguish the lower level of the distribution TR.
ST – Known as the Secondary test, this is the stage where price re-touches the level of the BC to test the strength of supply and demand. To confirm the high of trade, demand has to be lower than supply; the price spread and volume should be on the low side as the price gets to the resistance level of the BC. A secondary test could be in the form of an upthrust (UT), where the price crosses above the resistance level depicted by the BC and probably other STs before immediately overturning near the resistance level. After the upthrust, the price always re-touches at the lower level of the TR.
SOW – This stage is known as the sign of weakness, this stage is the bearish trend stage or a little below the level of TR, it often occurs when there is an increased spread and volume. The AR and the previous SOWs show a shift of character in the price of the trade, it shows that supply is now in control of the market.
LPSY – This stage is known as the Last point of supply. After the support level on an SOW is tested, a weak rally on tight spreads indicates that the market is finding it hard to move upward. This is caused by a decline in demand, significant supply, or both. LPSYs depict the end of demand and the last tides of big runs of distribution before the markdown phase starts.
UTAD – This is the stage known as upthrust after distribution. A UTAD is similar to the spring phase in the Wyckoff accumulation TR. This shows up in the latter phase of the TR and it offers a precise test of a rise in demand after the price breaks out at the top of TR resistance. Unlike the springs and shakeouts, a UTAD does not require a structural component.
During the Wyckoff distribution stage, TR signifies the end of an initial trend. Before this, demand had been in control of the market, and the first sign that supply is beginning to rise in the market is the provision of preliminary supply (PSY) and also the BC known as the buying climax. These conditions are accompanied by low volumes of other events known as the automatic reaction (AR) and a secondary test (ST) of the buying climax. However, in some cases, the uptrend can end without reaching its peak, indicating the end of demand with low spread and volume; Less uptrend is achieved on each tally b for the main supply comes into play.
During the redistribution TR within a bigger downtrend, Phase A looks similar to the emergence of accumulation TR, for instance, reaching its price peak, and volume in the bearish run). However, Phases B to E of a redistribution TR can be surveyed in a likely approach to the distribution TR at the market high.
This is the stage that provides the cause for a potential bearish trend. In this stage, the institutions and big companies, like banks, and hedge funds start to sell off their long trades, thereby causing a shift in the market and initiating short trades with the probability of the next markdown. The accumulation phase B is similar to the distribution phase B, the difference is that the big companies are the main sellers of the stocks as the TR arises.
The main aim is to get the demand of the market to its peak as much as possible. This procedure gives traders that slight indication of the possible change in the market. It shows a potential shift from demand to supply. For example, the SOWs are normally followed by a bearish high spread and volume.
In the Wyckoff distribution stage, Phase C arises via an upthrust (UT) or UTAD. As earlier stated, a UT is similar to the spring or shakeout but acts on the opposite side. It is the movement of price over TR resistance that immediately overturns near the TR. This is used to test the available demand. It is a bullish trap, it indicates the beginning of the previous bullish trend, but in reality, it’s a false breakout used to trap traders.
This stage gives the big investors the upper hand in the market, fooling retail traders and making them think the market is going to reverse the previous trend whereas it won’t. This makes the big investors sell off their trades at a high price to the retail trader before the markdown commences. Also, a UTAD may give rise to retail traders selling off their trades to the big companies that have created the shift in the market.
This stage arrives after the price movements in Phase C show the last test for demand. During this phase, the price moves to or via TR support. The confirmation is that the supply is obviously in control of the market, and it rises with a significant price breakout in support, or by price moving below the mid-level of the TR after a UT or UTAD. This phase shows various weak rallies; these short rallies give traders the opportunity to add profitable short trades. Traders are advised to not be in any long position when Phase D kicks in.
This phase shows the rise of the bearish trend. The trade leaves the TR showing the supply is in control. Observe price breaks through the TR support in a significant SOW, this initial bearish trend is tested by a rally that stops at support or near it; this indicates a sell signal. The rallies generated after this are weak rallies. Traders who are in a short position can monitor their trades and adjust their stop orders as the price continues to decline. After a period of a bearish trend, when it gets to its peak, the entire cycle is repeated again, either for accumulation or re-distribution.
Three Laws Of Wyckoff
There are three main laws used by Richard Wyckoff. These laws emphasize the natural circumstance of the market cycle.
SUPPLY VS. DEMAND
This law explains that, if the market experiences high selling pressure, propelled by the excess supply, it indicates a probable decrease in demand. If the market also experiences high buying pressure, propelled by excess demand, it indicates a probable decrease in supply and an increase in price.
EFFORT VS. RESULT
This rule states that every effort displayed in the financial market should lead to an outcome. For instance, let’s take a look at the relationship in trading volume. When an asset shows a high trading volume, it is expected to have a big price trend. This big price move indicates that traders are trying to gain control of the market. The big price trend is the result of the effort.
CAUSES VS. EFFECT
This rule states that every cause in the financial market generates an effect. For instance, in the Wyckoff accumulation and Wyckoff distribution systems; accumulation results in Markup and price rallies; and Distribution results in Markdown and price declines. In this case, the Accumulation is the cause, and the Markup is the effect.
How To Generate Profits With Wyckoff Trading Forex
Traders use the Wyckoff Price cycle to predict potential price trends. For instance, as the Accumulation stage ends, the Markup stage begins, which can be traded to the bullish side. At the same period, as the distribution stage comes to an end, the markdown phase begins, which can be traded as a short trade.
Knowing the various phases of the price cycle will help you know the right time to open and close a trade. Most readers prefer to open a trade close to the beginning of the markup and hold the position till the end of the markup. This action goes for the Wyckoff distribution stage.
Wyckoff Trading Strategy
After making your Wyckoff Analysis, it is important to note the recent market cycle. To generate more profits in the current market cycle, it is important to have a concise and precise trading plan that will help in guiding you throughout the market. Let’s discuss some important rules that must be adhered to help in generating good profits with the price cycle.
Wyckoff Trade Entry
It is advisable to open a year when the price trend is moving from the accumulation stage to the Markup stage or from the distribution stage to the markdown stage. Before opening a trade position, first, confirm the market stage when the Forex pair is ranging. This will enable easy identification of high lows for an accumulation and low highs for the Wyckoff distribution stage. Additionally, it is advisable to perform thorough research on the historic price move to help in clear predictions.
Another method used by most traders in confirming the Accumulation or Distribution stage is by specifying a spring or shake out, this is the transition price trend condition that always happens between the cycle phases.
Chart patterns can also be used by traders to specify the accumulation and distribution stage. Probable price action from a chart can help in specifying the transition of price to the markup or a markdown stage.
Normal trade occurs when the price trend breaks the range and moves toward the predicted direction. For instance, opening a long position when the price breaks through the range through the top level. For the distribution of phase, you can open a short trade when the price trend moves below the support level of the Wyckoff Distribution area.
Additionally, you should always take note of the trading volume for extra indications that will confirm that your predictions are correct.
Wyckoff Stop Loss Order
It is important to note, that in Forex Trading, there are no guarantees. This is why it is important to make use of stop loss order when opening a position. When trading a Markup, your stop loss order should be set under the lowest point of the accumulation cycle. When trading a markdown, your stop loss should be set at a point over the highest level during the distribution stage.
Wyckoff Take Profit
Traders use price action surveys to organize their take profit levels. Let’s take a look at a situation where a Markup trade is used.
The main indication that the price is moving from a Markup to Distribution is the existence of declining highs on the chart. This incident predicts that a potential sell-off is about to take place.
Another indication on the chart is the appearance of a bearish spring on the chart. When noticed, it indicates it’s time to exit the trade; this team the price movement has gotten to the last stage of the distribution cycle.
Another indication is to watch out for developing chart patterns and candlestick patterns. Detecting a price reversal formation can be an indication that the price is about to reverse or change the trend.
NOTE: Wyckoff’s analysis is similar to the price action strategy. Therefore, price action analysis is an important means to open and monitor trades within the Wyckoff price curve. Your analysis and strategy should give room for changes; this is because the market is highly unpredictable. You should be ready for whatever comes and be ready to adjust your trade settings accordingly.
How To Trade Using The Wyckoff Method
Firstly, have a good understanding of the five steps of the Wyckoff method, and also the Wyckoff cycle. Also, take note of the accumulation and distribution stage and the phases that follow.
Open your trade when the price transitions from accumulation to markup or Wyckoff distribution to markdown.
Additionally, set a stop loss order at the opposite side of the trend.
Monitor your trade and exit the trade when the price or the volume of the trade indicates a trend reversal.
The Wyckoff method is made up of Wyckoff theories, methods, and laws for trading.
Below is a summary of the laws outlined step by step. This method can be used in picking the right trades at the right time.
- Develop the general market trend, and also predict future price moves. Used the law of supply and demand to know the position of the market, and which is in control of the market.
- Pick the trade that moves in the same direction. Particularly the trades indicate higher volume than the market during bullish trends and less volume during bearish trends.
- Pick the right trade under accumulation, or if in a short position distribution. The probability of these trades generating profits is high.
- Determine if a trade is ready to trend. Study the price and the strength of the trade and the conditions of the general market. Ensure that the results are correct and the trade is a good pick before entering the trade.
- Monitor your trade, and set your parameters to help take advantage of the market swings. Sell off your sticks when the condition of the market indicates a downtrend.
Is The Wyckoff Theory Effective?
Wyckoff provides a different method of credible tools and strategies that can be used to access the market and trades. This process is examined and used by big investors, traders, and top market analysts worldwide who understand its importance.
What Is The Wyckoff Theory Used For?
The Wyckoff method is utilized by traders to know the exact market trends, pick the best financial assets, and the best time to enter and exit a trade. It also helps traders to know the time when the big investors are accumulating and distributing their trades. It can help individuals to know when a trade is in a highly profitable state. Additionally, its analytical method helps traders to enter and exit trades without any emotions.
What Do The Four Phases Of The Wyckoff Cycle Stand For?
The Wyckoff cycle is made of four phases namely: Accumulation, Markup, Distribution, and Markdown. They depict the trading condition and price trends. Once the final stage (markdown) is completed, it begins a new cycle starts from the accumulation phase.
In the early years of the 20th century, Richard Wyckoff developed fundamental laws on tops, bottoms, trends, and tape study. His theories, including the Wyckoff technique, market phases, and rules, continue to help traders and investors understand the market in the 21st century.