What is the Wyckoff method?
By Stjepan Kalinic, Updated on: Apr 07 2023.
The Wyckoff method is a technical analysis approach that analyzes the markets based on supply and demand. The method revolves around 4 phases: accumulation, markup, distribution, and markdown – each with distinctive behavior between buyers and sellers.
Origins of the Wyckoff Method
The Wyckoff method is attributed to Richard D. Wyckoff, a financial prodigy who started working in the industry as early as 15 years old and owned a brokerage company by the age of 25.
Working on the inside of the industry, Wyckoff figured out all the techniques that large investors used to manipulate the markets, and soon he developed a method to use that to his advantage. He claimed that the price action reflects the plans and purposes of those who dominated it, and thus it is possible to judge the future course of the market.
Using this approach, Wyckoff amassed significant wealth. Still, he became more altruistic as he grew older – turning to writing books and sharing his knowledge with others. His most known work, „How I Trade and Invest in Stock and Bonds, “ was published in 1922.
Understanding the Wyckoff Method
According to Wyckoff, the market cycle consists of movement between the accumulation and the distribution area.
When the market enters a ranging period after significant selling, the large institutional buyers are accumulating. However, they do so gradually so as not to create significant volatility and spook the markets. This phase is known as accumulation, and it lasts until the selling force gets depleted or large market participants accumulate enough liquidity.
Eventually, they start pushing the price up, and the market enters the next phase, known as the uptrend.
Uptrend is the fun part because that's where the price starts moving and those large positions are in profits. As the market keeps going up, other investors join the rally, and demand is excessively higher than supply.
Now, those large positions need to get out. Still, they can't get out at once and whipsaw the market. Instead, they get out gradually, and the price enters the sideways movement again. This is the distribution phase where new buyers, usually naive retail investors, absorb the large money selling.
Finally, retail buying gets exhausted, and the market starts breaking. At this point, big money has sold most of the position and realized those profits. Meanwhile, retail has capitulated on buying, and when it liquidates those positions, the supply becomes greater than demand, and the market enters a downtrend.
Wyckoff's 3 Laws
Wyckoff's methodology revolves around 3 laws that lay out the fundamentals of his analysis.
1. The Law of Supply and Demand
The first law states that the prices rise when the demand is greater than the supply and falls when it is the opposite. This is one of the first principles in the market in general, and it is actually what causes demand-cost inflation – as prices rise when there is not enough supply.
Investors who follow the Wyckoff method often look at the volume bars to see how the price fares when selling off and how when buying up.
2. The Law of Cause and Effect
The second law states that the differences between supply and demand are not random but happen when certain conditions are met.
Thus, a period of accumulation (cause) eventually leads to a price rise – an uptrend (effect). On the contrary, a period of distribution (cause) leads to a downtrend (effect).
Wyckoff created methods of defining trading targets based on the periods of accumulation to estimate the probable extensions of a market trend after breaking out of a consolidation zone.
3. The Law of Effort
The third law states that the change in an asset price results from an effort – represented by trading volume.
For the trend to continue, the price action has to be supported by volume. If they diverge significantly, the trend will probably stop or change direction.
For example, if there is a high volume (large effort) present but a low result (narrow trading range) after a substantial move. If the price fails to make a new swing high or low, this suggests that large market participants are unloading their positions, anticipating a change in trend.
5 Key Guidelines to Trading the Wyckoff Method
Consistent results require an approach based on a set of rules. For that reason, Wyckoff developed a five-step approach to market analysis. Although some are based on subjective interpretation, they still provide valuable guidance.
Step 1: Determine the trend
Is the market going up or down? What's its position based on the most popular moving averages? Is it making higher highs or lower lows, or is it ranging – and what happened before that?
Step 2: Determine the asset's strength
How strong is the asset relative to the broad market? What is the current asset correlation, and how does it compare to historic trends?
Step 3: Look for assets with sufficient Cause
Is the risk worth taking? Is the Cause strong enough that makes the potential reward worth it?
Step 4: Determine how likely is the move
What has been going on with the asset? Is it ready to move, and how does it relate to the bigger trend? Is there anything price and volume tell you?
Step 5: Time your entry
The odds of a successful trade improve with the power of the broad market behind it. For example, a currency trader might look to sell the US Dollar and buy the Euro if the dollar is sufficiently weak, while the Euro is developing the strongest trend out of all the major currencies. Meanwhile, a stock trader might look at the SP500 trends and relative sub-sector strength.
Wyckoff Example with Conservative and Aggressive Entry
The following chart shows EUR CAD daily candles with Wyckoff's method.
EUR CAD, daily chart Source: TradingView
In an established downtrend where the market is well below the 200-day moving average, the price consolidates in an established range before heading down.
Now it makes a narrower range with rather tight support and resistance and springs below to do a fake out while the volume starts picking up. Here the institutional investors buy while retail mostly sells. Following another test that puts in a higher low, the price breaks out of the previous trading range.
This is often an aggressive buying opportunity. However, a better, although more conservative one is to wait for a sign of strength when the price tests former resistance now turning into support.
Wyckoff's work was revolutionary at that time, as he was one of the pioneers pointing out the influence of institutional and other large operators while providing the framework to adjust to those rules.
Yet, his method can be complex and overwhelming for beginners, which might be why it is not widely followed by retail traders.
Still, it can be a valuable strategy for those who want a time-tested approach to any market. Except for Wyckoff's work, our reading recommendations include „The Market Maker Method“ by Steve Mauro and YouTube material by Trade ATS.
Frequently Asked Questions
What timeframe is best for Wyckoff?
Wyckoff method works on any timeframe, but it is the most useful on higher time frames like daily or weekly. Obviously, its application will differ from trader to trader based on their goals and targeted time horizon.
How long does it take to learn Wyckoff?
Although some talented students report times as low as several months, an average person will take closer to 2 years to become competent in trading the Wyckoff method.