Table of contents

• What is Wyckoff analysis?
• Wyckoff’s three laws
  • Law of supply and demand
  • Law of cause and effect
  • The Law of Disharmony between Volume and Price
• The main force of the market
  • Accumulation
  • Uptrend
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  • Distribution
  • Downtrend
• Wyckoff's schematic
  • Accumulation diagram
  • Distribution diagram
• Is the Wyckoff analysis method effective?
• Wyckoff’s five steps
• Summary of thoughts

What is Wyckoff analysis?

Wyckoff analysis method was proposed by Richard Wyckoff in the early 1930s. Initially, it consisted of a series of laws and investment strategies designed for traders and investors. Wyckoff devoted much of his life to teaching, and his work influenced many modern technical analysis (TA) methods. Wyckoff analysis method was originally mainly applied to the stock market, but now it has been applied to various financial markets.

Many of Wyckoff's results were also inspired by the trading methods of other successful traders, especially Jesse L. Livermore. Today, Wyckoff is highly regarded, along with other well-known figures such as Charles H. Dow and Ralph N. Elliott.

Wyckoff conducted a large amount of research and created a variety of theories and trading techniques. This article will provide a brief overview of the results of his work. The discussion includes:

• Three basic laws;

• Market main force concept

• Chart analysis method (Wyckoff’s diagram);

• Five steps to enter the market.

Wyckoff also proposed specific buy and sell tests, as well as an original charting method based on point-and-figure (P&F) charts. Testing helps traders discover better entries, while the P&F method is used to define trading goals. However, this article will not delve into these two topics in depth.

Wyckoff's three laws

Law of supply and demand

The first law states that when demand is greater than supply, prices rise, and vice versa. This is one of the most basic principles in financial markets, and of course it is not unique to Wyckoff analysis. We can illustrate the First Law with three simple formulas:

• Demand >Supply = rising prices

• Demand<Supply=price decrease

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

In other words, Wyckoff's first law states that demand exceeding supply will cause prices to rise. Because there are more people buying than selling. However, with more selling than buying, supply exceeds demand, causing prices to fall.

Many investors who follow Wyckoff analysis compare price action and trading volume to better visualize supply and demand. This can also often help traders formulate the next stage of market trading trends.

Law of Cause and Effect

The second law can explain that the relationship between supply and demand The differences are not random. Rather, they come after a period of preparation due to specific events. In Wyckoff's words, the accumulation (causes) over a period of time will eventually produce an upward trend (result). Conversely, distributions (causes) ultimately create a downward trend (effect).

Wyckoff applies a unique charting technique to estimate the potential impact of causes. In other words, he created a method for defining trading goals based on accumulation and distribution periods. This allows him to estimate the market trend following a breakout of the consolidation zone or trading range (TR).

Law of Inconsistency between Volume and Price

Wyckoff's third legal explanation, assets Price changes are affected by trading volume. If price moves in line with volume, there's a good chance the trend will continue. However, if trading volume and price differ significantly, the market trend may stop or change.

For example, let's assume that after a long-term bearish trend, the Bitcoin market begins to consolidate at very high volumes. High volume indicates that market traders are working hard, but sideways movement (low volatility) indicates that volume has little impact on price outcomes. Therefore, if there is an increase in Bitcoin trading volume, but the price does not drop significantly again. It may indicate that the downtrend has ended and a price reversal is about to occur.

Market main force

Wyckoff will be the "market main force" (or "banker") is conceived as an identity existing in the market. He suggested that investors and traders should study the stock market as they would physical institutions. This will make it easier for them to follow market trends.

Essentially, the main market forces represent the largest participants (market makers) in the market, such as individual and institutional investors who hold large amounts of funds. Their best interest is to ensure they can buy low and sell high.

The behavior of the main market players is contrary to that of most retail investors, and Wyckoff often observes that this situation is loss-making. But according to Wyckoff, "bookmakers" employ certain predictable strategies that investors can learn from.

We can use the concept of "market main force" to briefly explain the market cycle. Market cycles consist of four main phases: accumulation, uptrend, distribution, and downtrend.

Accumulation

The main players in the market will seize the opportunity. Most investors accumulate assets before. The market trend at this stage usually moves sideways. The main players in the market will choose to accumulate gradually to avoid significant price changes.

Uptrend

When the "market main force" holds enough shares and is bearish on the market When exhausted, the bookmakers start pushing the market higher. Naturally, this upward trend attracts more investors, leading to increasing demand.

It is worth noting that there may also be multiple accumulation phases in an uptrend. We can call them reaccumulation phases, where the larger uptrend stops and consolidates for a period of time before continuing its upward movement.

As the market rises, it will encourage other investors to compete to buy. Eventually, more ordinary investors began to pay attention and participate together. In this case, demand is much higher than supply.

Distribution

Next, the main market players began to distribute shares. They resell their profitable positions to investors who enter the market later. Typically, the market in the dispatch phase is characterized by sideways movement until market demand is exhausted.

Downtrend

Shortly after the distribution phase ends, the market begins to resume its downtrend. In other words, after the "market main force" sells a large number of stocks, he starts to push the market lower. Eventually, supply becomes far greater than demand, creating a downward trend.

Similar to an uptrend, a downtrend may also have a redistribution phase. Basically a short-term consolidation during a sharp decline. They may also include "dead cat rallies" or so-called "bull traps," where some buyers get trapped in the hope that the trend won't happen. When the bearish trend finally ends, a new accumulation phase will begin again.

Wyckoff schematic

The accumulation and dispatch schematic may be The most popular part of Wyckoff's analysis - at least in the cryptocurrency community. These models divide the "accumulation" and "dispatch" phases into smaller parts. Each section is divided into five stages (from A to E) and multiple Wyckoff events, which are briefly described below.

Accumulation schematic

Phase A

Selling force continues to decrease, and the downward trend begins to weaken. This phase is usually marked by an increase in trading volume. Initial support (PS) shows increasing buyers, but it is not enough to stop the downward trend.

When the Air Force surrenders, violent selling trades will form a "selling climax" (SC). This is typically a point of high volatility, where panic selling creates larger candlesticks and wicks. A strong decline quickly rebounds or forms an automatic rally (AR) as excess supply is absorbed by buyers. Typically, the trading range (TR) of an accumulation chart is defined by the space between the SC low and the AR high.

As the name suggests, when the market declines near the SC area, a secondary test (ST) is conducted to test whether the downtrend is truly over. At this time, trading volume and market volatility decrease. Although ST usually makes higher lows relative to SC, this is not always the case.

Phase B

According to Wyckoff's law of cause and effect, phase B can be regarded as the cause of the effect.

Essentially, stage B is the consolidation stage, in which the main players in the market accumulate the largest number of assets. During this phase, the market tends to test the resistance and support levels of the trading range.

There may be multiple secondary tests (ST) within the phase B interval. In some cases, higher highs (a bullish trap) and lower lows (a bearish trap) may result relative to the SC and AR of Phase A.

Phase C

Phase C contains the so-called "rebound". This is also often the last bear trap, typically occurring before the market begins to hit higher lows. In stage C, the main market forces will ensure that there is no remaining supply on the market, that is, all supply has been absorbed.

"Bounces" often break support levels, acting to deter traders and mislead investors. We can describe it as the "bookmaker"'s last attempt to buy stocks at a lower price before an upward trend begins. "Short traps" induce retail investors to abandon the stocks they currently hold.  

However, in some cases, the support level can hold but a rebound will not occur. In other words, the "accumulation diagram" may show all the other elements, but not the "bounce". Nonetheless, the analysis remains valid.

Phase D

Phase D represents the transition between cause and effect. It is located between the accumulation zone (Phase C) and the breakout trading zone (Phase E).

Typically, trading volume and volatility increase significantly during Phase D. Typically has last point support (LPS), which is set lower before the market moves higher. LPS will often attempt to generate higher levels before breaking through resistance levels. This is also a growing pressure to the upside (SOS) as previous resistance forms new support.

The above series of terms may be confusing, but it is important to understand that multiple LPS may be generated during Phase D. Volume is often increased when testing new support levels. In some cases, price may create a small consolidation area before effectively breaking out of the larger trading range and entering Phase E.

Phase E

Phase E is the last phase of the cumulative diagram. Increased market demand resulted in a clear breach of the trading range. This can effectively break out of a trading range at the beginning of an uptrend.

Distribution schematic

Essentially, the distribution schematic is the same as "accumulation" Schematics work exactly the opposite way, and the terminology is slightly different.

Stage A

The first stage occurs on top of an established uptrend, where momentum begins to slow due to reduced demand. Preliminary supply (PSY) shows that there is ongoing selling at this stage, although not enough to stop the move to the upside. At this time, the buying boom (BC) is formed by intense buying activities. This is usually caused by overbought sentiment on the part of inexperienced traders.

Next, a strong rally triggers an automatic reaction (AR) as excess demand is absorbed by market makers. In other words, market players began to sell their holdings to subsequent buyers. When the market retests the BC area, it often forms lower highs, leading to a secondary test (ST).

Phase B

Phase B in the distribution diagram is the consolidation zone (volume) before the (price) downtrend. At this stage, the main players in the market gradually sell their assets, absorbing and weakening the market demand.

Typically, this stage will test the upper and lower limits of the price within the trading range multiple times, which may include short-term bearish traps and bullish traps. Sometimes, the market moves above the resistance level created by the BC phase, creating a secondary test (ST) which can also be called an Upthrust (UT).

Phase C

In some cases, the market will have a final bull trap after the consolidation period. Called UTAD or Pull After Dispatch. Basically, it's the opposite of a cumulative spring.

Phase D

Phase D is almost a re-image of the accumulation phase. It typically has the last supply point (LPSY) in the middle of the range, producing lower highs. From this point on, a new LPSY will be created around or below the support area. When a market falls below a support line, there are clear signs of weakness.

Phase E

The final stage of the distribution marks the beginning of the downward trend. Due to the obvious advantage of supply far exceeding demand, the transaction price will be low within the trading range.

Does Wyckoff analysis work?

Of course, the market does not always follow these types of analytical models accurately. In fact, accumulation and dispatch schematics can appear in different ways. For example, in some cases Phase B may last longer than expected. Otherwise, there may be no rebound and UTAD testing at all.

Nevertheless, Wyckoff analysis provides traders with a variety of reliable techniques based on his many theories and principles. His analysis has undoubtedly been of great value to thousands of investors, traders and analysts around the world. For example, an "accumulation and distribution" schematic can come in handy when trying to understand common cycles in financial markets.

Wyckoff's five-step analysis method

Wyckoff developed a five-step analysis method based on many of his principles and techniques. In short, this approach can be seen as a way to put his theory into practice.

Step 1: Identify the trend.

Determine what the current trend is and what the next trend might be? What is the current supply and demand relationship?

Step 2: Determine the strength of the asset.

What is the strength of the asset relative to the overall market? Do assets and markets move in similar or opposite directions?

Step 3: Find assets with sufficient "reasons" to buy.

Analyze whether there is enough reason to enter at the current point? Is the case for entry strong enough to take the risk for the potential reward (effect)?

Step 4: Determine the possibility of asset appreciation in the next step.

Does the asset have a tendency to move? How will this asset perform within the broader trend? What is the relationship between price and quantity? This step typically involves using Wyckoff to conduct buy and sell testing.

Step 5:Confirm your entry time.

The last step is to arrange a time to enter. Often involves analyzing stocks comparatively within the overall market.

For example, traders can compare the stock's price action relative to the S&P 500 Index. Based on their position on their respective Wyckoff diagrams, this analysis can provide a reference for where an asset will trend next. Ultimately, this helps establish the right time to enter.

It is worth noting that this method is more effective for assets that are consistent with the overall market trend or index. However, in the cryptocurrency market, this correlation is not always consistent.

Summary

Since the birth of Wyckoff analysis method, it has been nearly a year century, but Wyckoff analysis is still widely used today. It is widely accepted because it is not just a technical indicator, but also covers many principles, theories and trading techniques.

Essentially, Wyckoff analysis allows investors to make more logical decisions rather than play based on emotion. Wyckoff analysis provides traders and investors with a range of tools to reduce risk and increase their chances of success. Still, there are no foolproof techniques when it comes to investing. One should always be wary of risks, especially in the highly volatile cryptocurrency market.