There are several Market Cycle theories. In fact, the Wyckoff method is one of the more famous. This theory is the basis behind the price action Wyckoff Trading method. We will go through the fundamentals of the Wyckoff trading method and explain how it can be used for your trading. It works because it allows you to predict upcoming price moves.
Richard Wyckoff created this method. The Wyckoff method is a 19th-century stockbroker’s theory based on market price action and cycle stages. His book, “Carting the Stock Market,” contains two rules.
- The market never repeats the exact same thing twice. The price action of the past won’t be precisely the same. The market is always unique.
- Market behavior is significant only when compared to the past. The market has no never fail levels, where the market is guaranteed to change. Everything the market does must be compared to its prior moves.
The Wyckoff Market Cycle Theory
“The price cycle of a traded instrument consists of 4 stages – 1. Accumulation, 2. Markup, 3. Distribution, and 4. Markdown” – Wyckoff Method
- Accumulation– the first stage of the cycle (blue lines) is caused by institutional demand. Bulls are slowly gaining power. This results in in a position where they’re poised to push prices higher. Although the accumulation phase has the bull’s power increasing, the price action of the chart structure remains flat. A rising bottom is the best signal of the accumulation phase.
- Markup– the second stage (green line) is when bulls surpass the upper level of the accumulation phase and signal that a bullish trend is forming on the chart.
- Distribution– the third stage (purple lines) is when bears begin to regain their market authority. The price action becomes flat again, like in the accumulation phase. The best indication is that higher bottoms are consistently unsuccessful. The price action will begin to create lower tops as a second indication. And the market starts a selloff.
- Markdown– The last stage (red line) is a downward trend indicating the bears have taken power and are now pushing the price lower. he markdown confirmation comes with the price action breaking below the distribution phase’s horizontal structure. And the cycle will eventually return to to the accumulation phase after markdown.
- Springs– breakout springs are opposite to expected price moves and are used to confirm the cycle is unfolding. Springs are often associated with stop running, where institutions will push prices to stop loss areas, finding the liquidity needed to fulfill their orders.
The Wyckoff Method Three Laws
Wyckoff has three laws that cause the market cycle:
- Supply vs. Demand– excess supply leads to selling pressure and a potential decrease in price. Excess demand leads to buying pressure and possible price increases.
- Effort vs. Result– every market effort leads to a result. I.e., if there’s unusually high trading volume, significant price movements are expected. Volume is the effort and the price movement the result.
- Cause vs. Effect- every market cause has a proportional effect. I.e. the accumulation phase cause, leads to a markup phase/price increase effect.
Wyckoff and Volume
Analysis of market volume provides confirmation of progressing events High volume leads to sustained movements. And volume spread analysis helps identify transitions of a cycle. A movement is valid if a breakout’s trading volumes are high; if decreasing, it may be a spring or false breakout.
In this accumulation phase example, the price bottom started to increase on decreasing volume then decreased on diminishing volume, suggesting the false break with the real breakout to follow with big bullish candles and volume behind it. The move slows with reducing volume, indicating a price action change and corrects, then resumes passing the corrective channel with increasing trade volume.
Wyckoff Method Trading Strategy
Wyckoff can be used to recognize price movements. If an accumulation phase is ending, a long position is warranted, or if a distribution phase is ending, a short position is possible.
After Wyckoff analysis and cycle phase recognition, we must follow a defined plan rather than just wing it.
Entry- Enter a trade when the price action moves from accumulation to markup or distribution to markdown. You will want to confirm the stage and the price range to identify tops and bottoms (increasing bottoms for accumulation and decreasing tops for distribution). You can also look for a spring. Accumulation and distribution can be identified with chart patterns; a price move outside the pattern can help identify the markup or markdown transition.
Your trade will occur when the price action breaks a range in the desired direction of movement. Buy when a price breaks an accumulation’s flat range through its upper level. Or below the flat support of a distribution phase. However, monitor the volume for additional clues and confirmation. –
Stop-loss- make sure to set a stop-loss; nothing is guaranteed. With a markup, your stop loss is below the lowest point of the accumulation, and with a markdown, the stop loss is above the highest point of the distribution phase.
Take Profit– with markup, the chart will begin showing descending tops and indicate a possible selloff. There may also be a spring which should be an immediate signal to close. Finally, look for a developing chart pattern or candlestick pattern, like a reversal formation, that signals a correction or trend change.
Wyckoff Method Trading Strategy
Wyckoff can be used to recognize price movements. If an accumulation phase is ending, a long position is warranted, or if a distribution phase is ending, a short position is possible.
After Wyckoff analysis and cycle phase recognition, we must follow a defined plan rather than just wing it.
Entry- Enter a trade when the price action moves from accumulation to markup or distribution to markdown. You will want to confirm the stage and the price range to identify tops and bottoms (increasing bottoms for accumulation and decreasing tops for distribution). You can also look for a spring. Accumulation and distribution can be identified with chart patterns; a price move outside the pattern can help identify the markup or markdown transition.
Your trade will occur when the price action breaks a range in the desired direction of movement. Buy when a price breaks an accumulation’s flat range through its upper level. Or below the flat support of a distribution phase. However, monitor the volume for additional clues and confirmation. –
Stop-loss- make sure to set a stop-loss; nothing is guaranteed. With a markup, your stop loss is below the lowest point of the accumulation, and with a markdown, the stop loss is above the highest point of the distribution phase.
Take Profit– with markup, the chart will begin showing descending tops and indicate a possible selloff. There may also be a spring which should be an immediate signal to close. Finally, look for a developing chart pattern or candlestick pattern, like a reversal formation, that signals a correction or trend change.
Summary
You can use Wyckoff trading together with price action to begin and manage your positions. Be flexible, pay attention to what the market is doing at all times, and act accordingly. As you get better at visualizing the cycle, you will see it play out and realize when things will happen according to the market volume. Use Wyckoff to help in making decisions, it will be an essential part of your trading arsenal, helping you make better choices and preventing big mistakes.
As always, never put at risk in one position more than you are willing to lose, and good luck with all of your trades.
