Richard Wyckoff – Successful Price Action 5 Step Method
Richard Wyckoff was a pioneer of technical analysis techniques, as well as an investor and editor of the Magazine of Wall Street. His study of market cycles and trends are known as the Wyckoff method.
His study of market cycles is based on larger underlying strength that moves the market; he closely quantified and applied what Charles H Dow and Jesse Livermore theoretically described about price movements in the real world.
Richard Wyckoff is also known for his famous “composite man” theory, which states that one should study market price movements as if they were managed by a single composite man.
Table of Contents
Composite Man Theory
Theory of composite man comprises of following points –
- Composite man is the main driving force behind the price fluctuations.
- Composite man acts as and disadvantage to those who do not understand the real game and psychology behind price movement.
- Larger public interest is drawn to those stocks which are accumulated by composite man, to the benefit of his own.
- To gain real insight behind the stock price move one should study the behavior of smart money.
- One should by practice acquire the knowledge of carefully studying the move of operator and able to distinguish market noise and underlying trend.
Wyckoff Market Cycle
Wyckoff market cycle is practical approach towards composite man theory, it describes and extends the concept of how smart money manipulates the market and how you can understand the moves made by larger market operators.
To understand market cycle one must look it as demand and supply prospective, according to Richard Wyckoff, price move can be better studied in relation to volume, time , demand and supply,
Wyckoff was able to understand and depict the price action of smart money by using point and figure charts, his understanding of a market cycle can be classified into following phases –
This phase is dominated by smart money footprints of large stock accumulation area, Operators always look for oversold stocks to accommodate them in their portfolios with larger quantities, they gain interest of other market participants by moving stock higher but in limited range.
This phase begins when more public interest develops in stocks manipulated by smart money or composite man in Wyckoff terminology; this is when demand outnumbers supply and stocks rise.
A trend begins to emerge, with increasing public participation driving up prices.
It is not an easy task to return large quantities of stocks to the market; it is done slowly and steadily by market participants once they determine that the market has become overbought and it is time to book profits.
The distribution cycle resembles the accumulation cycle and it is often difficult to distinguish between the two; this is where understanding price-volume analysis comes in handy.
Markdown phase is the starting of a downtrend, when supply of stocks surprasses the demand markdown phase starts and panic selling begins.
At the end of the markdown phase, accumulation resumes, and the cycle is repeated.
Wyckoff is well-known for his research and analysis of trading ranges, in addition to his contributions to trend and market cycles.
Range trading, also known as box trading, is still popular today. During market cycles, these consolidations to narrow ranges provide important consideration of trend reversal or continuation.
These ranges also give traders or investors opportunities to either enter a fresh position or to close an existing one.
Theories and rules from the trading style of Richard Wyckoff are listed below in step by step method –
- Identification :- Identify the current market structure, where this structure lies in the market cycle, where the smart money is invested ?
- Selection :- Find stocks that are in harmony with underlying market conditions, one way to find them is to look at their movement with respect to overall market trend for example during markup phase stocks that are selected should react more to upward moves and less to downward movement.
- Risk Adjustment :- Wyckoff always gave prime importance to opportunities to better risk adjusted positions, one way of doing it to take positions in direction of smart money, for example buying during accumulation phase and selling during distribution.
- Understanding Ranges:- Trading range, consolidation patterns or price movement in narrow ranges all provide excellent opportunities to trade in direction of major trend.
- Timing :- Timing your trades and investment as per market structure takes time and practice, once you have this skill you can take advantage of momentum trading which gives best risk to reward trades.
Richard Wyckoff methods are still as relevant now as they were in early technical analysis methods; in today’s market environment, understanding market cycle and market structure is even more crucial. Richard Wyckoff established the fundamental ideas of trend analysis and risk management, which served as the foundation for price action approaches.