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Wyckoff Method

In the article, the Wyckoff method and the use of this method as a technical analysis tool in financial markets are mentioned, enjoy reading.


What is the Wyckoff Method?


Wyckoff Method, in the early 1930s Richard Developed by Wyckoff. This method consists of principles and strategies designed for investors to use. Wyckoff introduced his methods to the investment world by teaching them and managed to impress modern technical analysts with his work. Although the Wyckoff Method was initially used in stock markets, it is now also applied in all other financial markets.


Wyckoff is also inspired by the trading methods used by other successful investors. One of the investors whose influence is felt the most is Jesse L. Livermore. Wyckoff has managed to make a name for itself among important people such as Charles H. Dow and Ralph N. Elliot, who brought innovations to the research of markets.


Wyckoff has carried out in-depth research on the markets and as a result of his studies, many investment theories and trading techniques have been produced. As a broad summary of his work, this article covers four topics:

  • Three Basic Wyckoff Laws

  • Composite Man Concept

  • Graph Analysis Methodology with Wyckoff Diagrams

  • Five Step Approach

Wyckoff also offers Trading Tests to help traders identify strong entry points and to define trading targets. developed the Point and Shape Graphics Method.




I. Wyckoff's Three Fundamental Laws


1. Law of Supply and Demand


According to the Law of Supply and Demand, when demand is greater than supply, prices rise. When demand is less than supply, the opposite is true, that is, prices fall. This is not a work that Wyckoff developed uniquely, but is essentially one of the most important principles of financial markets. The law of supply and demand consists of three equations:

  • Request > Supply = Price Increase

  • Demand < Supply = Price Fall

  • Demand = Supply = Price Equilibrium

This first law accepted by Wyckoff attributes the reason for the rise in prices when demand is higher than supply to the fact that there are more buyers than sellers. In cases where sellers are more dominant than buyers, it says that prices will decrease because supply is higher than demand.


According to the Wyckoff method, price movements and volume movements are used mutually to follow the relationship between supply and demand. In this way, predictions can be made about the future direction of the market.




2. Law of Cause and Effect


This law suggests that the process between supply and demand does not occur by chance, but rather occurs in the face of certain events. Wyckoff cites the accumulation period as a reason and states that the upward trend will begin after a while. Similarly, the resulting distribution period leads to a downward trend after a while. As can be understood, Wyckoff essentially produced a price chart technique to predict the possible effects of a cause. Thanks to the technique, he has developed methods that define transaction targets. According to the method, the direction of the future price movement can be predicted by breaking the channel range formed when the market is in the accumulation or distribution phase.




3. Law of Effort and Achievement


According to this law, changes in the price of an asset occur as a result of the effort against the transaction volume created. If price movements occur in line with the transaction volume, it is assumed that the market trend will continue. However, if there is a mismatch between price and volume movements, it is assumed that the market trend will end and the trend will change. In particular, an accumulation period occurs with an unusual volume inflow after a downward trend in an asset for a long period of time. Thanks to this strong hold-on effort, prices begin to fluctuate horizontally. Here, the asset is transferred from the weak hand to the strong hand and there are no significant price changes. As a result, it can be thought that the downtrend has come to an end and it can be inferred that the other side of the cycle, the uptrend, may occur soon.




II. Composite Man


Wyckoff put forward the idea of a Composite Man representing the personality of the market. This is a similar assumption to Adam Smith's Invisible Hand. According to him, investors can predict market movements as if there is a single entity in the market and it is controlled by it. The main reason for this is that markets are driven by wealthy individuals and institutions. After all, big market players, like everyone else, pursue their interests by buying low and selling high.


Composite Man behaves opposite to the majority of small investors. This often causes other investors to lose money. However, according to Wyckoff, this situation can be exploited because the Composite Man's movements follow a predictable strategy.


Let's talk about the market cycle to better understand the Composite Man concept. The cycle consists of four phases: accumulation phase, uptrend, distribution phase and downtrend.




1. Accumulation Phase


Composite Man creates his portfolio before other investors. During this period, prices move relatively horizontally. Because rational investors make their investments gradually, prices do not change significantly.


2. Uptrend


When Composite Man accumulates enough assets and sales in the market lose strength, prices begin to move upwards. As soon as the upward trend emerges, it attracts the attention of other investors and causes an increase in demand.


Within the upward trend, phases that constitute the accumulation phase and are called reaccumulation phases can be seen. In these phases, the trend pauses and the market moves in the accumulation phase for a while.


As the rise in the markets accelerates, fear of missing out (fomo) occurs on other investors and they show the courage necessary to buy. The profits made enable new investors to enter the market. Thus, demand exceeds supply and buyers are willing to pay higher prices for assets.




3. Distribution Phase


Composite Man begins to dispose of his assets while the markets are in an upward trend. It sells assets to other buyers to realize a profit. During the distribution phase, there is a horizontal period in which supply meets demand before the market decline.




4. Downtrend


After the distribution phase, the market shows a downward trend. Because Composite Man sold his assets and the market started to move downwards due to the exhaustion of buyers.


The downward trend gains strength as soon as supply exceeds demand. Within the downtrend, redistribution phases that constitute the distribution phase can be seen for a while. In these phases, the trend pauses and the market moves in a distribution phase for a short time.


bull trap or also known as dead cat jumpmay occur during this period. When the downward trend ends, a new accumulation phase begins to occur.




III. Wyckoff Schemes


The most important and unique part of Wyckoff's work is the accumulation and distribution schemes. Especially the cryptocurrency market approaches these formations seriously. Both models are divided into five sections. The episodes are called Wyckoff Incidents.




A. ACCUMULATION SCHEME


Accumulation Scheme, Preliminary Support (PS), Selling Climax (SC), Automatic Rally (AR), Trading Range (TR) ), consists of the movement points of the Second Test (ST), Spring (Spring - S), Last Point Support (LPS) and Signs of Strength (SOS).



1. Phase A


In phase A, with the decrease in sales force, the downward trend in the market slows down. The resulting Preliminary Support (PS) indicates that some buyers started to oppose the sellers, but this emergence could not stop the downward movement.


Selling Climax (SC), which occurs after a slight decrease, is a sales intensity due to panicking investors giving up It occurs because it increases. In this phase, high price fluctuations occur and price bars with large volatilities are formed.


A strong drop that created a shock effect, followed by a rapid bounce back as the large amount of supply created by desperation was met by buyers. Automatic Rally Creates Rally - AR). During this period, Trading Range (TR) is determined as the bottom of the Selling Peak (SC) and the top of the Automatic Rally (AR).< /p>

After the jump, prices fall near the Selling Peak (SC) region and Secondary Test (ST) occurs and In this way, a conclusion is formed about whether the downtrend has ended or not. In this case, the price change is generally low and the transaction volume is low. The price bottom formed by the Second Test (ST) usually ends above the price bottom of the Selling Peak (SC), but the opposite may also occur.




2. Phase B


Phase B is seen as the cause that leads to the result according to Wyckoff's Law of Cause and Effect. It is the accumulation phase in which the Composite Man collects a large amount of assets from the market. Prices are testing the support and resistance zones of the Trading Range (TR). Second Test (ST) may occur many times during the phase. Therefore, a bull trap or bull trap with higher highs (rising high - HH) compared to the Selling Peak (SC) and Automatic Rally (OR) in Phase A. with lower lows (falling low - LL) a bear trap may occur.




3. Phase C


Phase C covers the state called Spring (Spring - S). A bear trap is where the last low bottom occurs before the market starts making higher lows. The Composite Man wants to make sure that there is less supply in the market during this phase.


In essence, we can define Spring as an effort to buy assets at as low a price as possible before the beginning of the uptrend. Here, investors' stops are blown and support levels are broken and investors are tried to be misled. After all, a bear trap often causes small investors to sell their assets.


In some cases, especially when other investors are determined to hold on to their assets, prices hold at support levels and thus Spring conditions may not occur. However, this does not make the accumulation phase obsolete. For this reason, we can see Spring as an exception.




4. Phase D


Phase D is the transition zone between Phase C, as an accumulation zone representing the cause, and Phase E, where a process interval representing the result is broken.


In Phase D, price fluctuations and visible increases in transaction volume occur. Before the market moves upwards, a new higher low point is formed above the previous low points called Last Point Support (LPS). The Last Support Point usually occurs before the breakout of the resistance areas and creates higher peaks above the previous peaks. Afterwards, the resistance zones break and become new support zones, creating Signs of Strength (SOS)


Last Support Point (LPS) may occur many times during the phase. Meanwhile, while new support levels are being tested, transaction volumes also increase. In some cases, prices may break the Trading Range before moving to Phase E, causing a small accumulation zone to form.




5. Phase E


Phase E is the final phase of the Accumulation Scheme. It occurs by breaking the Trading Range as the demand in the market increases. With the clarity of the break, there is the beginning of an upward trend.




B. DISTRIBUTION SCHEME


Distribution Scheme works similarly in reverse to Accumulation Scheme but has different concepts of naming points. Distribution Scheme, Preliminary Supply (PSY), Buying Climax (BC), Automatic Reaction (AR), Trading Range (TR), Secondary Test (ST) or also known as It consists of the action points of Upthrust (UT), Upthrust After Distribution (UTAD), Last Point of Supply (LPSY) and Sign of Weakness (SOW).



1. Phase A


Phase A begins to occur with decreasing demand causing the rising trend to slow down. The Preliminary Supply (PSY) point, which shows that sales are getting stronger, is not effective enough to stop the rise in the market. Because, in a slightly falling market, purchases intensify again and as a result of the new high price, Buying Climax (BC) point occurs.


The main reason for the move is that inexperienced investors increase their purchases due to the fear of missing opportunities in the face of rising prices. This excess demand is met by early investors who want to realize profits and Automatic Reaction stops the upward trend. - AR) causes the situation.


In this situation of overconfidence in the market, Composite Man begins to distribute his assets to late investors. As a result, asset prices approach the old Buying Peak area again, but cannot reach there, resulting in a Secondary Test (ST) where a descending top is formed.




2. Phase B


In Phase B of the Distribution Scheme, an accumulation zone is created that will be considered as a cause that occurs before the downward trend, which is a result. Composite Man gradually sells his holdings throughout the phase and thus weakens the power of purchases by meeting the demand in the market. During this period, the support and resistance zones formed by the lower and upper bands of Trading Range (TR) can be tested many times, which causes the small investor to shake. bear and bull breakouts may occur. When the confidence in the market is at the level, prices rise above the resistance zone formed at the Buying Peak and enter a Second Test (ST) defined as Upthrust (UT) movement. It may cause.




3. Phase C


After the distribution phase in the market, in some cases a false rise may occur and bull trap may occur. The important point that occurs here is called the Upthrust After Distribution (UTAD) phase and has an inverse similarity to Spring in the accumulation process.




4. Phase D


Within the Transaction Range in the Phase D period, called Last Point of Supply (LPSY) and A new peak is formed, ending at a lower price than the previous peak. New Last Supply Points may form at or below the support zone of the trading range. Afterwards, when there is not enough demand in the market and therefore prices fall below the support zones, a Sign of Weakness (SOW) is seen to occur.




4th Phase E


Phase E, as the last phase of the distribution scheme, indicates that the downward trend may begin. It is observed that the expectation is coming true with the breakdown of the support zone within the Trading Range due to the insufficient demand against the increase in supply.




IV. Wyckoff Five Step Approach


The Five Step Approach is essentially a road map determined by Wyckoff to implement its strategies in the market.


  1. Determine the asset's trend. To determine the trend, answer these questions: What is the current trend direction? In which direction is the trend likely to move? Which direction is supply and demand more dominant?

  2. Determine the strength of the asset. To determine strength, answer these questions: How strong is the asset relative to the overall market? To what extent does the asset move in a similar direction to the market?

  3. Seek sufficient reason for the action. To find the reasons, answer these questions: What is the reason for choosing the entity? Is it worth taking the risk for the reward from the asset?

  4. Determine the probability of price movement. To estimate the probability, answer these questions: Is the asset preparing for price movement? Are price and volume movements compatible?

  5. Determine processing time. To time it, answer these questions: How is the asset moving relative to the overall market?




Validity Level of Wyckoff Method


Markets do not attempt to fully translate any model into reality. For example, the formation times of the phases in the diagrams may vary depending on the current situation in the market. As we mentioned before, Spring and UTAD phases do not necessarily have to occur. Of course, it is a known fact that Wyckoff constructed theories and determined principles in the light of the inferences obtained from the exact market in his studies. Accumulation and Distribution Schemes are preferred especially to understand the cycles that occur in financial markets.




Conclusion


The Wyckoff Method is quite different from other technical analysis methods because it is a rich whole consisting of many principles, theories and applications. The study offers various tools to increase investors' probability of success and reduce the element of risk. However, it should be known that there is no method without the risk of error. For this reason, investors should be constantly vigilant against the market and establish their own investment strategy in order to prevent losses that exceed the losses they can afford.




Hoping to see you again on another topic, best of luck.

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