Making Money The Wyckoff Way (CSC, DNR)

Legendary technician Richard Wyckoff wrote about financial markets at the same time as did Charles Dow, Jesse Livermore, and other iconic figures in the early decades of the 20th century. His pioneering approach to technical analysis has survived into the modern era, guiding traders and investors on the best ways to pick winning stocks, the most advantageous times to buy them, and the most effective risk management techniques.

His observations on price action coalesced into the Wyckoff Market Cycle that outlines key elements in trend development, marked by periods of accumulation and distribution. Four distinct phases comprise the cycle: accumulation, markup, distribution, and markdown. He also outlined sets of rules to use in conjunction with the phases, to further identify the location of price within the broad spectrum of uptrends, downtrends, and sideways markets.

Wyckoff Rules

Wyckoff’s first rule tells traders and investors that the market and individual securities never behave in the same way twice. Rather, trends unfold through a broad array of similar price patterns that show infinite variations in size, detail, and extension, with each incarnation changing just enough from prior versions to surprise and confuse market participants. Many modern traders would call this a shapeshifting phenomenon that always stays one step ahead of profit-seeking.

The second rule raises the misunderstood issue of market relativity, telling traders and investors that context is everything in the financial markets. In other words, the only way to evaluate today’s price action is to compare it to what happened yesterday, last week, last month, and last year. A corollary to this rule states that analyzing a single day’s price action in a vacuum will elicit incorrect conclusions.

Wyckoff established simple but powerful observational rules for trend recognition. He determined there were just three types of trends: up, down and flat, and three-time frames, short-term, intermediate term, and long term. He observed that trends varied significantly in different time frames, setting the stage for future technicians to create powerful trading strategies based on their interplay. Alexander Elder’s Triple Screen method, outlined in Trading for a Living, offers an excellent example of this follow-up work. 

Wyckoff Market Cycle

Image by Sabrina Jiang © Investopedia 2020

The new cycle begins with an accumulation phase that generates a trading range. The pattern often yields a failure point or spring that marks a selling climax, ahead of a strong trend that eventually exits the opposite side of the range. The last decline matches algo-driven stop hunting often observed near downtrend lows, where price undercuts key support and triggers a sell-off, followed by a recovery wave that lifts price back above support.

The markup phase then follows, measured by the slope of the new uptrend. Pullbacks to new support offer buying opportunities that Wyckoff calls throwbacks, similar to buy-the-dip patterns popular in modern markets. Re-accumulation phases interrupt markup with small consolidation patterns, while he calls steeper pullbacks corrections. Markup and accumulation continue until these corrective phases fail to generate new highs.  

Image by Sabrina Jiang © Investopedia 2020

That failure signals the start of the distribution phase, with rangebound price action similar to the accumulation phase but marked by smart money taking profits and heading to the sidelines. In turn, this leaves the security in weak hands that are forced to sell when the range fails in a breakdown and new markdown phase. This bearish period generates throwbacks to new resistance that can be used to establish timely short sales. 

The slope of the new downtrend measures the markdown phase. This generates its own redistribution segments, where the trend pauses while the security attracts a new set of positions that will eventually get sold. Wyckoff calls steeper bounces within this structure corrections, using the same terminology as the uptrend phase. Markdown finally ends when a broad trading range or base signals the start of a new accumulation phase.

The Bottom Line

Richard Wyckoff established key principles on tops, bottoms, trends, and tape reading in the early decades of the 20th century. These timeless concepts continue to educate traders and investors, nearly 90 years later.