Richard Wyckoff is the creator of this popular trading strategy that employs market cycles as a way to identify potential trading signals, based on different stages of the overall cycle. His successful career as a stock trader during the 1910s gave him sufficient authority to promote this method that was widely embraced by technical analysts and traders who were interested in testing his approach.
Here are the key details of the Wyckoff method and how you can use it to profit from your trading activities.
The Four Stages of the Wyckoff Method
The cornerstone of Wyckoff’s method is the assumption that markets have a cyclical behavior and, in that sense, they tend to behave similarly over time. Wyckoff identified four main stages that the market goes through and these are the accumulation stage, the markup stage, the distribution stage, and the markdown stage.
The Accumulation Stage
During the accumulation stage bullish pressure from institutional investors progressively gains momentum and while the upward limits are not modified, higher bottoms start to show up and they are the first indication that the security is going through a phase of accumulation based on the Wyckoff model.
The Markup Stage
At this point, the security’s price starts to rally as a result of increased bullish pressure. The consistent increase reaches its momentum and draws significantly higher volumes and trend lines shift in an upward direction.
The Distribution Stage
The distribution stage is initiated when bearish pressures start to gain ground and lower tops start to show up. This is an indication that the markup phase has ended and bears are now becoming the authoritative force that is driving market prices.
The Markdown Stage
Ultimately, bearish pressures invade the premises and break the security’s lowest bottom to initiate a consistent decline and the process repeats itself all over again once the market starts a new cycle through a subsequent accumulation phase.
These stages serve as a reference for traders to understand where certain security is in its cyclical pattern and they can profit from predicting the next stage of the cycle by following some trading signals provided by the Wyckoff method.
Trading Signals for the Wyckoff Method
There are basically two main trading signals that can be identified by the Wyckoff method and they are known as the Wyckoff’s “springs”.
These springs are essentially false breakouts that take place after the accumulation and distribution stages of the Wyckoff Method and they can be identified as follows:
- The Beginning of the Markup Stage: After an accumulation stage has been identified the trader will see subsequently higher bottoms in the charts. At some point, the lower bottom of the stage will be broken and this constitutes a trade signal that indicates that the markup stage is about to start.
- The Beginning of the Markdown Stage: After the distribution stage begins, the trader should pay attention to the appearance of subsequently lower tops. At some point, the upper ceiling seen during the distribution stage will be broken and that should be considered as the signal that the Markdown stage is about to start.
By using the trading signal or “springs” determined through the Wyckoff method traders can employ the model as a way to identify potentially profitable entry points.
How to Profit from the Wyckoff Method
The Wyckoff method provides the possibility to trade currencies and other financial instruments based on the trading signals discussed above. In this sense, traders can profit from two particular strategies:
Long Position at The “Spring” of the Accumulation Stage
Once the trader identifies the end of the accumulation stage through the spring signal, they can take a long position on the currency to profit from the markup stage. At some point, the markup stage will come to an end and the distribution stage will kick in. Traders can reap the benefits from the transaction by exiting during the distribution stage.
Short Position at the “Spring” of the Distribution Stage
After the distribution stage has initiated traders must observe the evolution of the trend and the occurrence of lower tops. Once the spring signal of this stage appears, a breakout in the upper ceiling seen during the distribution phase, the trader can enter a short position on the security to profit from the markdown stage. At some point, the cycle will repeat itself and the trader can exit the position during the renewed accumulation stage.
A Step by Step Guide to Start Using the Wyckoff Method
- Identify securities that follow the method’s underlying theory and principles.
While the Wyckoff Method can be applied to virtually any security including currencies, stocks, and mutual funds, traders should analyze the historical performance of the securities first to make sure they harmonize with the method’s theory of market cycles. If the trader can identify the occurrence of the stages during previous sessions or time frames the security should be a suitable candidate to be traded based on this method.
2. Determine the current stage at which the security is.
The stages described by Wyckoff could occur in a matter of months, weeks, days, or even throughout the course of a single trading session. In this sense, the trader must analyze the performance of the security during different time frames to identify in which of the four stages the security is in.
- Set a notification to act upon the “springs” immediately.
A notification can be set to be triggered once the price has broken the lowest bottom seen during the accumulation phase. At this point, a market order can be put to enter a long position.
On the other hand, a notification can be triggered by the false breakout of the highest top reached by the security during the distribution phase. At this point, a sell order can be entered to enter a short position.
- Remain observant of the shift between one stage and the next one to act promptly.
Since there’s no way to identify the peak of the markup stage or the lowest point of the markdown stage, traders must observe the evolution of the trend until it moves to the next one, whether that means entering the accumulation phase or the distribution phase.
Trade safe!
Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.
