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"The Ultimate Guide to Understanding Wyckoff Strategy: Exploring and Identifying The Key Principles"

The Wyckoff method is most commonly used in the stock market, but it can be utilised in the forex market also. In this post, I will go into detail about the method, why it works, and provide some examples on real charts.


Background


Richard Wyckoff, a trailblazer in the world of trading, left a lasting legacy through his pioneering work in technical analysis. One of his fundamental insights was the recognition that markets are subject to manipulation, leading to what he termed as the phases of 'accumulation' and 'distribution.' These concepts, central to his methodology, gave rise to the famous 'price cycle' – a cornerstone of technical analysis.



However, beyond these widely discussed concepts lie the often overlooked but invaluable teachings of Wyckoff. Among these are his three Universal Laws:


The Law of Supply and Demand

This law, while seemingly simple, forms the bedrock of our trading strategy. Understanding the imbalance between buyers and sellers at any given moment is crucial. When demand outweighs supply, prices rise, and vice versa.


The Law of Cause and Effect

Wyckoff emphasized the importance of understanding the causes behind price movements. Every price action is unique and must be analysed in relation to its preceding behaviour.


The Law of Effort vs. Result

This law underscores the importance of assessing the effort exerted by market participants relative to the resulting price action.


These principles guide us in navigating the complexities of the market. By identifying the imbalance between supply and demand, we can anticipate potential trading opportunities.


The Two Rules of Richard Wyckoff


Now, there are two main rules that Richard Wyckoff came up with.


Rule One: The market never behaves the same way. Price action will never create a move in exactly the same way that it did in the past. The market is truly unique.


The second Richard Wyckoff rule is related to the first one. It states that since every price move is unique, its analytical importance comes when compared to previous price behaviour.


So what we’re looking for is a comparison to certain price behaviour, not exact price behaviour.


The Four Stages


Wyckoff's approach emphasizes studying price action and recognizing the cyclical nature of market behaviour. His Market Cycle Theory outlines four distinct stages;


Stage One: Accumulation Phase 

The initial phase of the Wyckoff price cycle involves accumulation. This stage is instigated by a surge in institutional demand, gradually empowering the bulls and setting the stage for upward price movements.


Despite the growing influence of bullish sentiment during accumulation, the price action typically appears stagnant on the chart, characterized by a horizontal pattern. A series of higher lows within this range often signifies the presence of an accumulation phase in the current price action.



As an example, consider the below graphic of the accumulation area;



As the bear trend continues down, we get a Selling Climax (SC). This is our first point of where we’re going to get a support line. Then we get an Automatic Reaction (AR) – which will then be our first point of a resistance level.


If price comes up and breaks the AR level, it doesn’t mean we have a breakout. Rather, it then becomes our second point of resistance. We then get a Selling Thrust (ST), which will be our second level of support.


What we’re looking for is price to bounce back from the ST level and return to within the two resistance lines, and then to return back to within the two support lines. This is where we can sometimes get a “spring”, which is essentially all the sellers trying to push it down.


The general trade plan for the Wyckoff method is to be trading in Phase E, or if you’re aggressive, Phase D.


Stage Two: Markup Phase


Bulls assert dominance, pushing prices higher and signalling the emergence of a bullish trend.



Stage 3: Distribution Phase


The Distribution phase marks the third stage in the Wyckoff price cycle. During this period, bears endeavour to reclaim control of the market. Similar to the Accumulation phase, the price movement appears stagnant on the chart. A key indicator of the Distribution stage is the persistent inability of prices to establish higher lows. Instead, the price action forms lower highs, signalling a selling pressure in the market.



Similar to the accumulation stage, at the peak of a trend you’ll get the distribution stage;



We get a Buying Climax (BC), which is our first point of resistance, followed by our Automatic Reaction (AR), which is our first point of support.


From there, we have a Sign of Weakness (SOW), which is our second point of support, followed by our Upthrust (UT), which becomes our second point of resistance. Sometimes we also will get a ‘spring’ / second upthrust.


The spring / second upthrust doesn’t always happen. For example;




In this situation, the Last Point of Supply (LPSY), doesn’t quite break the initial upthrust.


Stage 4: Markdown Phase


Bears take control, initiating a downtrend confirmed by a break below the lower level of the distribution channel.



Understanding these stages empowers traders to identify trends and anticipate market movements effectively. As Wyckoff famously stated; successful trading is a study of forces, requiring the ability to discern market sentiment and act accordingly.


Using The Wyckoff Method


What the Wyckoff method does is teach us to be patient. By observing the phases within the accumulation / distribution stages, we’re able to take our trades with accuracy on completion for the pattern.


Here’s some examples;



Example 1: EURUSD




Example 2: USDCAD

What’s also noticeable about example 2, is that in the final stages, there’s a clear ABCD pattern with a 50% retracement.



Example 3: USDCAD

Another one on USDCAD, this time during the accumulation stage.


I encourage you to use this information and go back through the charts and see if you can spot this pattern. You don’t necessarily need to learn the rules, but learn to identify the pattern. In doing this, you’ll notice the confluence of all the different theories come together – Wyckoff, Elliott Wave, and classic technical analysis – ultimately leading to a higher probability trade.


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