Part of our complete series on Technical Analysis. Find more guides by clicking here.
Have you ever wondered how institutional investors manage their positions? What they’re doing right now and what they’ll do in the future? Tracking and following the whales is crucial for making profit in the markets – these investors are the main force behind every trend and you will get crushed if you get in their way.
Richard Wyckoff dedicated his life to studying operations of such investors. His trading method is based on analysis of market cycles, interpretation of volume and balance between supply and demand – the only hints which these institutional investors leave on the chart.
He was one of the pioneers of technical analysis in the beginning of 20th century. Wyckoff has been described as one of the titans of TA along with Gann and Elliot. He was an avid student of the markets and an active trader. Early in his career he observed trading of the legendary stock operators of his time – J.P Morgan and Jesse Livermore. He closely examined how they developed and maintained their strategies. All of this helped Wyckoff to develop techniques to assess future direction of the market analyzing price action and volume on charts.
As Wyckoff famously stated, small retail traders are losing billions of dollars to the institutional entities over and over again. He dedicated himself to educate the public how these big investors operate and wrote several books on this topic.
Though some of the techniques used by these investors in the 20th century are illegal now, Wyckoff’s methodology of assessing the future direction of the market is still very relevant.
Wyckoff came to conclusion that market action is a constant repetition of the same four phases: accumulation, markup, distribution and markdown. Each of these four phases occur directly because of “smart money” market manipulation techniques.
The Accumulation phase occurs on the chart as a tight trading range in which institutional operators absorb most of the available supply of the stock.
Then, since available supply is quite low demand rises causing a strong Markup movement.
Once price and demand reaches its peak, institutional operators begin to unload their supply slowly covering all demand and creating a tight Distribution range.
Since all shares are in hands of retail traders and there is no buying interest from the side of institutional operators price inevitably falls down creating a Markdown phase on the chart.
To make the most profit in the markets, a trader has to observe and understand how these institutional investors operate and follow their lead.
The Composite Man
“The market is made by the mind of man, and all the fluctuations of the market and all the various stocks should be studied as if they were the result of one man’s operations. Let us call him the Composite Man, who, in theory, sits behind the scenes and plays a stock to his advantage. “
The Composite Man is just a fiction. It is the aggregation of activities of a number of professional traders occurring at the same time.
The Composite man carefully plans and executes his trades. He attracts retail traders to buy an asset in which he has already accumulated a position by making a lot of transactions, both buying and selling, thus creating a high volume and advertising the asset this way.
Wyckoff and his students believed that if one could understand the actions of the Composite Man, one could find many trading and investment opportunities – and profit from them.
So how do we apply this concept to our trading strategy? Whenever you are studying the price and volume movement of the chart take a step back and ask yourself following questions:
- What is the motive of the Composite Man?
- What is he doing right now? Accumulating, distributing, or letting price mark up/down?
- How does he make money? Who is losing because of the Composite Man’s actions?
- If I were the Composite Man, what would my next step be?
Don’t worry if you can’t answer right away – these questions are very complex and require deep analysis. It’s a job of the Composite Man to cover his trails – the less people understand his motives the more money he makes.
“Avoiding detection was essential to the conduct of such large operations. Super traders are always in competition with other super traders for the available float of the most desirable stocks. Secrecy in the conducting of a campaign is critical.”
Luckily, while the Composite Man’s actions are stealthy, they are leaving footprints all over the chart and it is in our best interest to find and correctly interpret them. But before digging into technical analysis and the charts we need to understand the three main principles lying behind every price movement; the so-called “Wyckoff Laws”
The Three Fundamental Wyckoff Laws
Wyckoff’s strategy is based on three fundamental laws, which help to identify the best markets to trade, spot the bias of future price direction, decide whenever an asset is ready to leave a trading range and projecting price targets based on the asset behaviour in its trading range. These principles are basic and should be understood completely before moving on.
The law of supply and demand
The first principle is simple – when demand is greater than supply, price rises, and when supply is greater than demand, price falls. Whenever the Composite Man acquires a large chunk of available supply he shifts the supply/demand balance and price naturally starts to rise. If the Composite Man releases his previously accumulated shares he shifts the balance again and price marks down.
A trading range (accumulation or distribution) symbolizes an equilibrium of supply and demand – it means that there are two strong zones: a zone of demand (support) and zone of supply (resistance) situated next to each other. Price is usually bouncing between those two levels meanwhile shares are changing hands, either from retail traders to the composite man (accumulation) or from the composite man to retail traders (distribution).
To understand if the current trading range represents accumulation or distribution, students of the Wyckoff method analyze the relationship between price and volume and look for special events.
The law of effort versus result
Volume is the effort and the price change is result. It takes effort to drive price forward, either rising selling volume to drive price down or rising buying volume to mark price up. If the volume expands in the same direction of the price, it’s a reliable signal of trend continuation.
But if there was a great effort to push price higher (or lower) and it didn’t result in the proportionate price change then something is fishy. This behavior is called Price and Volume Divergence and it provides early tells for potential trend reversals.
This price and volume analysis works not only in ranging markets but also helps to spot directional bias during a trading range. If during a range, buying volume spikes don’t move price much higher it means that there is still a lot of supply and it’s unlikely that price will move higher until all supply is absorbed. The same principle applies to the opposite scenario – if during a range a high selling volume doesn’t result in a strong move down it means that there is a lot of demand – the Composite Man is potentially increasing his position at the current level.
The law of cause and effect
This law relates to the principle of the supply and demand. Before any effect there must be a cause. And this effect will be proportional to the size of its cause. Accumulation and distribution are periods of building the cause. Then, the subsequent markup or markdown is the direct effect of this cause.
Price can’t move up without preliminary absorption of supply and can’t move down without covering most of the demand. Longer accumulation (or distribution) implies that the Composite Man has acquired (or distributed) a larger portion of available shares. Thus the next move will be much stronger, since he needs a lot of liquidity to fully exit his position.
Longer accumulations and distributions cause more explosive mark ups and downs. Shorter accumulations and distributions are minor and result in smaller moves.
Here’s an illustration of the three laws mentioned above. First, there was a strong markup movement in which demand was prevailing over supply. Then, there were first signs of intermediate-term weakness – spikes of the increasing supply. These signs resulted in the break down of the short-term EMA which was previously completely untouched and that confirmed the change of character and establishment of the trading range.
Later, there was an attempt to break the trading range down, but strong demand showed up and price came back into the range. Note the spike of the volume – price moved accordingly, so the result was equal to the effort and it was a good sign of bullish continuation in the future. This consolidation ended with a bullish breakout and caused the next mark-up move.
This 6 month long Ethereum consolidation followed the same rules: it started with change of character and a first deep sell-off. Then it continued with fights between supply and demand. We got a very strong hint that demand is higher than supply right in the middle of consolidation and could plan our long positions way before a break out from the trading range had occured.
Retail traders might argue that a sell-off on the BTC chart was an Inverse Head and Shoulders pattern which continued as a bull flag and ended with a break out. And this Ethereum chart is an obvious ascending triangle – a common bullish continuation pattern. BUT Wyckoff dictates we don’t really care what pattern the price is forming – all that matters is the interrelation between price and volume; supply and demand.
We concluded that any significant move up or down happens because of the preliminary accumulation or distribution, and that accumulation and distribution always occurs after a significant move up or down. So where is an edge? When to sell or to buy? What to look for? Richard Wyckoff has the answers.
Analysis of Trading Ranges
The main goal of Wyckoff’s analysis is to enter the market at the right time anticipating moves in the right direction, minimizing an exposure to risk and increasing potential profits.
All of that is done by analyzing the trading ranges and identifying if the current range is an accumulation or a distribution.
Wyckoff’s method provides guidelines for determining events occuring in the trading range, which help to identify future directional bias. These events are shown in the famous schematics, created by Wyckoff and his students.
Schematic #1 : Accumulation Range
The trading range is divided into phases, and each phase comes with a set of events which define it.
Phase A represents the end of the prior downtrend (of at least an intermediate one). There are four events associated with it:
- PS (Preliminary support) is a support level where increasing demand signals of potential end of the mark-down. Usually it has higher than average volume and wider spread of candles.
- SC (Selling climax) is a point at which selling pressure climaxes, and where the Composite Man is showing his first interest of buying the stock, quickly buying up the panic of the retail traders.
- AR (Automatic rally) is a rally which occurs because of cessation of selling pressure. This rally should have wider spread than previous ones to ensure that previous sell-off was a climax. If that happens, combination of SC and AR create an estimate of boundaries of trading range. There should be a support close to SC and resistance close to AR.
- ST (Secondary test) – price comes back to the levels of SC to check the strength of the demand in this area. To confirm a trading range this area should hold, any break of the SC zone should result in the immediate high-volume return in the trading range.
Here is a BTC/USD chart, which we will update with the events as we learn them. A PS on the chart is confirmed when we see a move down with the bounce on higher than average volume. Once this level is broken we look for a sharp selling climax, which in this case was on a record volume and ended with a sizeable down-wick. After this move there was a lack of selling pressure and price rallied for a while. This rally ended with a very strong buying pressure and confirmed boundaries of the trading range.
Once AR finished, buying pressure was dried up and price retraced to look for new lows above SC. Several retests of the same price level and subsequent rally confirmed this level as the ST.
Sometimes the downtrend ends in much less dramatic fashion, for example in a slow and bloody drown-down and gradually rounding bottom – it doesn’t have a selling climax and automatic rally to form a trading range. However, it is in our best interests to look for charts with such events, because they directly indicate that the Composite Man has started his accumulation campaign.
Phase B builds “a cause” for the new trend. This phase represents slow accumulation of the shares in anticipation of the uptrend. The Composite Man creates high enough demand at the bottom of the range and pushes the price down at the top of the range. This process might take a very long time, depending on the ability of the Composite Man to control the price. This phase might include several retests of the lows (STs) and several retests of the high (AR). Keep in mind that these retests might break out of the trading range to mess with the breakout retail traders, but the structure remains unbroken as long as price quickly comes back into the trading range.
To further confirm that you are currently in Phase B look at the volume. At the beginning of Phase B, swings tend to have higher volume, which falls lower and lower as consolidation continues.
Phase C is where the Composite Man checks if an asset is ready to move up by testing the remaining supply. There are two main events:
- Spring (shakeout) – a drop in the price which takes it below the lows of trading range (below STs or even selling climax, depending on how deep it was). It’s usually the last attempt of the Composite Man to acquire shares at cheap prices before the mark-up move. Creating selling pressure forces retail traders to think that the current trading range will end in the mark-down movement and exit or reverse their positions. The Composite Man waits for breakout to create enough liquidity and then rapidly covers all available supply resulting in price getting back into trading range.
- Tests – A small retracement to check if there is enough support at the bottom of the trading range after a shakeout. The Composite Man stops his buying pressure and checks if the market has enough demand to not let price fall below the trading range. If so, the market is ready for the mark-up move. If not – the Composite Man continues his accumulation of available supply.
This example shows that the Wyckoff market structure is evident even on less liquid altcoin markets, and understandably so – these markets are easier to manipulate for smaller whales. As mentioned above, Spring doesn’t necessary cause a break of the bottom of the TR. If STs resulted in the strong bounces, chances are that a spring will occur just below them. But the stronger the spring, the faster the reaction and upcoming Mark-Up phase, because stronger springs cause the Composite Man to acquire all the shares he wants, meanwhile a weaker one might cause some prolonged consolidation as it happened with MANA here.
Let’s come back to BTC example. First, note the falling volume during consolidation of Phase B. Each ST and subsequent rally happened on the decreasing volume. Then there was a change of character in the middle of the phase – first signs of increasing volume, and then a rally up to TR highs without any significant dips.
Most of the traders who have at least heard about Wyckoff structure could assume that it was a sign of strength and that accumulation has come to an end and would pursue with buying in anticipation of breakout or buying the breakout. Obviously, they would fail. How would you prevent such a mistake?
The answer is simple: a breakout of the trading range is not a signal to enter the trade, but the retest of the trading range of the break out is. In this case, there was no real breakout – price closed below the AR and everyone who tried to buy in anticipation of the move or on the fakeout got shaken out by the next move down.
The most reliable signals the Wyckoff method looks for are retests of the spring and retests of the break-out.
On this chart you can see a perfect spring – a 37% move in a single day with a much higher than average volume. It broke through both ST and SC levels and quickly recovered, leaving a very long bottom wick. The next day was very active too – retail traders had no idea what to expect next, strongly pushing price in both directions and creating a 42% daily spread. It closed way above the ST level confirming that this move was a Spring.
Then comes the Test – another leg down to retest ST lows, the Composite Man checks for available supply again. It’s a great opportunity to buy, because most of the time a successful Spring practically confirms an incoming Mark-up move.
Phase D – Confirms if we were right with our previous analysis. If we correctly interpreted the previous Spring and Tests as bullish signs, then demand should prevail over supply and price should slowly climb up to the TR highs. Phase D has three events:
- LPS (Last point of support) is the reaction after a Test rally. It usually retests previous levels which were considered a resistance. These reactions are usually quite slow and have no volume.
- SOS (Sign of Strength) is a rally with a noticeably higher than usual volume and with wider price spread of the candles. Usually takes the price above AR.
- BU (Back up) – short-term reaction to SOS, light profit-taking by the CM (testing the demand) and retest of the trading range highs. It is the last chance to jump on the bull train.
Back in 2015, BTC moves were much more volatile and dramatic – it took much less money to move the market. Both Spring and SOS were very volatile and expanded; nowadays these moves are usually smaller. Obviously it’s easy to tell in hindsight, but “Test” was a great time to check the waters and buy a small position, “LPS” was an ideal place to increase it, and “BU” was a chance to add some more before the next Mark-up movement.
It’s important to note that these phases and events are just a schematic, a blueprint of how price might behave inside a trading range. Remember that all rallies and reactions are result of the Composite Man interfering with Supply and Demand to gain as much shares of an asset as possible – he will fuel the rallies creating hope just to crush the market to the trading range lows, he will create fakeouts below the trading range, he will use any tool to shake out as many “weak” retail traders as possible. So depending on the Composite Man some events might be skipped, or he might have his own tricks (not listed in this article) to trick the retail traders.
Schematic #2: Distribution range
Functioning similarly to the Accumulation trading range, the Distribution range is characterized by several phases:
Phase A of the distribution range marks the end of the previous mark-up movement. It mimics phase A of accumulation range, but with Preliminary Supply (PSY) instead of preliminary support and Buying Climax (BC) instead of selling climax. AR and ST work exactly the same way as they do during an accumulation phase, but in this case AR is driven by the lack of demand after the rally and ST is retest of the prior highs, not lows.
Phase B is the consolidation phase. There are usually several retests of the highs and lows of the trading range. These moves are usually there because of the constant fight between supply and demand – the Composite Man tries to unload all his shares without scaring the public of his asset, he wants to get rid of his whole position with the minimal slippage, so he needs to keep demand at high levels driving the price up and catching the liquidity provided by break-out traders.
There are several events occurring during Phase B:
- SOW (Sign of Weakness) is the first major selloff after the automatic rally. It usually breaks the bottom of the trading range thus showing a change of the character in the trend. It indicates that supply became dominant. The move down should be on higher than average volume and wider candle spread.
- UT (Upthrust) is the opposite of the Spring – it’s a rapid move above the trading range (usually on low volume). It is there to test the levels of demand and gain extra liquidity from the breakout traders. Often these are levels where the Composite Man initiates his short positions.
Phase C is the phase where the CM makes the last attempt to shakeout retail traders before the mark-down phase. It’s his last chance to sell remaining shares and/or open short positions at the best prices. The main event during this phase is the UTAD (Upthrust After Distribution), which is the same as a UT, but usually is much more volatile. Note that this event is not mandatory, same as Spring during an accumulation – presence of this event depends on a lot of factors, including fundamental events and availability of leftover demand.
Phase D is where price finally breaks bottom of the trading range. At this point it’s obvious to everyone that supply is dominant and that the prior uptrend is totally exhausted. There are last unsuccessful attempts to mark price up, which usually come at low volume and with low spread. The events of this phase are: LPSY (Last point of Supply) and SoW (Sign of Weakness).
Last Point of Supply is the last weak attempt to drive price up. Failure to break resistance and absence of volume confirms that distribution is coming to the end. Sign of Weakness is the same as one in Phase B, but it pushes the price below the trading range.
Alright, let’s imagine that you have spotted that Phase A is in action. There was a strong sell-off on increasing volume and an immediate Automatic Rally. When is it safe and profitable to look for shorts? What price action events confirm that the trend is about to change?
An aggressive trader might spot the change of character and first signs of weakness from the demand side and enter a short position at the first UT or UTAD in Phase B. It’s a solid move from Risk/Reward perspective – if a trader spotted clear signs that the trend is exhausted, he can potentially get in at the best possible prices. But the Composite Man is patient, and will probably drive price up to UT levels at least several times. Entering a short on UT/UTAD, the trader takes a low risk trade from price perspective, but potentially locks his funds in the trade for a very long time.
The safer approach is to wait for the SOW in Phase D and enter on LPSY. Sure, in this case, the trader is risking that price will come back to the highs of the trading range, but even if it happens he can quickly cut his losses and enter at the next signs of weakness.
Let’s break down all the steps which should be part of the thought process of the trader who wants to apply Wyckoff’s principles in his own trading strategy.
Current stage of the market
The market can be bullish, bearish or ranging. There are several tools to determine which stage market is in. The simplest one is analysis of the swing highs and lows – rising market should continuously print higher highs and higher lows; or lower highs and lower lows for the falling market. If lows and highs don’t follow these patterns then market is ranging.
If there is a sustainable trend and a trader doesn’t already have a position, he should stay out of the market until the trend exhausts itself. Wyckoff logic means that you enter the market when the trend emerges, not in the middle of it.
If there is no trend and the market is ranging, Wyckoff states that you need to determine if the range represents an accumulation or distribution – and it’s the trickiest part of the whole strategy.
Change of Character
Change of Character is a visible change in the behavior of an asset. It’s a crucial moment of the transition between markup / markdown and a consolidation. A trader who prefers to use price action as his main tool might seek it for selling or buying climaxes followed by an automatic rally, but it’s not the only way to spot a change of character. Other methods such as break of an EMA, break of the Ichimoku Cloud or any other indicator showing dynamic support and resistance also work.
Usually change of character is so evident that traders using different approaches can spot it at the same time. On this chart the same candle broke into the daily cloud, broke through a long-term EMA and volume matched this change. It wasn’t subtle and it showed that supply is exhausted and demand is stronger than ever.
In case of change of character after a markdown or a markup, a trader should look for hints showing in what direction market will move once this consolidation ends.
All the hints come from the three main laws mentioned above. After the consolidation, price will move in the direction of least resistance. If during a consolidation demand was significantly stronger than supply, then the price will eventually markup. And the opposite is also true – a stronger supply implies eventual markdown.
On this chart the main source of clues is excluded. There are no volume bars. Can you make a firm decision of the future price direction? Do breakouts above the range show the strength? Or are they upthrusts? Is it a spring at the bottom of the range? Or is it a final break down which will cause a markdown movement? In my opinion, it’s impossible to tell with somewhat decent accuracy. Let’s add volume and look for hints.
I’ve numbered sections which require close attention.
Section 1 is the first breakout from the trading range. Recall the law of the effort vs result – in this case result was massive, a breakout of the trading range is quite an event, but buying pressure was subpar. It was significantly lower than volume during the consolidation between AR and STs. It is an obvious divergence which should at least raise some concerns.
Hint: it’s a UT, volume is too low to consider it a sign of strength.
Section 2 started with very volatile reaction, which caused a break of previous ST. Both buying and selling were on a very high volume, and the result of this fight would indicate intermediate-term trend within a trading range. Demand won, and once it was confirmed with the retest of this level, we mark it as our new “go-to” level for the next potential reactions.
Hint: $10200 – $10300 is a zone of strong demand. We might expect a touch of trading range highs, and either a real sign of strength or reaction. This reaction should respect this zone of demand, and if it doesn’t, it confirms our concerns that this trading range is indeed a distribution.
Section 3 shows similar reactions to the trading range high as section 2. Very high supply drove price back to the zone of high demand and it held. Volume profile is also similar to previous section.
Hint: aAsuccessful retest of demand zone further increases chances of bullish continuation. We are preparing for either a Spring or SOS which breaks the trading range on significant volume.
Section 4 is the second breakout from the trading range. Note the volume. There is none! And it breaks into the trading range on significantly higher volume.
Hint: This move wasn’t strong at all. Since first UT was much higher we might redraw trading range to highs of the first UT and consider this action as the retest of the highs. All eyes on the zone of the demand now. If it holds again we want to see a proper breakout above this UT level, if it doesn’t we are sold on bearish continuation.
Section 5 broke the demand zone without any resistance. There was a candle which provided the BEST hint during all this consolidation – look at the highest volume bar with buying pressure – there was a great effort to reverse price to previous levels but it had no effect at all!
Hint: if this amount of buying pressure can’t save the demand zone then nothing can. Future retests of the demand zone from below (between section 5 & 6) confirm that this zone now is zone of supply, and we are waiting for signs of weakness or start to build a short position right there.
Section 6 is the first test of trading range lows. Volume is much higher than average again. We need to make a final decision – Is it a Spring or a SoW?
Let’s list our previous findings to come to the logical conclusion. First, there were several attempts to break the high of the trading range, but there was no demand to support these breakouts. Second, the highest volume usually comes with reactions on supply zones, not rallies from demand zones. Third, the most recent zone of demand broke down. Also, the best attempt of bulls to mark price up didn’t result in any movement – we might assume that most of the demand is gone.
Here is the result. It indeed was a distribution, and SOW ended with a violent attempt to break back into the trading range, but even with this massive demand there was not enough strength to make it happen. Later, there was another attempt, which probably scared most of the weak hands who decided to short, but note the volume – this attempt had no back up and you could use it to increase your short position without any risks.
Analysis of the trends
Price trend is gradual change in the balance between supply and demand. In uptrends demand level rises, so price is making higher lows. In the downtrend, demand decreases thus letting price to make new lows.
If the trend has some kind of linear structure, we can connect consecutive highs or lows to project potential supply and demand levels.
Any break of this structure implies a change of character, a short-term move against the trend. Analyzing this move we can see if it is indeed significant and something has changed.
If not, one can expect that price will act as if nothing had happened – it will get back into the previous trend and respect previously projected zones of supply and demand.
Here is a closer look at the short-term trading range formed after the breakout of the ICX downtrend. Remember, all clues are based on the volume analysis. The start of the trading range looked very promising – every rally down ended with a long wick – signs of strong demand.
But the 14th of May killed all hopes of the bulls. There was an enormous effort to break through resistance and start the new trend up, but it failed. This single attempt dried up all the demand and every following rally was weak. Supply became dominant and price eventually broke the support and returned to the prevailing long-term trend.
Wyckoff market theory is based on observation of the markets through the lens of institutional operators. The trader has to think what the end goal is of these institutional operators and how current price action represents their interests and actions.
To make a trade based on Wyckoff’s ideas a trader needs to:
- Determine the current stage of the market cycle. If it is in a trend, then wait patiently for the next change of character.
- Otherwise, mark the chart with events discussed above.
- Based on the events decide what phase the trading range is currently in
- Look for footprints of institutional money analyzing volume and supply/demand.
- If you a have an accurate read on current price action, wait for the best opportunities to long (short) risk/reward wise – tests after a Spring (UTAD) or SOS (SOW)
At last, I prepared a short quiz. It is a set of charts containing a trading range, and your job is to determine if it’s an accumulation or distribution, and to decide if it’s worth to take action on it or not. All answers will be in the imgur album at the end of the article.
Also I can’t recommed enough a blog of Bruce Fraser, who wrote more than 130 articles on applications of Wyckoff Method over the last 3 years. He is one of the brightest Wyckoffians out there.