Wyckoff 5 Step Process
Current Market Structure July 25, 2022
Introduction
Wyckoff had a well defined process for identifying when and how to trade.
Wyckoff was a pioneer of early technical analysis and is considered one of the “5 titans of technical analysis”.
In light of where the market sits into a big slew of important earnings, data releases and a key FOMC this week, I would like to review this 5 step process with you.
After reviewing this, I will briefly cover where I see broad markets relative to the 5 step process.
The bolded step headings are Wyckoffs steps. The description of each is my own modern interpretation, but you can certainly refer to his writings for study.
His writing is as valid today as in the early 1900s. The only difference today is that we may word it a bit differently and also have technological tools/software which can assist with parts of the process - which he did then manually by careful study and analysis.
There was no charting software platform. He drew these by hand.
Wyckoff Process
Step 1 - Determine the present position and probable future trend of the market.
This is basically a determination of whether we should be in the market at all. Wyckoff advised trading only in the direction of a clearly identified trend, which I favor. Many today gamble on shorter timeframes against a larger trend.
(If you have multiple intraday timeframes showing alignment and clearly identify the above, you can still trade counter to a larger trend while in sync with this Wyckoff process and smart money. I prefer to trade only with a daily and/or larger trend.)
In order to determine whether to be in, we look at market structure, supply/demand. If we see clear indications there of probable direction, we can decide whether to look for positioning long or short.
We use analysis of bar charts, candlestick charts, P&F charts to make our Step 1 decision - In? Out? Sidelines?
Step 2 - Select stocks in harmony with the (probable) trend
For uptrends, we want stocks stronger than the broad market. For downtrends, we want stocks weaker than the broad market. In an uptrend, we want stocks with a larger percentage increase relative to broad markets on rallies, smaller decrease relative to broad markets during pullbacks.
In Wyckoffs time this was done by manually reading several hundred charts each week. Today there are many tools which can simplify the process.
For downtrends, we want stocks with a larger percentage decrease on drops, and smaller percentage increase on upside reactions.
Refer to your charts and/or software tools for Step 2.
Step 3 - Select stocks with a “cause” that equals or exceeds your minimum objective.
I prefer a minimum objective of $1 risked for every $5 of potential profit. Wyckoff used P&F charting to identify his price objectives for both long and short trades. Many today wholly neglect risk/reward. For Wyckoff this was a key component of his process.
Wyckoff posited a fundamental law of “cause and effect”. Simply put, the horizontal P&F count of a trading range represented the “cause” and the resulting price movement, the “effect”.
Today, when we have a proper setup - we can simply go to a charting platform that offers P&F charting and punch in the ticker to have this calculated objectively for us.
If we want to go long, we want stocks showing enough cause (accumulation) to meet the desired effect (risk/reward objective).
If we want to short, we want stocks showing enough cause (distribution) to meet the desired effect (risk/reward objective).
Step 4 - Determine the stocks’ readiness to move.
There many tools for this today, writing scans yourself, buying them, some are given for free. Some are rather well known and/or widely used such as Minervinis VCP (volatility contraction pattern).
Wyckoff utilized the 9 tests for buying and selling. This is something I've pretty much internalized by studying. In choppy trading ranges, it is not as clear.
Once we have fully set up a trading range (accumulation or distribution range) and approach the end of that range and breakout it becomes more evident.
You can read about the 9 steps further in his instructional writings. I may cover this in the future, but today I just want to primarily focus with you regarding the nuts and bolts of the basic fundamental 5 Step Process itself.
Simply:
For shorts, is significant supply entering the market after a trading range and/or rally to resistance?
For longs, has supply been fully absorbed while confirming a support in a potential accumulation trading range?
Step 5 - Time your commitment with a turn in the stock market index.
I realize many love to trade counter-trend, short bull markets, rallying stocks, etcetera. This is a specialized skill, and sometimes works well for those with the proper experience and a clearly defined edge.
Here we are discussing the Wyckoff method. His method is advisable for those not possessing the experience, edge described above.
Roughly 80% of stocks will move in sync with the overall market trend. Identifying this trend and trading with it improves your odds of success.
If you have adhered to Step 1 using Wyckoff VSA and other technical tools at your disposal, followed Steps 2-4, to then proceed boldly into tradesat the identification of a turn in Step 5, you're stacking the deck in your favor.
This is a simplified explanation of Wyckoffs 5 Step Process. Further study within all of his writings and those of others on the Wyckoff method is advisable for those wishing to grow as traders.
5 Step Process Relative to Current Market Analysis
My analysis of SPY is that we have created a weekly distribution top (Stage 3) or weekly trading range. The support of this top was identified by the breadth rollover zone in April/May 2021, and the price action which followed to create this top was broken several weeks ago.
Over the past few weeks, we have rallied back up to test that support from below. Into this week’s catalysts we have shown some signs of accumulation on a daily timeframe basis creating a potential accumulation trading range below the above key weekly support.
When a daily trading range forms within the context of a larger downtrend, often it shows some the key 9 signs of buying as it goes through the initial phases of the trading range pattern.
This is clearly described in Wyckoffs writings on the subject. It is a place where many become trapped.
In today’s much larger markets, it is vitally important to be aware of this and to watch various sectors, indexes, ETFs which may show signs of this type of bullish daily pattern within a larger bearish weekly, monthly downtrend (sometimes prior to it being reflected in the broad market index, stocks analyzed).
If these then fail their counter-trend move, reverting to clear signs confirming that already present larger downtrend - we can be on our guard.
This is why I share many charts and analysis with you in addition to the big indexes themselves. That in depth analysis of these other charts can sometimes give us a helpful early warning of what broad markets may be close to doing, but not quite indicating themselves yet.
At the time of this post, I still see a daily countertrend up move within the context of a larger confirmed weekly downtrend for SPY.
Some of the other key charts which may lead already show more signs of weakness on a daily basis within their larger weekly downtrend.
For this reason, I see myself at Step 1 of the process. Analysis says I should be taking little action here other than possible daytrades, catalyst trades and/or staying liquid to watch for clear setups.
If I have clearly identified setups that are catalyst trades in confirmed Stage 2 markup or see short ETFs setup in their Stage 2 markup patterns as the broad markets weaken, these are my current focus for entries.
SIGA 0.00%↑ continues to be one of these current positions for me.
~ Scott - Black Tiger Trading
Disclaimer: I am not a licensed adviser. Trade ideas, strategies, analysis are shared for educational purposes. Trade involves risk of loss of capital. Accordingly, trade at your own risk.