The Wyckoff Method is a type of financial analysis designed to help traders understand market movements and predict their future behavior. Consisting of multiple elements which combine to produce an entire strategy, Wyckoff is one of the most used charting principles and forms one of the foundations of modern technical analysis.
Does Wyckoff’s Theory Work for Cryptocurrency Trading?
Cryptocurrencies, despite tending to be much more volatile than traditional financial assets, still comply with the theories set out by Richard Wyckoff one hundred years ago.
There has been some debate about whether one can use traditional charting principles to analyze and forecast the behavior of cryptoassets. This has mainly revolved around their inherent volatility and unpredictability, along with trading environments which differ considerably to those of assets such as stocks and commodities.
Nonetheless, Wyckoff is now a common feature of cryptocurrency market analysis. Indeed, on a high-liquidity token such as Bitcoin (BTC), the price characteristics essential for using Wyckoff are if anything more obvious than in less volatile assets.
As such, traders proficient in Wyckoff analysis should have little problem transferring the tool to the crypto realm.
The difficulty comes when attempting to analyze coins which have thin liquidity or little history. Here, given the dynamics of the specific market under scrutiny, Wyckoff may be difficult to implement given the lack of data and underlying understanding of how that token might perform in future.
This is less a shortcoming of Wyckoff, however, as such cryptocurrencies are by definition unpredictable and trading them comes with inherently high risk, regardless of the strategy employed.
What is the Wyckoff Method?
The Wyckoff Method is a set of phenomena devised by American investor Richard D. Wyckoff which combine to form a trading strategy for financial assets.
Active from 1888 until his death in 1934, Wyckoff pioneered the use of some of the best-known aspects in chart analysis today. Concepts such as analyzing the “trading range” on a chart and following the activity of smart money while trading an asset stem from his research and teaching.
The Wyckoff Method is more than simply looking at a chart in a specific way and following specific rules. In fact, it is an entire ecosystem in its own right, containing laws, phraseology and even charting styles which combine to form a complete suite of analysis tools for financial assets.
Wyckoff devised three “laws” of trading under which analysis should take place: the law of supply and demand, the law of cause and effect and the law of effort versus result.
With these in effect, charts are divided into sections according to what is called the Wyckoff Price Cycle, which consists of four main areas: accumulation, uptrend (or “markup”), distribution and downtrend (or “markdown”).
Spread across these areas are a series of “phases” in which price action unfolds in up to five steps, labelled A, B, C, D and E. These are applied to a chart and the resulting structure is then referred to as a Wyckoff “schematic”.
Both the “areas” and “phases” involve chart fractals, meaning that they can technically repeat ad infinitum, and also contain smaller versions of themselves within larger, longer-timeframe structures.
The Composite Man
Wyckoff thus allows analysis of price movements over different timeframes and to different degrees of exactitude. It accommodates different types of asset, including cryptocurrency, and ultimately helps users to identify suitable entry and exit points while being mindful of the activity of other market players, notably the “smart money.”
This forms the basis of the next major concept of the Wyckoff Method. Known as the “Composite Man” or “Composite Operator”, it refers to how the market participants with the lion’s share of volume — in Wyckoff’s day, banks — trade an asset.
Wyckoff argued that such players — just like today’s Bitcoin or altcoin whales — aim to fool smaller retail investors with their buys and sells, ultimately forcing them to hand over their capital.
The Wyckoff Method is therefore designed to help traders avoid being ruined at the hands of the Composite Man by following his example and preempting his movements.
“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 Operator, who, in theory, sits behind the scenes and plays a stock to his advantage.” — Richard D. Wyckoff, “The Richard D. Wyckoff Method of Trading and Investing in Stocks: A Course of Instruction in Stock Market Science and Technique”
Wyckoff’s Five-Step Approach
The last essential feature of the Wyckoff Method is the approach to actual trading that users adopt after taking the Composite Man into account and learning to use the analytical tools above.
Wyckoff advocated a five-step process when choosing an asset to trade and when to buy or sell it. This revolves around the key concept of market trends — using the Wyckoff Method demands an understanding of whether an asset is going with or against the trend.
The strength of the trend is also important, and for this, Wyckoff uses a type of charting structure called Point & Figure (PnF), which uses volume rather than timeframes to track asset performance. PnF charting is a separate science in itself, and this article will focus on Wyckoff trading as a whole rather than the specific use of PnF charts and how they are constructed.
Wyckoff’s five steps are:
- Decide what position the broader market is in right now where it is likely headed — is it trending?
- Select assets which exemplify the trend — these will provide a higher chance of success.
- Using PnF is in fact a science which determines the strength of an asset’s “cause” (see the section of Wyckoff’s three laws below). Traders should select assets with a suitably strong potential cause.
- How primed is the asset for a significant move? The use of volume data can help here.
- A specific asset trade can be more successful if conducted in tandem with a decisive move in the overall market.
Wyckoff Buying Tests
The above five-step approach forms part of another key component of the Wyckoff Method: the nine buying tests for an asset. A suitable asset in which to take a position should pass these tests, as they confirm that an uptrend or Markup has begun.
In brief, the tests, which make use of both standard vertical and PnF charts, are as follows:
- Has prior downside completed?
- Has the asset shown initial support, along with a selling climax and retest (see the section on the Wyckoff Price Cycles below)?
- Does volume increase on price rises and decrease on price drops?
- Has the downtrend been broken?
- Is the asset making higher lows?
- Is the asset making higher highs?
- Is the asset responding more strongly than the majority of the market on uptrends?
- Is a strong base support line forming?
- Does estimated profit potential at least equal three times the potential losses (in the event a stop price is reached)?
Wyckoff’s Three Laws
The Wyckoff Method uses three “laws” which determine why price action unfolds in the way it does on a given asset chart. These are as follows:
The Law of Supply & Demand
If demand for an asset is greater than the available supply, its price will increase. The opposite is also true — more supply and insufficient demand will cause a price retracement. Somewhere in between and ranging-type price action will result as the forces of supply and demand play out.
This concept is fundamental in chart analysis, even outside Wyckoff. Cryptocurrency traders can use volume bars as an easy way of gauging supply and demand active on a market at a given time or over a given period.
The Law of Cause & Effect
In Wyckoff trading, nothing happens at random; an asset’s activity is the result of something which occurred in the past.
Accumulation, for example, is an area marked by weak price action but increasing volume, followed by a breakout. The breakout occurs because of that volume — while retail investors are losing faith, the Composite Man is accumulating and buying up their supply as they sell.
Further on in the Wyckoff Price Cycle, the opposite phenomenon can be observed — the Composite Man sells into price strength just as retail investors gain the confidence to enter positions.
The Law of Effort vs. Result
Similarly, strong activity will result in a similarly strong price reaction. This activity thus dictates the strength of an asset trend and how long it can endure.
For example, high volume on an uptrend provides for sustained gains as the volume — the “effort” — mirrors the price action, which is the “result”.
At a local or macro top, however, the Composite Man may be selling, resulting in a supply increase which is reflected in large volume but a lack of continued price upside. Here, effort and result are not uniform, which leads the Wyckoff trader to conclude that a trend change could be on the horizon.
Wyckoff Price Cycles
The most fundamental structure in the Wyckoff Method is arguably the Price Cycle or market cycle.
Analyzing an asset’s price movements, Wyckoff traders aim to identify which stage of the cycle the asset is in and when or if it is about to enter the next. These stages are often called “phases” or “areas”. There are four: accumulation, uptrend (also called the “markup”), distribution and downtrend (also called the “markdown”).
Each area contains price phenomena which frequently occur and in turn validate the asset price being in a specific place in the Price Cycle. These are referred to with abbreviations, and learning them is part and parcel of using the Wyckoff Method.
Accumulation
In the area of accumulation, the price is flat or trending downwards at a fairly slow rate, while volume is rising. It often begins with an event called the Selling Climax (SC) in which the sell-off from the previous markdown reaches its most intense point in terms of volume.
Ranging then begins, with Secondary Tests (ST) of the sell-off swing low occurring in tandem with swing highs. What traders are looking out for is the key event in the accumulation area known as the “spring”. This is a swing low outside the expected range which traps weak hands and is a classic moment when the Composite Man buys up their excess liquidity.
Once the spring occurs, the asset sees a rebound, often followed by a test of the spring level and a series of higher lows before the markup area enters.
Both accumulation and distribution are key examples of a market building a “cause”, as described in the Law of Cause & Effect (see the appropriate section in this article).
Schematics covering the entire accumulation area often have the spring as the focus, and this becomes Phase C in the five-phase Wyckoff progression from A to E.
Markup (Uptrend)
After accumulation has taken place, the asset can move into a period of upward price action which gathers pace over time.
This markup area is characterized by the gradual reawakening of retail investors or those previously shaken out in previous sell-offs or during the low-sentiment accumulation phase. As they become more confident, price trajectory increases further, and the Composite Man begins selling his position entered into at the lows.
A swing high which marks the top then begins the Distribution stage of the Price Cycle.
Distribution
An asset tends to show signs of distribution once a noticeable swing high has been achieved on high volume, followed by a failed retest of that high.
The Composite Man has begun selling his position, “distributing” units of the asset to buyers convinced that there is still plenty of upside left. A period of decreased volatility but no noticeable downside then ensues, and could be followed by a new high which only emboldens retail traders further. This could be accompanied by media coverage or other activity which creates a false sense of bullishness on the asset’s potential which is completely devoid of technical evidence.
Once a peak is in, known as the Upthrust Action (UTA), selling, which was not expected by the majority of investors, quickly begins to create unease, and the Markdown area emerges.
Markdown
A series of lower highs within an emerging downtrend, known as Last Points of Supply (LPSY) are followed by Signs of Weakness (SoW), at which point the asset price is looking like it will collapse after a blow-off top. This is the Markdown stage of the Wyckoff Price Cycle.
At this point, panicking late buyers are rapidly losing faith in their investment and seeking to cut their losses, while the Composite Man has already exited.
The asset price looks for a point which will end up being the site of a new Selling Climax (SC) and a new period of accumulation will then begin.
Does the Wyckoff Method Work?
Used correctly, the Wyckoff Method can be extremely valuable for timing entries and exits in a wide variety of markets — not just cryptocurrency.
Its success as a trading strategy broadly depends on the trader, who needs to be sure that its various aspects are correctly applied.
That said, cryptocurrency markets with consistent high liquidity are some of the best environments in which to test and deploy Wyckoff. In Bitcoin and Ethereum (ETH), for example, the market movements which are essential ingredients of the Wyckoff Method are often very clearly visible.
This can be in contrast to assets such as stocks and bonds, which tend to make less obvious price movements and thus make trend identification more difficult.
Wyckoff Method FAQ
What is the Wyckoff Method?
The Wyckoff Method is a style of trading used to identify entry and exit points for financial assets, broadly based on data about their trends.
Is the Wyckoff Method profitable?
The Wyckoff Method can help traders increase the profitability of positions if they use it correctly. There are many components of Wyckoff as a strategy, and a trader needs to know and understand them, as well as complete market tests and assessments before entering a position.
How long do Wyckoff phases last?
Wyckoff uses five phases, and each can last a different length of time depending on the asset and market involved. Accumulation can be a long-term phenomenon, while Distribution, Markups and Markdowns can occur over much shorter timeframes.
How do I trade Wyckoff accumulation?
Accumulation is an essential area to judge correctly when using the Wyckoff Method. Traders tend to look for rising volume and a “spring” event which marks the bottom, keeping in mind the activity of the Composite Man when estimating when an uptrend may begin.
Is the Wyckoff Method still effective?
Despite being around for almost one hundred years, the Wyckoff Method in its original form is as valid today for trading as it was at its creation. Modern resources often adapt the original strategy, but its fundamentals remain the same.
What is the Wyckoff Composite Man?
The Composite Man or Composite Operator is the name given to the “smart money” in financial markets. Its aim is to maximize profits at the expense of less experienced traders, and Wyckoff trading is all about attempting to think like the Composite Man and avoid being on the wrong side of the trade at the wrong time.
