Recently, an investing buddy introduced me to the Wyckoff Effect. Chartists and technicians may have heard of Richard Wyckoff, but this name is unfamiliar to me.
Richard Demille Wyckoff (1873 - 1934) was a trader, educator and stock market authority in the early 1900s. He was an astute observer of market action, and had developed his own trading technique based on watching the stock price and volume. Wyckoff emphasized on identifying the accumulation and distribution of stock by "smart money" (i.e. financial institutions) and to ride the trend as it develops.
There are two principles espoused by Wyckoff:
The first principle states every market and security is unique and never behaves in the same way twice. Present price movement bears no resemblance to any pattern in the past;
The second principle states since every price movement is unique, present price action should be studied in context to the price action on the previous day, week, month or year.
To ride a price trend, it is important to understand the forces behind it. Wyckoff had three laws to explain this phenomenon. For novices with a basic knowledge of economics, they are relatively easy to comprehend.
The three laws are as follows:
1. The Law of Supply and Demand - When demand is more than supply, the price rises. When supply is more than demand, the price falls.
2. The Law of Effort versus Result - Any price change is the result of an effort expressed by the security's traded volume. When there is consistency or harmony (i.e. a price change on increasing volume), the price movement will continue; when there is divergence or disharmony (a price change but on decreasing volume), the price movement will experience a reversal in direction.
3. The Law of Cause and Effect - Any price trend is due to the combined effort (or cause) in the market. The bigger the cause, the bigger the effect.
Wyckoff's Price Cycle describes the price movement in four phases: (a) accumulation, (b) markup, (c) distribution and (d) markdown. Any price movement up is preceded by the effort of financial institutions accumulating (buying) the stock. While the accumulation is ongoing, the price may trade sideways. When the supply eventually dwindles relative to the demand, the price will enter a markup phase (uptrend). As the price moves higher, there will come a point when the smart money starts to take profit (distribution). While the distribution is ongoing, the price may trade sideways. When supply eventually outstrips the demand, the price will enter a markdown phase (downtrend).
In a nutshell, to benefit from trading the market, one should always swim with the big fish. Wyckoff provided an analogy of the "Composite Man", as follows:
Wyckoff has a witty example on how the average person ought to react:
There are plenty of websites that provide examples of Wyckoff's Price Cycle in action, and how to trade profitably from it. You can Google for them if you are keen.
To me, Richard Wyckoff's trading strategy makes sense. However, my purpose for investing is to accumulate positions in healthy companies that can provide sustainable dividend income through the years. So I am not really motivated to churn my holdings as they fluctuate between accumulation and distribution. (There is no telling when I can buy them back at the same cost the moment I sold my holdings.)
That said, I do believe studying the stock price movement can help an investor, albeit indirectly. If a downtrend is developing, we can ask ourselves whether to buy at the current price, or wait a bit to acquire the stock at a lower entry level.
While we can never predict accurately the bottom on the right side of the chart, the possibility of saving a few cents can provide a little less angst and a little more return when compounded over the long run.
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| Image by mohisinabbas from Steemit |
Richard Demille Wyckoff (1873 - 1934) was a trader, educator and stock market authority in the early 1900s. He was an astute observer of market action, and had developed his own trading technique based on watching the stock price and volume. Wyckoff emphasized on identifying the accumulation and distribution of stock by "smart money" (i.e. financial institutions) and to ride the trend as it develops.
There are two principles espoused by Wyckoff:
The first principle states every market and security is unique and never behaves in the same way twice. Present price movement bears no resemblance to any pattern in the past;
The second principle states since every price movement is unique, present price action should be studied in context to the price action on the previous day, week, month or year.
To ride a price trend, it is important to understand the forces behind it. Wyckoff had three laws to explain this phenomenon. For novices with a basic knowledge of economics, they are relatively easy to comprehend.
The three laws are as follows:
1. The Law of Supply and Demand - When demand is more than supply, the price rises. When supply is more than demand, the price falls.
2. The Law of Effort versus Result - Any price change is the result of an effort expressed by the security's traded volume. When there is consistency or harmony (i.e. a price change on increasing volume), the price movement will continue; when there is divergence or disharmony (a price change but on decreasing volume), the price movement will experience a reversal in direction.
3. The Law of Cause and Effect - Any price trend is due to the combined effort (or cause) in the market. The bigger the cause, the bigger the effect.
Wyckoff's Price Cycle describes the price movement in four phases: (a) accumulation, (b) markup, (c) distribution and (d) markdown. Any price movement up is preceded by the effort of financial institutions accumulating (buying) the stock. While the accumulation is ongoing, the price may trade sideways. When the supply eventually dwindles relative to the demand, the price will enter a markup phase (uptrend). As the price moves higher, there will come a point when the smart money starts to take profit (distribution). While the distribution is ongoing, the price may trade sideways. When supply eventually outstrips the demand, the price will enter a markdown phase (downtrend).
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| Image by Every Penny from Pinterest |
In a nutshell, to benefit from trading the market, one should always swim with the big fish. Wyckoff provided an analogy of the "Composite Man", as follows:
"…all the fluctuations in the market and in 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 manipulates the stocks to your disadvantage if you do not understand the game as he plays it; and to your great profit if you do understand it."
Wyckoff has a witty example on how the average person ought to react:
"Figuratively speaking, therefore the small trader should imagine himself as a hitch-hiker in the market. For the ordinary hitch-hiker, someone else supplies the car, chauffeur, oil and gas. When he thinks the car is about to go in his direction, he jumps aboard and rides as far as he thinks the car will go."
"When he notices the machine has been stopped by a red light, or is about to turn a corner and go in some other direction, or that the car is running out of gas, or the brakes failing to work properly, he steps off and figures he has secured about as long a ride as he may expect."
"All he has supplied in this transaction is a modest commission and whatever brains were necessary to observe and recognize the opportunity when to get on and off."
There are plenty of websites that provide examples of Wyckoff's Price Cycle in action, and how to trade profitably from it. You can Google for them if you are keen.
To me, Richard Wyckoff's trading strategy makes sense. However, my purpose for investing is to accumulate positions in healthy companies that can provide sustainable dividend income through the years. So I am not really motivated to churn my holdings as they fluctuate between accumulation and distribution. (There is no telling when I can buy them back at the same cost the moment I sold my holdings.)
That said, I do believe studying the stock price movement can help an investor, albeit indirectly. If a downtrend is developing, we can ask ourselves whether to buy at the current price, or wait a bit to acquire the stock at a lower entry level.
While we can never predict accurately the bottom on the right side of the chart, the possibility of saving a few cents can provide a little less angst and a little more return when compounded over the long run.
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