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What is Wyckoff Theory?
The Wyckoff Method was developed by Richard Wyckoff in the early 1930s which consists of a series of principles and strategies initially designed for traders and investors. However, the Wyckoff Theory can be used to navigate any financial market like stocks, ETFS and even cryptocurrency. The theory is based on three fundamental laws:
- Law of supply and demand,
- Law of cause and effect
- Law of effort versus results.
The key part of Wyckoff market observations is the price movement, in order to understand the assets and the market as a whole, he named the method as “composite man”
Wyckoff’s “composite man” theory explains that all the price movements in the market should be looked at as the result of one man’s manipulation of assets. If one doesn’t understand the game as he plays it, the assets move away from your favor. If one understands the movement, it will work in your favor.
The method also states some rules: Individual assets never behave in the same way twice. Instead, there are trends that unfold through a wide variety of similar price patterns and display unlimited differences in size, detail, and extension. Every time they appear, they change which surprises the traders and confuse the market. This is known to many current traders as the “shape-shifting phenomenon.”
Use of Wyckoff Theory
Stock and forex traders uses Wyckoff’s method because it allows traders to recognize upcoming price moves. Understanding the end of an accumulation stage, traders will be alerted to the beginning of a markup which they can then proceed to trade on the long side. A similar method can be explained on the cryptocurrency market, where the accumulation of Bitcoin, Dogecoin and other cryptocurrency took place bringing a bullish market.
On the contrary, the end of a distribution phase marks the beginning of a markdown in which traders can trade on the short side. As a trader understands the different stages of the price cycle, this allows them to position for the next expected price tendency and try to buy the beginning of the markup and hold hold it towards the end.
Limitations of Wyckoff’s method
The Wyckoff theory is a useful framework for technical analysis but there are certain limitations when applied in practical trading.
- The recognition of the accumulation and distribution stage is not a simple task, this can confuse most traders. The accumulation stage turns out to be distribution, vice versa, and the bottom may drop and the market does not behave as expected.
- It is also a very sophisticated task to time out of accumulation or distribution stages and it is not easy to buy or sell as there are no clear and obvious points to place stop-losses.
- Trading markups and markdowns aren’t easy either because it takes real expertise to trade price action patterns appearing in those stages. Moreover, the likelihood of trend reversal is more than the continuation.
In conclusion, Wyckoff method is a complete and valuable trading theory and despite of its limitation, traders cannot deny the fact that Wyckoff price cycle, laws and rules are great concept for analyzing the behavior of the market. A combination Wyckoff theory and other technical analysis can be used to overcome the limitations.