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Educational
September 9, 2020

Applying The Wyckoff Method to Crypto Trading

Shubham GoyalProduct Specialist

The Wyckoff Method is a series of principles and strategies originally focused on stocks. However, it is now applied to all sorts of financial markets. It was developed by Richard Wyckoff, around approximately the same time when Charles Dow was publishing the Dow theory (link to be provided), in The Wall Street Journal. Today, Richard Wyckoff’s name is taken in the same breath as the other titans of technical analysis, such as Charles H. Dow, and Ralph N. Elliott.

The Wyckoff method includes

  1. Three Fundamental laws
  2. The composite man concept
  3. Wyckoff’s schematics
  4. 5 step approach

Let’s dive deeper into these concepts

The Three Laws of Wyckoff

The Law of Supply and Demand

The first law states that prices rise when demand is greater than supply, and drop when the opposite is true. This law is not exclusive to the Wyckoff method but is a basic principle of the financial markets. In other words, excess demand over supply of even a cryptocurrency will cause the price of the asset to go up, since there is no lack of buyers for that asset in the given price. 

However, when the situations are reversed, i.e, when the supply is excessive when compared to the market demand, the prices will drop. 

There is also the third possibility, called the equilibrium state, when the level of demand is equal to the level of supply, signalling a low volatility market. 

The Law of Cause and Effect

The second fundamental law notices that the differences in supply and demand arise as a direct result of specific events. According to Wyckoff, a period of accumulation will eventually cause an uptrend, while a period of distribution will be followed by a downtrend.

The Law of Effort vs. Result

Wyckoff agrees with Dow’s theory that trends should be confirmed by market volume. If a particular trend is backed up by significant volume, it is likely that the trend will continue. If there’s a disagreement, however, the movement has high potential to stop or reverse.

Take a hypothetical example of the litecoin market starting to consolidate with a very high volume after a long bearish trend. The high volume of consolidation indicates that the consolidation will continue, and the price change would be minimal. Such a situation could indicate the end of the downtrend, signalling towards a possible reversal.

The Composite Man

Wyckoff proposed the idea of the Composite Man as a hypothetical identity of the market. According to him, individuals should study and analyse the markets, as if it is controlled by a single entity, making it easier to go along with the market trends. 

Essentially, the Composite Man represents the market makers (wealthy individuals and institutional investors). The composite man acts only in his self-interest, aiming to buy at lows and selling at highs. His behaviour tends to be the exact opposite of most retail investors, who often lost money. According to Wyckoff, the Composite man, follows a predictable cycle, making it easier for others to learn from.

wyckoff accumulation

Accumulation

The Composite Man begins accumulating assets before most investors. The accumulation is gradual, avoiding significant price changes, making a sideways movement.

Uptrend

After the initial accumulation phase, the Composite Man holds enough shares, and/or the selling force is depleted, he pushes the market up, causing more investors to join in the trend increasing the price. At one point, even the general public can see the movement and get involved.

Distribution

When he’s convinced that the push has lost the steam, the Composite Man sells his positions to late entry buyers. Like the accumulation phase, the distribution phase is also marked by a sideways movement, as the distribution will be gradual, preventing significant price drops.

Downtrend

The Composite Man has sold a majority of his positions, starting to push the market down. Eventually, intelligent investors catch on selling a majority of their positions, creating a position of excessive supply. A new accumulation phase will start at the end of the downtrend, making this a continuous cycle, for as long as the asset exists.

Wyckoff’s Schematics

Within the crypto community, the Accumulation and Distribution Schematics presented by Wyckoff is his most popular work. These models break down the Accumulation and Distribution phases into smaller sections. The schematics go into detail on the various events that can potentially occur during a bull/bear trend, dividing it into five phases (Phase A to E), along with the various possible Wyckoff events.

Wyckoff’s five-step approach

Wyckoff developed a five-step approach to the market as a way to put his teachings, principles and strategies into practice.

  1. Determine the trend
  2. Determine the strength
  3. Determine assets with sufficient cause
  4. Determine the probability of the move
  5. Time your Entry

For example, a trader can compare the price action of an altcoin in relation to Bitcoin. Cross-referencing with the individual Wyckoff Schematic prediction about the potential movements of the cryptocurrency, will aid in establishing a good entry point. It is important to know that this method works better with assets that move together with the general market or index.

Though an entire century has passed since Richard Wyckoff established this method, it is still one of the most fundamental concepts governing the modern Technical Analysis sphere. The concepts are similar to that of Dow theory, but Wyckoff’s method goes one step further and provides us with schematics, and a systematic approach to technical analysis when trading any cryptocurrency. It is important to know that any of these methods aren’t guaranteed to work at any given time, but only provides generally accepted views and ideas about how the market might move. 

No technical indicator is foolproof, and the Wyckoff method isn’t an exception. Please ensure that you thoroughly understand the market risks associated with trading in crypto derivatives, before beginning to trade. If you’re looking to start your trading journey with crypto derivatives, Delta Exchange is a great place to start.

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