An Introduction to the Wisdom of Wyckoff

When confronting what often appears to be an irrational market, an investor who is trying to remain calm and clearheaded can become frustrated or confused by new methods of stock selection, market timing and predicting market movement. Now is the time to return to basics.

Back in the 1930’s, Richard Wyckoff, a self-taught broker, promised to show his students the “real rules of the game.” Wyckoff’s method of trading and investing in stocks has survived to this day, and it gives users a solid foundation for analyzing the fundamental relationships between the market’s driving forces. As a stock broker, Wyckoff saw first hand that “the basic law of supply and demand governed all price changes; that the best indicator of the future course of the market was the relation of supply to demand.” His theories are applicable today to stocks, bonds, options, and commodities.

Wyckoff published the first technical analysis method in 1908, and in 1911, he began sending his clients weekly forecasts, employing charts of price and volume movements and an analysis. Disagreeing with analysts using charts for buy/sell decisions, he insisted, “Stock market technique is not an exact science. Stock prices are made in the minds of men.”

In his opinion, purely mathematical or mechanical chart analysis could not compete with finely developed, practiced judgment. He often ignored financial reports, news items, earnings reports, rumors, brokers’ tips, and was especially scornful of “half-baked trading theories expounded in boardrooms and popular books on the stock market.” Wyckoff believed that an analyst should be a detective uncovering the forces behind price and volume fluctuations. He was a market psychologist, weighing the human motivations that fuel these moves, and a general who is planning a financial campaign to intercept stocks when the charts showed they were at their most profitable stage.

Wyckoff’s goals were not any different from yours today:

• To select only stocks that will move the fastest, the soonest, and the farthest in a bear or bull market

• To limit losses and let profits grow

• To make the most efficient use of your investment capital

Wyckoff’s popularity as an analyst grew dramatically, and his newsletters were in huge demand. After over 40 years in the market, he continued to teach a method based squarely on the law of supply and demand. Saying, “When the demand for a stock exceeds supply, prices rise; when supply is greater than demand, prices decline.” He compared the stock market ticker tape to a movie, saying, “Every minute of the day it is demonstrating whether supply or demand is greater.”

The Wyckoff method charts price and volume and their relationship over time. The goal is to judge how the market, groups of stocks, and individual issues are reacting to the supply and demand struggle. You look for turning points—the final top of a bull market or the last low in a declining bear market. You spot peaks and troughs of the intermediate moves that appear in between.

Wyckoff’s theory is guided by the fact that every change in the market is made up of waves of buying and selling that will go on as long as they can attract a following. When the following is exhausted, that wave ends and a contrary wave begins. Small daily waves gradually develop into larger 3 to 5 point waves, which eventually build into a bear or bull market with swings of 10 to 20 points or more. If the wave is significant, Wyckoff acts in harmony with it.

In addition to the wave chart, the Wyckoff method is built upon a vertical (bar) chart and a point and figure chart. By learning to use all three charts, an investor can determine:

• The direction in which prices are moving

• The most opportune time to buy, sell, or close out

• The prices in which a stop order should be placed

Once mastered, the Wyckoff method is direct and uncomplicated and an investor can follow the market with a financial newspaper, notebook, and 1 hour per day. I will take you step by step through Wyckoff’s method in future articles and show you how it can be applied to today’s stock market.