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Two Goals, Three Laws & Five Steps

Two Goals, Three Laws and Five Steps

Applying the Wyckoff approach to stock market trading can be complicated due to the many variations in the manner in which stock market action can unfold.  However, the foundation upon which the method is built is quite simple.  The foundation of the Wyckoff method consists of two goals, three laws and five steps all of which can be simply stated in a relatively few words.  The stock market trader or investor who builds his understanding of the Wyckoff approach on this foundation can become consistently successful no matter how complicated the curves are that the markets throw at him.

One goal of the Wyckoff stock market trading approach is to make a profit on a consistent enough basis that exceeds the rewards available from investment vehicles where the return is absolutely guaranteed and for those profits to exceed guaranteed returns by a wide enough margin to make the effort worth while.

However, this is not the most important goal of the Wyckoff method.  The most important goal is the preservation of capital.  Every time the stock market is entered capital is put at risk.

There is no way around this.  However, risk can always be managed.  Wyckoff teaches that no position should be taken unless it has a predetermined exit strategy.  The stock market provides vehicles such as stops and options that help manage risk.  One or more of these tools should always be in place when position is taken.  Protection of capital should never be an after thought.  Having something in mind to do later if developments warrant frequently results in doing nothing until the pain of a mounting paper loss becomes unbearable.

The three laws in the foundation of the Wyckoff stock market trading method are the law of supply and demand, the law of cause and effect and the law of effort vs. result.  The price of every trading or investment vehicle moves up or down because there is an excess of demand over supply or supply over demand expressed in the form of urgency to exchange dollars for shares or contracts or to exchange shares or contracts for dollars.  The law of cause and effect states that the excesses that develop in supply and demand are not random but are the result of key events in market action or the result of periods of preparation.  Wyckoff teaches what these developments are and how to judge when they are unfolding in time to take advantage of the excesses in supply or demand that will follow.  The low of effort vs. result states that the change in price of a trading vehicle is the result of an effort expressed by the level of volume
and that harmony between effort and result promotes further price movement while lack of harmony promotes a change in direction.

The third cornerstone of the foundation of the Wyckoff approach are the five steps.  These are the general procedures that every student of the Wyckoff stock market method needs to employ each and every time the action of a market or trading vehicle is considered.  Here are those five steps.  Determine the trend and position of the market being traded.  Determine the relative strength or weakness of the issue being considered.  Select issues that are presenting a cause that is likely to produce an acceptable effect.  Determine the readiness of an issue being considered to respond to its cause.  Time trades in individual issues to anticipated turns in the market in which they are traded.  Learning how to correctly apply each of these five steps is
what makes a successful trader or investor.  Most of what Wyckoff teaches is the finer details of applying these steps.

Once a trader or investor understands the foundation of the Wyckoff approach to stock market trading and accepts the philosophy that it embraces, he can begin building the knowledge that can lead to a more successful market operation.  In the next installment of this series, a closer look will be taken at the first step of the Wyckoff stock market method.

© The Jamison Group, Inc.: Stock Market Trading, The Wyckoff Method

The Wyckoff Method Step 3

Step Three of the Wyckoff Method

Step three of the Wyckoff method is intended to help traders avoid marginal trades. Wyckoff teaches us to select only those issues that have built a cause.  A cause can be defined in more than one way.

In step three, Wyckoff is referring to the use of a figure chart to get an indication as to how far from its current level, the price of an issue is likely to move.  This indication is derived by taking a count on a figure chart.

While an issue is in preparation for a move, its action produces a horizontal formation on a figure chart.  The horizontal formation contains the count.  When the price has completed its preparation and begins to move out of the area in which the preparation was done, the count has been completed and can be measured.  To measure the count, the trader selects the appropriate price level within the horizontal formation and simply counts the number of horizontal divisions on the chart beginning at the right side of the formation and ending at the left side of the formation.  The trader counts all the horizontal divisions both those that have a posting in them and those that do not.  The total number of horizontal divisions is the count.  It provides an indication as to how far from the level at which the count was taken the price is likely to move.

If the price leaves the zone of preparation, normally referred to as the trading range, to the up side, Wyckoff says to add the count to the level at which it was measured to get an indication as to how high the price is likely to go.  If the price leaves the trading range to the down side Wyckoff says to subtract the count from the level at which it was measured to get an indication as to how low the price is likely to go.

The anticipated ending point of a move indicated by a count is called its objective.  An objective may be a single level, but is more often than not a range of values referred to as the objective range.  If a count for an advance is taken at the very bottom of the trading range, it will indicate a single level as the objective of the move.  However, if the count is taken at some other level within the trading range, the result will be an objective range.

This range is determined by adding the count to the level at which it was measured and by adding it to the lowest level in the trading range.  If a count for a decline is taken at the very top of the trading range, it will indicate a single level as the objective of the move.  If the count is taken at a lower level in the trading range, the result will be an objective range.  In this case, the objective range is determined by subtracting the count from the level at which it was measured and by also subtracting it from the highest level in the trading range.

Individual issues are not the only place were counts are taken and objectives are measured.  They can also be taken and measured for a general market index.  If a trader is operating in the options or futures derived from an index, it is essential that the trader take a count and determine an objective for the index that is being traded.  When the index reaches its objective range, the move is likely to end and the position in the derivative trading vehicle can be closed.  Measuring counts and determining objectives on the underlying index usually provides more reliable indications than does taking the counts and determining objectives on the particular trading vehicle that has been selected.

Traders who only operate in individual issues should not ignore the indications for the general market.  Situations where both the general market and an individual issue are indicating an objective above or below current levels are the most desirable.  If the market and an individual issue both have higher or lower objectives, the movement of the market as a whole is likely to help the individual issue reach its objective.  If the general market does not have an objective that is in harmony with that of an individual issue being considered, the individual issue may still reach its objective, but the odds of that happening are not as good as they are when the market has a similar objective to that of the individual issue.

Wyckoff does not provide specific directions as to how large of a count an issue should have to be considered for a trade.  In making this determination, the trader needs to be realistic.  If the trader only wants to hold positions for a short period of time, smaller counts should be identified with relatively nearby objectives.  Identifying much larger counts with much higher or lower objectives and expecting those objectives to be reached in a short period of time is not realistic.  Traders who are comfortable with the idea of holding a position for an extended period of time should also be realistic.  It is a waste of time and effort for these traders to focus on small counts and nearby objectives.  A trader who is willing to wait for his reward to develop should demand a larger count and more distant objective before taking a position.

All Wyckoff traders should always remember what Wyckoff says about figure charts, counts and objectives.  They provide indications only.  Above all else is the character of the price and volume action.  If it supports the idea of the indications being realized, positions can and should be held.  However, if the character of the action does not support the idea of the indications being realized, positions should be closed.

The Wyckoff Method Step 4

Step Four of the Wyckoff Method

In step four of the Wyckoff Method, Wyckoff tells us to determine a stocks readiness to move.  Taking a position in an issue that has not or has not nearly completed it preparation for its next move  is wasteful and dangerous.  It is wasteful in that funds committed to a position that is not making progress in the intended direction could be better used in a position that begins to move in the desired direction quickly.

It is dangerous in that time spent waiting for an issue to begin moving in the intended direction is time during which the character of the action can change making the desired move less likely or not likely at all.

Determining an issues readiness to move involves two considerations.
The first consideration is the position of the price in its trend.

The second consideration is the character of the price and volume action that has brought the price to its current position.

Wyckoff teaches that there are a relatively small number of what have come to be called primary trading positions.  These are places in the unfolding stream of the action where a worthwhile move in one direction or the other has a high probability of beginning.  There is a set of primary trading positions that favor the start of moves to the up side and another set that favor the start of down moves.  Those that favor advances are the spring position, the test of the spring, the back up to the edge of a creek and the normal correction of a previous advance.  Those that favor declines are the up thrust position, the test of the up thrust, the rally back to an ice level and the normal correction of a previous decline.  In each case, the primary trading position represents a last point of support following a sign of strength if an up move is anticipated, or a last point of supply following a sign of weakness if a down move is anticipated.

Each primary trading position is worthy of a detailed presentation.  In future installments in this series each primary trading opportunity will be discussed in greater detail.  For now, only a brief introduction of each position will be given.

Wyckoff identifies a potential spring position as a price penetration of a previously defined support level.  For a potential spring position to be worthy of consideration of an entry point on the long side, the price spreads should narrow on a day to day basis as the price approaches and penetrates the support level.  Generally, this type of price action in combination with declining volumes results in the highest quality springs.  If the price responds to a spring position as it should with a rally. the response will in the overwhelming number of cases be followed by a test of the spring.  The purpose of the test of the spring is to confirm the bullish indication provided by the spring.  This is accomplished by a narrowing of the price spreads as the price approaches the low point of the spring.  As was the case with the spring itself, a higher quality test generally results if the test of the spring unfolds on declining volumes.  It is also desirable for the low point of the test of the spring to be higher than the low point of the spring and for the average volume during the testing phase to be lower than the average volume as the price approached the spring position.

The jump across the creek is defined by Wyckoff as an advance that takes the price through a zone of resistance defined by the tops of earlier rallies.  The characteristics of a jump are wide spreads to the up side with strong closes and high volumes.  The jump across the creek is not a primary trading opportunity.  However, following the jump across the creek there will likely be a back up to the creek that can provide a primary trading opportunity.  This is the phase in the action when the price reacts back toward the zone of resistance that was overcome on the jump.

The purpose of the back up is to confirm that the former zone of resistance has been converted to a zone of support.  The confirmation is provided by a combination of narrowing price spreads and declining volumes as the price approaches the former resistance.  The up trend that is defined as the price of an issue leaves a trading range to the up side will normally consist of a series of thrusts.  Following the completion of each thrust, there will be a corrective reaction.

A normal correction will result if the price returns to the vicinity of the halfway point of the previous advance.  A primary trading opportunity exists if the price approaches the halfway point on narrowing spreads and declining volumes.

The first primary trading position that is likely to develop on the short side is identified by Wyckoff as being the up thrust.  The price of an issue enters an up thrust position when it penetrates a previously defined resistance level.  A high quality up thrust is one from which the price begins a prompt decline.  A high quality up thrust is one that develops on narrowing price spreads as the price approaches and penetrates the resistance level.  Generally, a high quality up thrust will also unfold on declining volumes.  After the price has responded to the upthrust with a decline, there will almost always be a test of the up thrust.  The test is another primary trading position for the short side.  The characteristics of a high quality test of an up thrust are narrowing price spreads to the up side on decreasing volumes.  It is also desirable for the test to not put in a higher high than the up thrust and for the average volume as the price makes the test to be lower than was the case on the up thrust it self.

When the price of an issue leaves a trading range to the down side, there will frequently be what Wyckoff refers to as a fall through the ice.  Ice is identified as the zone of support defined the bottoms of previous reactions in the action.  The fall through the ice occurs when the price trades through this zone on widening spread and increasing volumes. 

The fall trough the ice is not a primary trading opportunity.  However, the rally that follows the fall through the ice can develop into a primary trading position.  This advance is identified as the rally back to the ice.  The purpose of the rally back is to confirm that the former support provided by the ice has been converted to resistance.  When this confirmation is in place, the price can resume down side progress.  The rally back that is likely to provide the best entry point on the short side if it unfolds on narrowing price spreads to the up side and declining volumes as the price approaches the zone of former support.  Down trends that develop as the price leaves a trading range consist of a series of thrusts and corrections.  The correction of each thrust can provide a primary trading position if it is completed in the vicinity of the halfway point of the previous thrust to the down side and if it unfolds on declining volumes.

Primary trading positions in individual issues should not be considered to be automatic buy or sell points.  Although most will provide an opportunity to take a profit, there are some that are likely to be more profitable than others.  One consideration that goes into determining which primary trading positions are better than others is the indication provided by the figure chart of the issue.  Those that indicate the largest potential are likely to provide the biggest profits.  Another consideration that is involved in judging which primary trading positions should be acted upon and which should not is covered in the fifth and final step of the Wyckoff method.

© The Jamison Group, Inc.: Trade the Stock Market-Step four of the Wyckoff Method

The Wyckoff Method Step 5

Step 5 of the Wyckoff Method

The final step of the Wyckoff method is the one that actually results in a position being established.  Wyckoff tells us to time trades in individual issues to anticipated trends in the general market.  While it is true that there are always individual issues that make substantial moves in the opposite direction of the general market, most move with the market to some degree.  By identifying a point in the general markets action from which it is likely to turn in the direction of an established trend or begin the development of a new trend and taking a position in an individual issue at that time, the Wyckoff trader has a better chance of realizing a profit from that position and realizing a better profit than if the position is established in a more random manner.

The market is most likely to make a turn that can benefit a position in an individual issue if it located near but not below the demand line of an up trend, near but not above the supply line of a down trend, or near the support level or resistance level of a trading range. 

It is not necessary that the individual issue in which a position is being considered be in the  same position as the general market.  It is necessary that the positions of both the individual issue and the general market compliment each other.  For example, the general market may be in a trading range and positioned in a potential spring from which an immediate response to the up side is anticipated.

If the individual issue under consideration is also in a trading range but is testing an earlier spring, the two positions compliment each other and a position in that individual issue is likely to perform better than it might otherwise perform because of the anticipated turn in the general market.

The general market and the individual issue do not have to be in the same trend to compliment each other.  For example, the general market may be in a trading range and testing an earlier spring position.  The test assuming it has been constructive is a position from which the market is likely to make an immediate turn. 

At the same time, an individual issue that has already begun to trend higher by jumping the resistance level of a trading range may be backing up toward the former resistance.  As the general market begins to respond to its bullish position, it is likely to help the individual issue complete its back up and resume up side progress possibly moving into new high ground.

The above examples are both cases in which the individual issue is ahead of the market in the development of a bullish scenario.  These situations should be considered first.  The second set of situations that should be considered are those where the market and the issue are in the same position that is likely to produce an immediate move at the same time. 

The third set of situations that should be considered are those where the general market is ahead of the individual issue in the development of its bullish or bearish scenario.  In the above examples, the positions of the market and the issue could be reversed and establishing a position in the individual issue could be justified because the markets position suggests an immediate turn.

Wyckoff traders have three tools that can assist them in judging whether a turn in the market should be anticipated.  These tools are the O. P. Index. the Technometer and the Force. 

The O. P. Index when used in combination with the Wyckoff Wave indicates whether the result indicated by the Wave is in harmony with the effort indicated by the O.P.  If they are and the market is in a position from which an immediate turn can be anticipated, the harmony between effort and result is likely help a position in an individual issue perform as anticipated.  However, a lack of harmony between the Wyckoff Wave and the O.P. Index can be even more helpful in assisting the market make an anticipated turn.  For example, consider the situation where the Wyckoff Wave has previously been in a spring position and is now testing the spring with a higher potential bottom.  If at the same time the O.P. is making a lower low than it did when the Wave was in spring position, a bullish divergence is in place.  The indication is that there has been too much down side effort for the result.  This situation leaves the Wyckoff Wave more vulnerable to making a turn than one where the Wave and O.P. are in harmony. 

Divergences should be used to confirm indications provided by the position of the market.  Divergences that develop when the Wyckoff Wave is not in a position from which an immediate turn may be anticipated are interesting, but they do not provide a reason to establish a position in an individual issue.

The Technometer and the Force are like the Wyckoff Wave/O.P. relationship in that they are intended to confirm an indication of an impending turn by the Wave.  If the Wave is in a primary buying position, it is most likely to make an immediate response out of that position  if the Technometer is indicating an over sold condition at the same time.  These situations are when trades on the long side in individual issues are more attractive.  The same is true if there is a bullish relationship between the Wyckoff Wave and the Force. 

Divergences between the Wave and the Force develop in a manner similar to the divergences that develop between the Wave and O.P.  Primary buying or selling positions in the Wave that develop in conjunction with bullish or bearish divergences between the Wave and the Force are more likely to result in an immediate turn in the general market than those that develop without such divergences.  The ultimate in confirmation that there is likely to be an immediate turn in the market is when it is in a primary trading position and all three of the confirmations mentioned are in place.  At that point, a position in an individual issue can be established with the greatest degree of confidence that it will yield a profit.

© The Jamison Group, Inc.: Trade the Stock Market- Step 5of the Wyckoff Method

Analyzing Trends Using the Wyckoff Method

Analyzing Trends Using the Wyckoff Method

 Wyckoff tells us that the most important thing that anyone can know about the market or an individual issue is its trend. The trend is most simply defined as being the line of least resistance. Prices will tend to follow the line of least resistance until there is a significant development in the action that suggests that a change in trend should be anticipated.
A trader can look at the price of a market or issue and compare it to the price from the previous day, week, month or year and determine the direction in which it is trending. While this can be helpful in keeping a trader on the right side of the action, Wyckoff had something more specific in mind for determining the trend. He provided guide lines as to the proper way to define a trend so that it could be more helpful in applying the five steps of the Wyckoff Method.
Trends can be defined in three directions and in at least three time frames. There are up trends, down trends and horizontal trends normally referred to as trading ranges. Trends can be short term in nature, intermediate term or long term.
The time frames that one Wyckoff trader uses to define the three duration of the trends may be different than another Wyckoff trader uses. This does not necessarily mean that one trader is correctly defining the trends and the other is incorrectly defining them. The important point is that the trends that are defined by consistent with the time frame of the market operation that is being undertaken. A short term trader may define the short term trend as being one that is defined and completed in just a few days.
This trader may view intermediate term trends as being those that are defined and completed over several weeks and he may look at long term trends as those that last no more than a couple months. The intermediate term or longer term trader may see the short term traders idea of a long term trend as being his short term trend. These traders may look at intermediate trends as lasting for several months and long term trends as lasting a year and more.
These traders cannot be faulted for the different time frames they use to define trends with a different duration. A problem only develops if a trader defines trends in one time frame, but then attempts to operate in a different time frame. This type of error can be fatal for a market operation.
An up trend in any time frame is defined by a demand line and an over bought line. A demand line connects the low points of two consecutive reactions of similar significance where the second reaction low is at a higher level than the first. Finding two reaction lows where the second is higher than the first is a simple matter.
However, some Wyckoff traders who are new to the approach have difficulty with the idea of similar significance. Looking for reactions that last for approximately the same number of days or move the price approximately the same distance can be helpful in identifying reactions of similar significance. While Wyckoff would not necessarily frown on this approach, he would prefer that the trader identify two consecutive reaction lows that are both important points in the action. The most important points in the action for those looking for an up trend are the primary buying opportunities.
Combining two of these to define the demand line of an up trend is seen as being the best approach.To complete the definition of an up trend, the Wyckoff trader needs to define the over bought line of the trend. This line is constructed parallel to the demand line. It passes through the top of the rally or advance that is between the two reaction lows used to define the demand line. A common error that new Wyckoff traders make in defining the over bought line is to use a top that comes before or after the two lows used to define the demand line.
Making this error will result in a trend channel that is either too wide or too narrow. The purpose of the over bought line is to indicate where thrusts in the up trend are likely to end. Defining a trend that is too wide or too narrow can result in the trader looking for rallies to end higher than is likely or to close out positions at prices that are lower than necessary.

A down trend is defined by a supply line and an over sold line. The supply line connects the high points of two consecutive rallies of similar significance where the top of the second rally is at a lower level than the first. Wyckoff would prefer that two consecutive lows that are both important points in the action be used to define the supply line.

The most important points in the action are those that Wyckoff identifies as primary selling opportunities. The over sold line of a down trend is constructed parallel to the supply line through the low point of the reaction or decline that separates the two points used to define the supply line. Defining the over sold line through a point before or after the two points used to define the supply line will result in a distorted trend.

Normal trend development will have an up trend and a down trend or two trends pointing in the same direction separated by a horizontal trend or trading range. Trading ranges are defined by a support level and a resistance level. If a trading range is following an up trend, the resistance level will be defined first.

If a trading range is following a down trend, the support level will be defined first. The resistance level of a trading range following an up trend is defined horizontally through the high point of the up trend that is being completed. The support level of this trading range is constructed parallel to the resistance level and passes through the low point of the reaction that follows the point used to define the resistance level. The trading range is confirmed by the rally that follows the low used to construct the support level if that rally respects the resistance level of the range. The support level of a trading range following a down trend is defined horizontally through the low point of the down trend being completed.

The resistance level of this trading range is constructed parallel to the support level and passes through the high point of the rally that follows the point used to define the support level. This trading range is confirmed by the next reaction if that reaction does not make a lower low than the one used to define the support level,

Since the trend is the most important thing that any Wyckoff trader can know about the action of a market or an issue, defining the appropriate trend or trends for the time frame of the market operation that is being undertaken is the first thing that a trader should do each time an assessment of the action is made.

A chart that does not have accurately defined trends drawn on it is unlikely to produce a profit for the trader. Without trend channels, it is not possible to identify buying or selling opportunities or to properly asses the progress of an existing position. The trend is your friend as long as you trade in harmony with it.

Figure Charts, Counts and Counting

Figure Charts, Counts and Counting

An important part of the Wyckoff approach is the use of figure charts. Figure charts are a tool that Wyckoff traders can use to compress the action of the market or an individual issue to provide a perspective that may not be effectively provided by a bar chart.

They provide an insight as to the future level of the market or future price of an individual issue. They can be effectively used as a supplement to the study of price and volume action and they can be grossly misused by traders who are caught up in wishing and hoping for things that have little chance of ever being realized.

Figure charts come in a wide range of shapes and sizes. In order to be a effective tool in a market operation, a trader must learn how to select the type of figure chart that it best suited for the chosen type of market operation.

To some extent this has to be a trial and error exercise. However, there are some general guide lines that can prove helpful. The most important of these is to match the time frame of the figure chart that is used to the time frame of the market operation. If a Wyckoff trader is focusing on a short term market operation, he is likely looking for moves in individual issues of ten to fifteen percent in a four to six week time frame. This type of operation requires a more sensitive figure chart.

For moderately priced issues that normally means a one point figure chart. However, for low price issues, a half point figure chart may be selected to provide the sensitivity needed to measure the smaller moves that these issues usually make.

For very low priced issues, a Wyckoff trader may even choose to use a quarter point figure chart. If a trader is operating in an intermediate time frame focusing on twenty-five to forty percent moves over three to six months, the one point figure chart may still be acceptable for most moderately priced issues.

In this type of operation, a trader might also want to use the one point figure chart for lower priced issues as well to reduce the sensitivity of the chart allowing the trader to focus on the more important developments. In a similar manner, the intermediate trader might choose to use a two point modified or five point modified figure chart for high priced issues or those that have a history of being especially volatile.

The longer term investor looking for moves of fifty percent or more perhaps lasting as long as a year should focus on the modified variety of figure chart so as not to be distracted by shorter term developments.

A figure chart will not help a Wyckoff trader assess the quality of the price and volume action of an issue or a market. Its purpose is to provide a projection of future value. It does this with the development of a count.

A count is a vertical projection based on the horizontal development on the figure chart produced by the price movement from day to day and in some cases even intra-day. The count taken at a particular price level includes all of the horizontal divisions on the chart at that level whether there is a positing in the division or it is blank. As long as the price trades at or around the level being counted, the count provides a measure of the amount of potential being built for the advance or decline that will follow. When the price leaves the area in which the count level is located, the count is actually taken and the target of the anticipated move is indicated.

The manner in which a Wyckoff trader selects the level at which the potential is measured and at which the count is taken depends on whether an advance or a decline is anticipated based on the character of the price and volume action.

If the trader is anticipating an advance, a sign of strength and the last point of support that follows the sign of strength are identified. A sign of strength may be a spring position and the response to the spring. It could be a jump across the creek. It might also be a rally within a trading range accomplished on widening price spreads and increased volumes.

In the case of the spring and response, the last point of support is the test of the spring. For a jump across the creek, the last point of support is the low point of the back up. If the sign of strength was an aggressive rally within the trading range, the last point of support will be the low point of the correction that follows the sign of strength. In each case, the potential is measured and the projection of future value is made from the last point of support.

If a Wyckoff trader is anticipating a decline, a sign of weakness and a last point of supply must be identified to determined at what level the potential should be measured and the count taken. Signs of weakness include an up thrust and response, a fall through the ice and a reaction within a trading range that unfolds on widening spread and increased volume. The last point of supply following an up thrust and response is the test of the up thrust. The rally back to the ice is the last point of supply following a fall through the ice. The last point of supply following an aggressive reaction within a trading range is the high point of the corrective rally that follows the reaction.

If a spring position or an up thrust position makes a small penetration of the support level or resistance level being penetrated and if the level of volume on the penetration is a small percentage of the average volume, the indication of strength or weakness and the last point of support or supply will be represented by the spring or up thrust. In these cases, there may not be a clearly defined test.

Therefore, the trader is justified in measuring the potential and taking the count from the low point of the spring or the high point of the up thrust. Even if a test is anticipated, a trader may want to take a count from the spring or up thrust so as to get a more conservative indication of potential an objective. Wyckoff teaches that the most conservative count should always be taken first and that the decision to trade or not to trade should be based on the projection of the most conservative count.

Many times, counts can be broken into phases. Within a trading range, the price may rally and react several times before the last point of support or supply is reached and the price is ready to leave the range.

If an up count is being taken, the low point of each reaction in the trading range represents the end of a phase. If a down count is being taken, the high point of each rally in the trading range represents the end of a phase. In addition to indicating the objective of the entire count, a Wyckoff trader should identify the objective as each phase is added. This is done because the reaching of each of these interim objectives is potentially the end of the move. As each objective is reached, the trader needs to focus on the character of the price and volume action looking for indications of continuing bullish or bearish action or for a change in the character of the action. If there is no change in the character of the action, the trader can look to the next indicated objective.

If there is a change in the character of the action, the trader needs to be more defensive in the management of that position even to the point of closing out the position even if the maximum objective is much higher or lower.

Frequently as larger long term moves unfold, the price will move into short term trading ranges along the way to rest following a thrust. Often, these resting spells occur in and around the objectives of phases in a larger count. These trading ranges build short term potentials resulting in short term counts that may confirm the objective of the next phase of a larger count. If so, they are called stepping stone confirming counts. They provide an indication that the move will be continuing and not ending.

Counts on a figure chart should never be considered to be more than an indication only. Once set in place, they do not guarantee that the price will reach the indicated objective. Above all else is the character of the price and volume action. In the final analysis, it determines what is possible and likely.

If a position is held in an issue where the indicated objective is higher or lower than the current price but there is a change in the character of the action in that issue, the trader needs to respond to that change in character.

The response may be to increase the level of protection. The response may be to close the trade. Opting to do nothing in response frequently results in ending up with less than was possible and much less than was anticipated.

 

© The Jamison Group, Inc.:  Figure Charts, Counts and Counting

Directional Indicators and Timing Tools

Directional Indicators and Timing Tools

Wyckoff traders have several tools that can help them determine the direction in which the market or an individual issue is likely to move and the likelihood of a change in that direction.

These tools are the Optimism-Pessimism Index (O. P.), Technometer (Tec) and the Force. They are all derived from the volumes of the intra-day buying and selling waves. The purpose of these tools is to confirm the indications provided by the price and volume action. They are not intended to take the place of a regular interpretation of the character of the price and volume action, the trend of that action or the position of the action in the trend.

Those who attempt to use them in this incorrect manner are embracing an mechanical approach to Wyckoff. The market may let them get away with this approach for a while. However, the Wyckoff approach is judgmental and not mechanical. Those who persist in efforts to use these tools in a mechanical manner will eventually pay a price for their laziness.

Wyckoff tells us that for a move in the market or an individual issue to continue there needs to be harmony between effort and result. The result is measured by the amount that price moves from point A to point B. The effort is measured by the O. P. The O. P. moves from point A to point B by adding the volume in the up waves and by subtracting the volume in the down waves.

As long as the price of an index or an individual issue and its O. P. are moving in the same direction at approximately the same rate making similar highs and lows relative to previous highs and lows, the price is likely to continue making progress toward an indicated objective. Positions taken in anticipation of an objective being reached can be maintained as long as this harmony exists and new positions can be considered at appropriate points in the action.

If there is a lack of harmony between effort and result, Wyckoff traders need to be more defensive with respect to existing positions because the lack of harmony suggests a change in the direction of the price movement. Although these indications can be detrimental to existing positions, they also represent opportunities to consider positions on the other side of the market.

When effort and result are not moving in the same direction at approximately the same rate, the condition is referred to as inharmonious action. Inharmonious action can be corrected without a change in the direction in which prices are trending by either effort or result accelerating to catch up with the other or hesitating to allow the other to catch up.

If harmony is not restored, there will be a change in the direction in which the trend of the action is pointed. Some inharmonious actions are obvious and some are not. However, there is one type of inharmonious action that is
especially obvious. It is a divergence.

A divergence develops when the lack of harmony is so great that the price action and the action of the O. P. do not make new highs or new lows relative to previous rally tops or reaction lows at the same time. Divergences can be bullish or they can be bearish. They can result from too much effort for the result, or they can result from too much result for the effort. In each case, the development of a divergence is a warning of an impending change in the direction of the price movement.

A bullish divergence develops when the price of a market or an issue makes a lower low on a current reaction than on the low point of the previous reaction but the O. p. does not make a similar lower low. A bullish divergence also develops when the O. P. makes a lower low on a current reaction than on the previous reaction and the price does not make a similar lower low. Either way, the lack of harmony is so great that the result is likely to be a change in the direction of the price movement away from the direction in which it was moving when the divergence developed.

Although both types of bullish divergence favor an advance in the price, one has over time tended to be more reliable than the other in turning the price. If the O. P. makes a lower low and the price does not, the situation is indicating effort without result. This is the more reliable bullish divergence. The effort has been expressed but the price has not responded.

Therefore , as the effort is relaxed, the price is likely to move in the opposite direction. In the other type of bullish divergence where there has already been a result expressed by the price not supported by the effort, the effort may still enter the market and eliminate the divergence. Since the effort has this extra opportunity to correct the situation, this type of bullish divergence is somewhat less reliable in warning of a likely change in direction.

Bearish divergences are measured across the tops of rallies rather than across the bottom of reactions. As was the case with bullish divergences, there are two types of bearish divergences. One is where there is effort without result. It is the more reliable type. There is also the type where there is a result without effort. The effort without result variety is when the O. p. on a current rally makes a higher high than on the previous rally, but the price does not. The result without effort variety is when the price makes a higher high on the current rally relative to the high on the previous rally but the O. p. does not.

Divergences should not be used as timing tools for entering or exiting positions. They provide warning of likely changes in the direction of price movement, but they do not trigger the change in direction by themselves. A divergence that develops on one day may widen over the days that follow resulting in a more extreme divergence providing a stronger warning.

Therefore, a position taken on the first day that a divergent condition develops could be stopped out as the divergence becomes more extreme resulting in the trader being moved to the sidelines just where he should actually be taking a position. The best place to act on the indication of a divergence is when it confirms a primary buying or selling opportunity.

A bullish divergence in combination with a primary buying opportunity is more likely to produce a change in direction than either the divergence or the buying opportunity alone. The same is true of bearish divergences in combination with primary selling opportunities.

The development of divergences is not limited to the price action and the O. p. action. They can also develop between the price action and the Force. The Force measures the amount of volume in the intra-day buying waves relative to the volume in the intra-day selling waves over a ten day period. The primary difference between the Force and the O. P. is that the Force looks at a limited amount of time while the O. P. does not.

As the excess of volume in the up waves grows relative to the volume in down waves, the value of the Force moves higher. It may move from a more negative number to a less negative number, or from a negative number to a positive number, or from a less positive number to a more positive number.

The absolute value of the Force reading is not what matters most. What does matter is how the peaks and valleys in the Force relate to rally tops and reaction lows in the price. Divergences develop when the price and the Force do not make higher tops or lower bottoms together. When this happens, the excess or lack there of in the accumulated up side volume over the down side volume during the ten day period reaches an extreme that needs to be corrected by a turn in the direction of the price movement.

The short term excesses mentioned above are a tool that can be used in timing the entry or exiting of a position or an adjustment in how a position is managed. The Force also provides a directional indication. If the values of the Force from day to day are posted to a chart, the Wyckoff trader will note that they tend to trend. This means that there will be periods of time when there are lower peaks and lower valleys and periods of time when there are higher peaks
and higher valleys.

Trend lines can be drawn on a chart of a Force just as they can be drawn on a chart of the price action. When a tend in the movement in the Force is broken, the indication is that a change in the direction of the price action should be anticipated. As with the price and O. p. relationships, the price and Force relationships are most reliable when they confirm primary buying and selling opportunities.

The Technometer is a timing tool only. It indicates over bought and over sold conditions. The Technometer measures a ratio of the volume in the intra-day buying waves relative to the volume in the intra-day selling waves over a five day period. However, longer time periods can be used to provide longer term over bought and over sold indications.

Theoretically, the Technometer reading of a market or an issue can range from zero to one hundred. However, neither of these extremes has ever been recorded or is likely to ever be recorded. A reading of zero would require five consecutive days during which there were only one intra-day wave per day and only down waves for each of the five days.

A reading of one hundred would require five consecutive days during which there were only one intra-day wave per days and only up waves for each of the five days. Decades of monitoring Technometer readings have revealed that readings of 50 or higher should be viewed as indicating an over bought condition and that readings of 38 or lower should be viewed as indicating over sold conditions.

A reading of 44.4 indicates absolute neutrality. When an over bought condition is indicated, the price is vulnerable to down side progress. When an over sold condition is indicated, the price is vulnerable to up side progress. If an over bought or over sold condition on one day is replaced by a more over bought or more over sold condition the next day, the vulnerability of the price to a reaction or rally increases. The degree to which the market or an issue is over bought or over sold does not provide any indication as to the size of the reaction or rally that is being forecasted. These indications are provided by figure charts. Although over bought or over sold indications may develop at any time as the price action unfolds from day to day, those that develop when the price is in primary buying or selling positions are the most important.

The indications provided by the O. P., the Technometer and the Force should be used to confirm the indications of the price action. They should not be used in lieu of an interpretation of the price and volume action. Anyone who does so is attempting to use these tools in a mechanical manner and that will not result in the desired results over time. This warning cannot be stressed to much.

© The Jamison Group, Inc.:  Directional Indicators and Timing Tools