Every valid market approach needs three elements to be effective.  The first element is the approach itself, sometimes called the system. There are thousands of them for sale, some work and others do not. Regardless of the profitability of the approach, they all attempt to guide you, by various means, into selecting a trade.  There are numerous books, seminars, software packages and training manuals devoted to teaching people a "valid market approach." Some of these approaches are based on fundamental analysis (price earnings, balance sheets, economic conditions, etc.), while others are based on technical analysis (a manipulation of price, volume and open interest to generate various "studies" such as moving averages, oscillators and trend fold indicators).  Most people use fundamental analysis while fewer use technical analysis. 

You can divide the technical analysis camp into two parts; mechanical and judgmental.  Mechanical technical analysis is simply a system that gives buy and sell signals automatically, without the judgement of the user.  A judgmental system is one that requires judgement to validate whether a trade should be made. The Wyckoff method is a judgmental approach, which I believe is superior to both the mechanical approach and the fundamental approach.  As we progress along our path, I will point out the reasons for this.

As I have mentioned, there are three important elements to every valid trading system.  The second element is the money management aspect of the trading system. This area has come a long way over recent years with a current emphasis on the importance of position sizing.  The important point of money management is that it must be tailored to the type of approach you are using, to insure you achieve the anticipated results.  You can have a valid approach and apply poor money management and lose money. Or, you can have a poor approach, and apply good money management and still stand a chance to make money.  Money management will turn a losing trader into a winning trader.it is powerful!

The third element is the belief system that is needed to trade the system you are using.  Almost all market approaches neglect this important area.  Just think of the racecar driver that really believed he was going to crash.  What chances would he have of success? How about if he had the belief that it was okay to drink alcohol the day before his race, or that he didn't need to keep himself in top physical condition.  A professional racecar driver, or athlete, or doctor or any professional for that matter, needs to have the proper belief system in place in order to be successful.  Can you imagine a doctor who held the belief that medical school taught him everything he needed to know and that further study was not important.  Would you want to go to that doctor? When the right belief system is in place, the subject has a much better chance of success.  The same is true for your market approach. Each approach needs its own, unique set of beliefs in order to be successful in that approach.  As we progress, I will point out the beliefs that are needed to trade the Wyckoff method profitably.

Again, the three important elements in a trading approach are: The system itself, the money management aspect and the psychological belief system.  If you have all three elements in place, and working properly together, what does it give you? It gives you the ability to align the probabilities in your favor. Let me give you an example of this. 

Imagine that there is a table in front of you with three Safeway bags on top of it. In each bag there are nine balls.  Some are red and some are green.  The red balls represent losing trades while the green balls represent profitable trades.  A wining ball gives you one-dollar profit while a losing ball gives you a one-dollar loss.

Bag # 1:                      

4 red balls,      

5 green balls    

Bag # 2:

6 red balls,

3 green balls

Bag # 3:

3 red balls,

6 green balls

Base on the above, you would want to pick from the bag with the greatest number of green balls.

Bag three represents the Wyckoff Method where if you play a perfect game, you will be right two out of three times. Playing a perfect game means  following the rules of your system that lead to proper trade selection while applying proper money management, both supported by the proper belief system. It is then, and only then that you will be picking out of bag # 3. If you don't apply your approach  properly or consistently, you will not know which bag you are reaching into.  However, even though you do everything right (which means you will be reaching into bag 3), you still have a change of picking a red ball.  In fact, if you play the game nine times (replacing the ball after each try) you still may end up picking 7 red balls and two green balls, or some other combination.  However, over may tries, you will eventually move closer to having a record of pulling 66% green balls out of the bag.  This is an important point to keep in the back of your mind and relates to the third area we talked about, the psychology of trading. 

There are systems where you can be right 10% of the time and make money, as well as systems where you can be right 90% of the time and lose money.  Every system is different.  They must be evaluated to determine their desirability. Don't fall into the trap of thinking a 90% winning system is better than a 50% winning system; it just doesn't work that way. "Trade Your Way To Financial Freedom" by Dr. Van Tharp, shows how to evaluate different systems to determine which is better.  When you play a perfect Wyckoff game, expect to have 66% winning trades, with a reward / risk ratio of greater than 3:1. An intermediate trend trader, using the Wyckoff methodology should strive for between 25-40% on each trade.  Your losing trades should lose no more than 8%. With nine to twelve trades a year, you should realize a profit between 50-150%, WHEN YOU ARE PLAYING A PERFECT GAME! Again, not all losing trades will be has high as 8% and not all winning trades will be as high as 25%. We want to look at the picture that starts to reveal itself after many tries.  That picture will simply be a win/loss ratio of 3:1 (average profits are three times the average loss) with 66% winning trades.  As a side note, you can see that by changing the dollar amount of the winning and losing trades, you can clearly see that bag two, which offers the worst win / loss ratio, could be constructed to be the most profitable system.

Many market students come to the market trying to find a system where they will know exactly what the market is doing, all the time.  Such a system does not exist. Despite this fact, people still search for the holly grail, jumping from system to system. I believe much of this comes from the illusion that professional money managers create in order to attract your money..  They know what is going on and where to invest.  They know which stock is going to blast off. They are in 100% control, all the time. Nonsense! They spend millions of dollars each year creating this illusion for the sole purpose of attracting your money.   So what is reality? The reality is, that no one knows anything for sure.  Get ready because here comes one of the beliefs I told you about. "There is no such thing as a riskless trade" (Bob Evans). What this means is, that there will always be some doubt as to whether the trade will turn out profitably.  It's just like reaching into the Safeway bag.  You just don't know until the trade is over.  The best you can do is to play a perfect game so that you will be reaching into the right bag.  Here comes another belief: "no mater how thinly you slice it, there are always two sides". This means that even after you have followed the Wyckoff methodology, or any methodology for that matter, there is always some evidence that may contradict what you are about to do.  It is a simple matter of weighing the evidence.  Have you ever seen lady justice? You know, that lady holding the scales, blindfolded, often found in front of a courthouse.  Well, we are doing the same thing.  We are using our methodology, our set of procedures, or way of thinking, to weight the evidence, to determine which side of the market we should be on and when and what issues to buy or sell. Do we know for sure..NO. Do we know we will be profitable in the long run if we play a perfect game..YES!

All of the above needs to be said, because some people come to the market  with the wrong ides of what its about.  It is simply a game of probabilities and exploiting the nature of those probabilities through a valid system coupled with proper money management and the right set of psychological beliefs.  There is no one alive that can understand the market's action all the time. Bob Evans once said that if he looks a one hundred charts, he may only find one where he understands what is going on.  One of the greatest traders ever, James Keene, was only right about three out of five times. Understanding that the game you are about to play is not about knowing what the market is doing and where it is going at every moment.  It is about developing a low risk idea through a set of procedures (your system), and using proper money management so that you do not ruin yourself (50% or more of your capital and you are considered ruined), before your system has a chance to show you a profit, while using a belief system that supports your approach.  That being said, lets move on to the really good stuff.

Richard D. Wyckoff was the undisputed master of the trading range.  Wyckoff found that a trading range could be one of five things: accumulation, re-accumulation, distribution, redistribution, or nothing at all.  Wyckoff found that by analyzing a trading range, the trader could determine which direction the ensuing move was likely to go.

For now, we are going to talk about two general areas, accumulation and distribution. We will leave re-accumulation and redistribution for later.

Within a Trading Range, we may be able to detect some of the following principles in operation. It should be noted that Preliminary Supply and Preliminary Support are generally not part of aTrading Range, but are strongly associated with other principles that are. Therefore, they are listed. Moreover, the Rally back to the Ice and the Back up to the Edge of the Creek are also principles that form just out side the Trading Range, but because their other half (Fall through the Ice and Jump Across the Creek ) occur within the Trading Range,  they are also  included. Not all of the principles listed are trading positions, some of them are indications that a possible trading position is coming on the next move. For Example, a Sign of Strength is the action that tells you to expect the next move to be a Last Point of Support. The Last Point of Support is the Test of the Sign of Strength. So as we proceed through these principles, we will be using the idea of Action-Test, Action-Test.  If we see an Action that has a poor Test, we don't make the trade. The Action may have to be re-tested. We will monitor the situation until we have a valid test.

This may not make too much sense to you right now, but it will as we move on.. Please take the time to print out the material on each of the links, so that you can easily access it as we move through our discussions.

For a trading range that follows an up trend:

Preliminary Supply  

A Buying Climax

Automatic Reaction

Secondary Test

Sign of Weakness (SOW)

Last Point of Supply

Upthrust

Upthrust After Distribution

Number 1 Spring

Fall through the Ice

Rally back to the Ice

For a trading range that follows a downtrend:

Perliminary Support

A Selling Climax

Automatic Rally

Secondary Test

Number 2 Spring (with or without test.usually with test)

Number 3 Spring (no test needed)

Sigh of Strength (SOS)

Last Point of Support

Teminal Shakeout

Jump Across the Creek

Back up to the Edge of the Creek

In addition to these principles, there are other clues that distinguish the difference between an area of accumulation (the area of horizontal congestion following a downtrend), and an area of distribution (an area of horizontal congestion following an up trend). They are as follows:

For an area of accumulation:

The volume may remain low on reactions or possibly tapering off. You may not be able to detect this during the early parts of the trading range but as the trading range progresses the volume should start to dry up and bullish price behavior should become more obvious.

You may see a narrowing of price swings and persistent support at the bottom of the trading range.

For a stock, you would expect that it would be able to hold within its trading range even if the market makes a new low. Again, this lends itself to the idea of relative strength.

For an Area of Distribution:

You should be able to detect large volume with no material gain.remember the law of Effort VS Results.

There will be wider price swings and may be erratic in nature

There will be violent reactions.

Just keep these general considerations in mind as we examine trading ranges, and wait for one of the three laws to express itself in the form of a principle.

Lets start our discussion with the idea that we are in a down trend and are looking for signs that the trend may be nearing its completion. What are we likely to see?