This week I wrote a little piece about the Telltale Trading Action to watch for prior to Price Changing Directions.
Richard Wyckoff (1873-1934) was a stock market trader and educator who founded and edited the Magazine of Wall Street. At the time the only data available to traders came via ticker tape. This was a machine that printed onto a thin paper strip the company code, each trade transaction, and the volume. Many traders would stand next to a ticker machine reading the tape as it was produced.
Over time the constant reading of ticker tape Wyckoff found that the buying and selling of an individual stock appeared to come in waves. For instance, there would be a period where buying easily out weighted the selling, then a period where selling outweighed the buying, and this alternated during a trading session. Wyckoff began to think of these alternating periods as waves......waves of buying, followed by waves of selling, back and forth. At the time there were no charts to illustrate these waves, however as time when on, he also became aware that these buying and selling waves were also felt over larger timeframes of days and weeks.
Above is is an original print of the type of chart Wyckoff made for himself.
To the left is a little wave chart, showing the waves of buying and selling, and the data he collated from the ticker tape is to the right.
The data breaks down the waves and shows the number of alternate waves for the day, the time they occurred, the duration of each wave, the price, and the volume traded for each wave.
Interestingly, activity is the last column, and shows in feet how long the ticker tape was for that period, or wave.
(if we still traded with ticker tape today, it might be measured in metres, and even kilometers for some instruments)
Thanks To David Weis for the chart.
Wyckoff's understanding of trading served him well, and as time went on, he became very wealthy (at one point owning nine acres in the Hamptons), and slowly turned his attention to another passion, education, and in particular educating other traders and explaining how he analysed the stock market.
When asked how to determine when a market top maybe in, or when price may be about to change direction he answered "When the waves of buying shorten in both length and duration, and the waves of selling increase in both length and duration, the market may be poised to change direction, or trend". This statement refers to a market top, the mirror image opposite is also true for a bottom, and would read, 'When the waves of selling shorten in both length and duration, and the waves of buying increase in both length and duration, the market may be poised to change direction, or trend'.
So, considering this statement in context with current markets, charts, and how we analyse them now. When price is strongly trending higher, price pushes higher for a period, until a price level is reached where the higher prices begin to draw out increased supply (either as profit taking, stale holders 'getting out', or short positions being placed). This increased supply makes it more difficult for price to continue higher. At this point, instead of just grinding higher, price may instead come back a little and attempt to absorb (buy) this increased supply. And once it has been successfully absorbed and selling is now low, any more demand will begin pushing price higher again. On a modern chart, this pullback to absorb the supply may appear as a bull flag or pennant in an uptrend (and a bear flag or inverted pennant in a downtrend).
This pattern of trading may continue for some time, however at some point demand begins to reduce somewhat. At this time it may become noticeable that the buying waves begin to shorten in both length and duration. This phenomenon has become known amongst the Wyckoff community as Shortening of the thrust (higher, in an uptrend - and lower, when in a downtrend). Shortening of the thrust may be an indication that demand is beginning to wane, and the trend is becoming tired. This reduced demand may lead price to morph sideways into a trading range where price can recover and consolidate for a period. However, if price instead sees the waves of selling increase in both length and duration, a change of direction or trend may occur. At this stage if the overall trend is very strong price just come back a little before eventually consolidating sideways, or if the changes have been very serious a complete change in trend may occur.
Consider below, both the two line schematics for a high and a low, and the bar chart below that, which illustrate how this event takes place. Just remember these illustrations show an almost perfect textbook example, and in the real world the trading patterns may not be quite so obvious. Study these carefully, as you will see price action similar to this quite regularly on all types of markets.
