Wyckoff In The Original
|March 29th, 2013, 12:28 PM||#11 (permalink)|
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Wyckoff and Auction MarketsTraders who have a lot to buy or a lot to unload will avoid trying to catch the tops and bottoms and focus on "the middle", since "the middle" is by definition where most of the trading is going on. However, since the middle is by definition largely non-directional, there is also a lot of whipsawing there, and that generates a lot of losing trades. One can sometimes avoid this by widening the stops, but, since the market always teaches us to do what will lose the most money, this will turn out to be an unproductive tactic.
The safest and generally most profitable trades are found at the extremes. Therefore, you wait for the extremes. Wyckoff used a combination of events to tell him when a wave was reaching its natural crest or trough: the selling/buying climaxes, the tests, higher lows/lower highs, and so on, all confirmed by what the volume was doing and by the effect the volume had on price (effort and result). As a result of this work and of his exploration of trading ranges, he developed the concepts of support and resistance along with their practical application. Auction Market Theory (AMT) takes these investigations into support and resistance further, an “organic” definition of support and resistance like Wyckoff’s, that is, determined by traders’ behavior, not by a calculation originating from one’s head or from a website somewhere. Determine whether you are trending or “balancing” (ranging, consolidating, seeking equilibrium, etc), determine the limits of the range (support and resistance), and you’re in business.
The notion of support and resistance has been and is the missing piece for many market practitioners. One can try to hit what appear at the time to be the important swings again and again and be stopped out again and again, hoping all the while that once one hits the true turning point, all the effort will turn out to have been worthwhile and the P&L will change from red to black. But by waiting for the extremes, one avoids most or all of those losing trades, and, even more important, avoids trading counter-trend. These boxes are nothing more than a means of locating those extremes. What I've found more useful about them is that they are encapsulated by time, i.e., the price and volume ranges have a beginning and an end. This enables me to see at a glance where the important S&R are, or at least are likely to be. Without them, one ends up with line after line after line until the S/R plots become a parody of themselves.
All of this can be very confusing to someone who’s learned to view the market in a different way, perhaps less so to someone who’s just starting since he has so much less to unlearn. But backing up to the basic tenets of AMT, as well as to the concepts developed by (and in some cases originated by) Wyckoff, one can perhaps find a solid footing and proceed from there. Those who have read Sections 2, 3, and 4 of Wyckoff's course will be in a particularly good position to benefit from what follows since you will at least have been introduced to the dynamics of demand & supply and buying & selling pressure.
To begin with, in the market, price is often not the same as “value”. In fact, one could say that since the process of “price discovery” is a search for value, they match only by accident, and then perhaps for only an instant. Blink and you missed it. Add to this the fact that for all intents and purposes there is no such thing as “value” but rather the perception of value. After all, what is the “value” of, say, Microsoft or GE or that little stock your stylist told you about? This state of affairs may seem like a recipe for chaos, but it is in fact the basis for making a market, that is, reconciling the differences – sometimes extraordinarily wide differences – in perceptions of value.
As Wyckoff put it, if a stock (or whatever) is thought to be below “value” and a trader or group of traders see a large potential for profit ahead, he/they will buy all they can at or near the current level, preferably on “reactions” or pullbacks , so they don’t overpay. If the stock is above what they perceive to be value, they'll sell it (or short it), supporting the price on those pullbacks and unloading the stock on rallies until they are out (or as much out as they can be before the thing begins its downward slide). “This”, he writes, “is why these supporting levels and the levels of resistance (a phrase originated by me [Wyckoff] many years ago), are so important for you to watch.” When price then begins to lose momentum and move in a generally sideways direction, you’ve found “value” (if value hasn’t been found, then price won’t stop advancing or declining until it has). Value, then, becomes that area where most of the trades have been or are taking place, where most traders agree on price. Price shifts from a state of trending to a state of balancing (or consolidation or ranging), the only two states available to it.
The trading opportunities come (a) when price is away from value and (b) when price decides to shed its skin and move on to some other value level (that is, there’s a change in demand). This is also where it gets tricky, partly because demand is ever-changing, partly because you’ve got multiple levels of support and resistance to deal with and partly because we trade in so many different intervals, from monthly to one-tick. If we all used daily charts exclusively, it would all be much simpler, though not necessarily easier. But that’s not the case, so we must remember always that a trend in one interval – say hourly – may be a consolidation in another, such as daily. The hourly may be balancing, but there are trends galore in the 5m chart. Or the 5s chart. Or the one- tick chart. Regardless of how one chooses to display these intervals – line, bar, dot, candle, histogram, etc – there are multiple trends and consolidations going on simultaneously in all possible intervals, even if they’re in the same timeframe, even if that timeframe is only one day (to describe this ebb and flow, Wyckoff used an ocean analogy: currents, waves, eddies, flows, tides).
To sum up where we are so far, and keeping in mind that there is no universally-agreed-upon auction market theory, the following elements are, to me, basic, and are consistent with Wyckoff in the original:
I'm sure everyone has noticed that swing highs and lows and the previous days’ highs and lows and other /\ and \/ formations can serve as turning points and appear to act as resistance. However, this type of resistance stems from an inability to find a trade and is accompanied by low volume*. Price then reverts to an area where the trader finds it easier to close that trade. That's what provides that ballooning look to the volume pattern “A” in the following chart. "Resistance" in this sense, then, refers to resistance to a continuation of the move, whether up or down.
*Volume may look “big” at the highs and lows, but the price points are vertical, not horizontal (as they would be in a consolidation), so the volume – or trading activity – at each price point is less than it would be if the same price were hit repeatedly (again, as it would be in a consolidation).Note that you may have more than one "zone of concentration" (this is how jargon gets started), as in the first balloon. Nearly all the volume is encompassed by the pink lines, but there is a heavier concentration within the blue lines because of where price spends the greater part of its time. The volume in the balloon “B”, however, is more evenly distributed throughout the zone, partly because price spends so much time in it and partly because it ranges fairly steadily within it. Instead of rushing to the limits and bouncing back toward the center, they linger at those limits, the sellers trying to push price lower, the buyers trying to push price higher. Thus there is more volume at these edges than in balloon “A”, but buyers eventually fail in their task as sellers do in theirs, and trading drifts back toward the center, providing, again, a relatively even distribution of volume throughout the range.
Balloon “C” is similar to “A” but much thinner due to the fact that price has made only a single round trip to the bottom of the range. It lingered a bit in the middle, simultaneously creating that protrusion in the center of the volume pattern. But volume at each end is thinner than in “B”, thinnest at the bottom due to the \/ shape, giving the volume – if one is fanciful – something of a P shape.
If price drops through one of these zones, those who bought within that zone are going to be miffed. Some of these people are going to try to sell if and when price re-approaches that zone. This is the basis of resistance. There's just too much old trading activity to work through in order for price to progress unless there is enough buying pressure to take care of all those people who want to sell what they have, then push price even higher (in which case those who sold may think they screwed up yet again and buy back what they just sold). However, those who bought or sold at the outer reaches of these zones will also be disappointed if they can't find buyers for whatever it is they just bought, not because there's too much volume but because there isn't enough.
So how does one trade all this? First, you will have to monitor several intervals at the same time in order to (a) find out what interval you want to trade and (b) where price is within whatever range or ranges is/are in that interval. For example, if you’re most comfortable with a 5m interval, you’ll want to check a smaller interval or two to see what price is up to down there, but you’ll also want to look at larger intervals, such as the 15m or 60m or even the daily (I’m using time intervals here in order to keep this from becoming even longer than it will be, but the same approach applies whether you’re using range bars, volume bars, tick bars, candles, lines, etc).
Second, locate the ranges. Box them or circle them or color them or in some other way highlight them. If you find a range that is wide enough for you to trade (that is, there are enough points from top to bottom to make a trade worthwhile), get “into” the range via a smaller interval in order to find a trend. Perhaps at some smaller interval, price is at the bottom of that range. That gives you a good possibility for a long (or it may be at the top of the range, giving you a good possibility for a short).
At this point, you have three options: a reversal, a breakout, or a retracement. If, for example, price bounces off or launches itself off the bottom of the range (support), trade the reversal and go long. If instead it falls through support, short the breakout (or breakdown, if you prefer). If you don’t catch the breakout, or you prefer to wait in order to determine whether or not the breakout was “real”, prepare yourself to short whatever retracement there may be to what had been support and may now be resistance.
A more boring alternative is that price is nowhere near the top or bottom of any range that you can find but rather drifting up and down, aimlessly. No change is occurring; therefore, there is no trade, or at least no compelling trade. Finding the midpoint of the range may be useful since price sometimes ricochets off the midpoint, or launches itself off the midpoint if it has settled there. Such actions represent change since price may be looking for a different value level. It may come to a screeching halt and reverse when it gets to one side or the other of the range and return to the midpoint, or it may launch itself through in breakout form and extend itself into the next range, if there is one, or create a new range above or below the previous range (in determining which, back off into larger intervals in order to determine whether or not price is in a range in one of those larger intervals).