Lately, the cryptocurrency market, including Bitcoin, has experienced a period of relative stability with minor fluctuations. However, many individuals who tried to enter the market during signs of an upward trend or avoid losses during sharp drops have found themselves losing money as the market unexpectedly reversed. If you have experienced similar frustrations and feel as if someone is intentionally causing you financial losses, it’s essential to understand the concept of the Wyckoff method and its impact on your crypto investments.
You may have come across the term “Wyckoff method” without delving deeper into its meaning. It is crucial for you to gain a comprehensive understanding of this method and how it influences your crypto investments. By familiarizing yourself with the Wyckoff method, you can gain valuable insights and potentially make more informed decisions in the volatile cryptocurrency market.
What Does the Wyckoff Method Entail?
To grasp the Wyckoff method, it is important to have a basic understanding of technical analysis. Technical analysis involves analyzing charts to identify patterns that can potentially predict price movements. Traders then make decisions based on these patterns. While technical analysis does not consider the fundamental aspects of an asset, it focuses on studying human psychology and emotional responses, such as fear and greed.
Support and resistance levels play a significant role in technical analysis. Traders look for these levels to determine where prices tend to bounce back or reverse. However, this predictability makes it easier for large institutions to manipulate the market by deliberately going against these established patterns.
For instance, when the price breaks above a resistance level, it typically continues to rise. However, if institutions deliberately push the price down, it triggers fear and uncertainty among traders who expected an upward movement. This panic selling further drives the price down, allowing institutions to buy at lower prices.
The Wyckoff method revolves around institutions exploiting these common trading patterns by intentionally going against them. They take advantage of the fear, uncertainty, and doubt (FUD) created among traders to benefit from their actions and profit from market manipulation. Understanding the Wyckoff method can provide insights into how market manipulation occurs and how it can affect your crypto investments.
The Principles of the Wyckoff Method
There are three fundamental principles that form the basis of the Wyckoff method, namely:
- The Principle of Supply and Demand
- The Principle of Cause and Effect
- The Principle of Effort Versus Result
The Principle of Supply and Demand
The first principle of the Wyckoff method, known as the principle of supply and demand, asserts that when demand increases, prices will rise, while when demand is lower than supply, prices will decline. An upward price movement indicates a higher number of buyers in the market, whereas a downward price movement suggests a larger number of sellers compared to buyers.
The Wyckoff method employs a straightforward charting technique to assess the effects of a given cause. In simpler terms, Wyckoff introduced useful techniques for representing trading targets based primarily on the duration of accumulation (accumulating assets) and distribution periods. As a result, traders can determine the extent of market volume following a breakout from a price range where a pause in price movement is expected.
The Principle of Cause and Effect
The principle of cause and effect posits that certain events lead to non-random disparities in supply and demand. In other words, a distribution period leads to a downtrend, while an accumulation period results in an uptrend. Traders utilize this principle as a filter to establish their price targets. This is one of the most significant principles outlined by the Wyckoff method and is commonly employed in financial markets.
Specifically, the principle of cause and effect suggests that when prices increase, it indicates that demand exceeds supply, meaning more individuals are buying the assets. Conversely, when prices decrease, it signifies that supply surpasses demand, indicating reduced interest from buyers.
The Principle of Effort Versus Result
The third principle of the Wyckoff method, known as the principle of effort versus result, highlights the relationship between price and volume as an indicator of market trends. If there is alignment between volume and price action, the trend is likely to persist. However, any divergence between price and volume suggests that the current market trend will eventually stall or change direction.
For instance, in the Ethereum market, a surge in volume following a prolonged bearish trend indicates a strong effort and reduced volatility. Consequently, despite ongoing fluctuations, significant price drops become less prominent. Such trends serve as a clear indication that the downtrend has come to an end.
How to Identify the Wyckoff Method?
Spotting the Wyckoff method involves recognizing two distinct patterns, both of which are relatively easy to identify. However, understanding and benefiting from these patterns can be challenging due to their complex structure.
Each pattern is divided into phases, and distinguishing between these phases can be difficult since patterns can span over several months or just a few hours. One of the patterns is known as accumulation, where institutions push prices down to purchase assets at a discounted price. The other pattern is called distribution, where institutions aim to sell at higher prices.
Wyckoff Price Cycle Wyckoff accumulation and distribution
Wyckoff Phases Price action follows a series of phases. Image via Stockcharts.com These patterns consist of various phases because institutions with significant holdings cannot simply buy or sell as much as they want without impacting the market. Hence, they form these sideways movements to consistently buy or sell.
As mentioned earlier, the duration and size of the sideways movement can vary depending on the extent of institutional buying or selling. Other factors, such as unexpected events (like a black swan event), can disrupt the pattern, making it more challenging for both institutions and retail traders to navigate the market. However, in general, it is possible to identify the essential phases if institutions or large investors are indeed using the Wyckoff method.
How Does It Apply to the Crypto Market?
Given that Wyckoff did not live during the time of cryptocurrencies, you may question its applicability to this digital asset class. The simple answer is yes, it does apply, and in my opinion, it is even easier to utilize the Wyckoff method in cryptocurrencies compared to stocks. Allow me to explain.
Cryptocurrencies, in general, exhibit higher volatility than stocks. Due to the relatively limited knowledge about cryptocurrencies, estimating their intrinsic value is more challenging compared to traditional companies. This makes it easier for institutions to manipulate the market, triggering fear or greed among participants.
For instance, if the price of Bitcoin suddenly drops 20% due to manipulation, it can induce panic among inexperienced retail investors who were hoping for quick gains from cryptocurrencies. This panic-driven selling further drives down the price, potentially causing a greater than 20% decline. Such market conditions present an ideal opportunity for institutions to enter the market and buy assets at a favorable price.
Wyckoff in the Crypto Market Wyckoff distribution in Bitcoin. Image via YouTube The same principle applies when institutions intend to sell. In fact, the spike to $64,000 in Bitcoin earlier this year serves as a perfect example of the Wyckoff method being employed by large investors.
While prominent figures in the business industry were making bold price predictions ranging from $100,000 to $500,000, Bitcoin continued its ascent beyond $50,000 and $60,000. This prompted many retail investors to experience FOMO (fear of missing out) and greed, driving them to buy at any price.
Concurrently, however, large investors were selling their holdings and reaping substantial profits, resulting in an abundant supply of coins. Eventually, the supply outweighed the demand, leading to a market crash.
Wyckoff Patterns and Trading Approach in Crypto Futures
The Wyckoff method consists of four distinct patterns that drive market or asset growth and decline.
These patterns are:
- Accumulation Phase
- Markup Phase
- Distribution Phase
- Markdown Phase
The Accumulation Phase commences when demand from the Composite Operator (large players) increases. Both the Composite Operator and bullish market participants seek to expand their positions and drive prices higher.
As prices begin to rise, the Markup Phase unfolds, leading to the Distribution Phase. During the Distribution Phase, as a new high is reached, the opposite of the accumulation phase occurs. The Composite Operators and bearish market participants aim to exit their positions by selling and securing profits.
The subsequent sell-off triggers a downward movement called the Markdown Phase, causing prices to drop until another Accumulation Phase occurs.
Wyckoff’s Five-Step Approach Within the accumulation and distribution patterns of the Wyckoff Method, five distinct phases occur. Since this article focuses on the early signs of an accumulation phase, let’s begin there.
Phase A – At the tail end of a significant sell-off, there is a notable increase in trading volume, indicating preliminary support (PS). Despite these support efforts, a selling climax (SC) eventually takes place, marked by large downward candlesticks stemming from panic selling. Automatic buying and active purchases lead to an automatic rally (AR), presenting trading opportunities at lower prices.
The SC and AR form the boundaries of a trading range, where the accumulation stage occurs. Phase A concludes after a secondary test (ST) occurs following the AR, leading to another price drop that indicates the accumulation scheme is not over.
Phase B – Following the secondary test, a period ensues where the Composite Operator accumulates the underlying asset. As the trading range is tested, premature bull and bear traps may occur, providing opportunities for the Operator to take advantage of.
Phase C – The end of Phase B is characterized by a definitive bear trap designed to scare investors into selling. This event, known as a Spring, may occur before price lows begin to climb. However, the absence of a noticeable Spring does not imply that the rest of the schematic will not unfold.
Phase D – This transitional stage serves as the final opportunity for investors and traders to buy at lower prices. As price lows gradually increase, a Last Point of Support (LPS) is eventually reached. The LPS represents the highest low before the market breaks through resistance levels.
Signs of Support (SOS) form at previous resistance levels, turning them into new support levels. With the growing support levels, an upward trend emerges, leading to Phase E.
Phase E – A clear breakout from the trading range indicates an uptrend fueled by increased market demand. Investors are confident that the accumulation phase is over, resulting in a surge of buying activity.
The distribution pattern follows similar phases as the accumulation pattern, but the events unfold in the opposite direction.
Phase A – Occurring during the Markup Phase, Preliminary Supply (PSY) marks the first opportunity to sell for substantial profits. The Buying Climax (BC) occurs when the Composite Operator and bears initiate selling, establishing a new resistance line. Price then drops until an Automatic Reaction (AR) takes place, leading to a Secondary Test (ST).
Phase B – Similar to Phase B in the Accumulation Schematic, this phase is where the Composite Operator sells off its investments and realizes profits from previous phases. Bull traps and bear traps may occur within the trading range. An Upthrust (UT) might briefly surpass the BC, setting a new resistance line.
Phase C – Just like the Accumulation Schematic, Phase C in the distribution pattern may or may not occur. An Upthrust After Distribution (UTAD) may result in a new high. However, the absence of this event does not mean that the remaining schematic phases will not occur.
Phase D – This stage represents the last opportunity for investors to sell at higher prices before a price capitulation ensues. Typically, a Last Point of Supply (LPSY) is identified within the trading range, followed by a buy/sell reaction and the identification of another LPSY at or below the support line, triggering Phase E.
Phase E – The downward capitulation begins with a clear break below the trading range as investors sell off, resulting in diminished demand and a plummeting price.
Trading the Wyckoff Approach in Crypto Futures When employing the Wyckoff approach in trading, it’s crucial to recognize that market cycles are not uniform. Numerous external factors influence markets, making it unrealistic to expect a standardized Wyckoff maneuver every time.
It is essential to stay informed about the phases of each pattern, particularly when Phase A of either pattern has occurred. This phase marks the lowest or highest point (accumulation or distribution, respectively) where placing stop-loss orders is advisable.
The most opportune time to enter a trade is during Phase E of accumulation when a Markup is underway. Monitoring previous trends can assist in determining the current phase and identifying potential Last Points of Support or Last Points of Supply. Paying attention to trade volume can also aid in pinpointing these moments.
For instance, during the first four months of 2021, the crypto market underwent a distribution phase, as evidenced by the Binance BTC-USDT perpetual contract chart. Recognizing the initial bounce as an indication of a potential distribution phase would have been advantageous.
Marking support and resistance levels, setting up stop losses, and preparing for a Bullish Spring (where a new all-time high occurred) could have been beneficial. In this scenario, the candlesticks were not green, signaling that the Composite Operator had started selling off, and a market correction was imminent.
In any case, maintaining an open mind and analyzing market conditions diligently are essential due to the fact that basic charts may not always serve as foolproof guides. A meticulous analysis is key in navigating the Wyckoff method effectively.
Conclusion
The Wyckoff Method is a valuable approach for analyzing and trading cryptocurrencies. This comprehensive guide has provided a thorough overview of the method, including its primary principles, patterns, and phases. By understanding the concepts of accumulation, distribution, and the interplay between supply and demand, traders can identify potential market trends and make informed decisions.
While the Wyckoff Method can be applied to crypto markets, it is important to consider the unique characteristics and volatility of digital assets. The patterns and phases described in this guide serve as a roadmap, but external factors and unexpected events can impact market dynamics. Therefore, traders must remain adaptable and conduct diligent analysis to effectively utilize the Wyckoff Method in crypto trading.
