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Wyckoff Part 5: Timing Is Everything

06/06/00 02:03:57 PM
by Sean Moore

When should your next trade be established? According to the Wyckoff method, you want to follow the trend of the overall market and enter a position when the market is primed for a reversal. With improved timing, you'll be able to take full advantage of the market trend.

Security:   DJIA
Position:   N/A

One of the basic principles of the Wyckoff method, developed by Richard D. Wyckoff, is to trade with the overall market trend. According to Wyckoff, this will help yield the greatest profits and also help to reduce risk. Sure, profitable trades can be found trading against the trend of the overall market, but these kinds of trades tend to lend themselves to greater risk. Step 5 of the Wyckoff method focuses on trading securities that are following the overall market trend and trying to maximize the potential for profit by entering and exiting positions when the overall trend is ready for a reversal.

This task depends upon some measurement of the general market. This can be any sort of market index. Typically, you would choose an index that represents the securities that you're interested in trading. So, if you are interested in technology stocks traded on the Nasdaq, then you would use the Nasdaq as your general market barometer. When looking at the overall market trend, you want to be able to identify and predict market tops and bottoms. These are the points at which you should begin to watch the securities that seem to be closely following the market trend. By entering your positions with a turn in the market, you are maximizing your profit potential.

One of the main reasons for a market reversal has to do with the law of supply and demand. One effective way to measure this supply/demand relationship is by studying the market volume. Look for areas where volume tails off in an uptrend. This is a great indication that the market is overbought and a reversal could be right around the corner.

Figure 1: Price and volume chart of the Dow Jones Industrial Average.
Graphic provided by: TradeStation.
Figure 1 shows the daily price and volume data for the Dow Jones Industrial Average. Points 1, 2 and 3 depict market tops or bottoms. These are the points that you want to be able to identify. The drop off in volume at point A is an indication that a reversal is imminent. The on-balance volume indicator (OBV) can also be used to help relate volume and price. Notice at point B that the uptrend on the OBV line is broken, another sign of a reversal. The trendline from point C to D shows steady increases in volume. This is a strong indication that the market is preparing for a turn, and buyers are becoming increasingly interested. The trendlines from points E to F represent an interesting scenario. The price continues to make slight gains, but the OBV indicator is trending in the opposite direction, downward, indicating that the volume on down days is outpacing the volume on up days. This divergence of trends can also be seen as a likely clue for a market reversal.

Being able to identify these market reversals in a timely fashion is certainly something that takes a great deal of practice. But, if you're able to do so, you'll be happy with the results. By analyzing the general market trend and focusing on the issues that are following the general market, you can look to improve your timing and reduce your risk.

Related Articles:

Wyckoff Part 1: Defining A Trend

Wyckoff Part 2: Determining Relative Strength And Weakness

Wyckoff Part 3: Recognizing Potential

Wyckoff Part 4: Supply vs. Demand

Sean Moore Staff Writer.

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