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Wyckoff Part 1: Defining A Trend

05/09/00 12:03:06 AM
by Sean Moore

Richard D. Wyckoff outlined the necessity for defining the market trend in his classic stock analysis method first published in the early 1930s. Seventy years later, this remains an important concept for traders in a variety of financial markets.

Security:   NASDAQ
Position:   N/A

The Wyckoff method, developed by Richard D. Wyckoff in the early 1930s, has aided traders in their pursuit for successful trading since its inception. The goals of the method are simple:

Select securities that will move soonest, fastest and farthest.

Limit losses and let profits run.

Make the most efficient use of investment capital.

The philosophy of Wyckoff's teachings rests squarely on the law of supply and demand - when demand exceeds supply, prices rise; and when supply outpaces demand, prices decline. This universal theory can be applied to a variety of financial markets - stocks, bonds, options, or commodities.

The first basic building block for the Wyckoff method is the determination of the present position, and the probable future trend of the market. Then the trader decides whether the market is in a long (buy or cover), short (sell or sell short), or neutral position. To obtain an overall view of the market trend, look at a composite index chart, such as the Dow Jones Industrial Average, the S&P 500 Index, or the Nasdaq Composite Index.

Figure 1: Supply (resistance) and demand (support) lines for the Nasdaq Composite Index.
Graphic provided by:
Uptrends can be charted using a demand line and an overbought line. A demand line shows an advancing angle in a bull market by passing through two successive points of support (the lowest points of two successive reactions). An overbought line is drawn parallel to the support line and passes through the first point of resistance (top of rally) that occurs between the support line's successive points of support (Figure 1).

Downtrends are defined with a supply line and an oversold line. A supply line shows the angle of decline in a bear market by passing through two successive points of resistance (tops of rallies). An oversold line is drawn parallel to the supply line and passes through the first point of support (lowest point of a reaction) that occurs between the supply line's two successive tops (Figure 1).

If the market is in a neutral position, the trading range is determined with a support level and a resistance level.

For a trending market, the demand and oversold lines provide support, while the supply and overbought lines provide resistance. Demand and oversold lines alert a trader to buy or cover, while supply and overbought lines indicate it's time to sell.

These types of supply and demand lines can help the trader identify the trend and enter and exit trading positions with a little more certainty. For the Wyckoff method, this trend identification is the first step in determining what your trading position will be.

Sean Moore Staff Writer.

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