Richard Wyckoff is one of the most famous traders and analysts in the stock market. He invented many ground-breaking concepts in technical analysis which still remain valid today. One of his greatest contributions is his analysis in the different stages of the market. According to his work (e.g. Wyckoff, 1931), the share price of a company usually goes through four stages. Each stage has different characteristics in terms of fundamental and technical behaviours, and should be handled differently as a result.
The first stage is Accumulation. It is a long period of neglect and sideways movement. Fundamentally, the earnings usually lack surprise or growth, and nothing notable comes out of the company. The price usually oscillates around its two-hundred-day moving average. If it has a previous active period, then the volume in this stage is usually lower.
Value investors usually hope to bottom-fish the “undervalued” companies selling at a discount. While there is nothing wrong with that, it requires extreme patience to bear with a frustrating and fruitless period. Even if they are fortunate enough to pick the exact bottom, the price usually just sits there without much progress for months or even years. For other kinds of investors, it makes more sense to wait and buy wait on the side-line no matter how appealing the option is looking right now. As explained before, the trend is not in place yet.
The second stage of the cycle is Mark-up. The price starts to make higher highs and higher lows on the charts. The volume is often large on up-days and up-weeks as compared to down-days and down-weeks. The price must at least have rallied thirty percent off its annual low. The two-hundred-day moving average starts to turn up, and trails behind the price curve along the way.
The greatest time to buy shares is when the Accumulation period has just ended and the Mark-up period has just begun. All greatest runs of the best winners in the stock market happen during the Mark-up period. This is the time when you should look for companies with great fundamentals, like earnings acceleration or new innovative products.
The third stage of the cycle is Distribution. In this stage, the big holders start to distribute their shares to the public for a profit. Although the company is still enjoying growth, it starts to slow down. The price movement starts to become more erratic and large price swings are usually seen. Volume on down-days starts to pick up. The two-hundred-day moving average starts to turn flat and intersects with the price more often.
If you still hold some shares of the company, you may consider selling them as the price rallies, because if the general market turns sour, there could be a lot of room for the price to go south.
Finally, it comes to the Mark-down stage. Eventually, the company will miss earnings and there comes a negative surprise. For retail businesses, one may discover that the inventory starts to build up, which is often a result of diminishing demand or increased competitions. Technically it is just the opposite of the Mark-up stage. The volume on down-days and down-weeks is larger. The price starts making new lows. The two-hundred-day moving average turns down and hovers above the price curve.
After the Mark-down is done, the share price goes back to the first stage: a long boring period of consolidation and neglect. And the cycle starts all over again, assuming the company does not go out of business and the big holders are willing to drive up the share price once more.
Wyckoff’s cycle analysis is a valuable tool to traders of the stock market. It gives the traders an idea when should they trade and when they should not trade. As they say, the trend is your friend, and one should only enter a trade when there is a directional market. Therefore, on one hand, it is not a good idea to act during Accumulation or Distribution because there is a higher chance of whipsaw. On the other hand, it is much more favourable to buy during the Mark-up stage (or sell during the Mark-down stage) because you are going with the tailwind of institutional money.
REFERENCE:
Wyckoff, R. D. (1931). The Richard Wyckoff Method of Trading in Stocks. New York, NY: Wyckoff Associates.
No comments:
Post a Comment