Wyckoff 2.0: Structures, Volume Profile and Order Flow

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Prologue

With the publication of this new content we give continuity to the first book The Wyckoff Methodology in Depth, where all the analytical tools that this methodology covers are presented in a clear way, as well as the more theoretical aspect in the study of the behavior of financial markets. 

In this book we will go a step further and discuss more complex concepts; we will review the doubts most commonly raised by students of the methodology and incorporate new tools based on the information provided by the volume data that will be very useful, such as the Volume Profile and Order Flow. 

I strongly recommend that before starting the study of this book you have previously internalized all the concepts covered in the first one, since everything seen is taken as understood and, if not, it could cause some confusion or lack of understanding.

Part 1. Advanced concepts of the Wyckoff methodology

Both the previous book The Wyckoff Methodology in Depth and this one do not intend to divulge at any time the approach of the Wyckoff methodology from its purest point of view. There may be Wyckoff operators who do but we understand that today's markets have changed substantially from those studied by Richard Wyckoff and it is our task to know how to adapt to these changes.

But if there is one thing that is invariable and where the advantage of this approach over others really lies, it is the principles on which his teachings are based. Regardless of how markets and their operators have changed, everything continues to be governed by the universal law of supply and demand; and this is the cornerstone of the methodology.

This new way that I propose to analyze the markets has caused me some discussion with known (purist) disseminators of the method. As I said, my objective is not to teach the most primitive form of the methodology, but to take the principles I consider valid and enhance them together with the most modern tools of volume analysis.

In fact, I believe that spreading Richard Wyckoff's teachings as he shared them is practically impossible. In the end, each one teaches his point of view of the methodology together with the tools that give him more confidence; and this does not mean that any one is above the rest. The important thing is to obtain profitability from the market regardless of the approach used.

Having said that, I am sure that if Richard Wyckoff were alive today, he would have taken care to evolve his own teachings by adapting them to new markets. As he was at the time, he would still be a student of volume, and this would have led him to delve deeper into tools such as the Volume Profile and Order Flow.

And this is exactly what we have done and what I will present to you throughout the book; bringing together the most solid principles of market analysis with the most advanced tools of volume analysis.

But before we get to that point let's add some advanced concepts that you should know and clarify a number of doubts that occur frequently.

1.1 The labels

The entire theoretical section seen in the first book is a necessary and indispensable content to master this approach and truly understand how the market moves, but the Wyckoff methodology, or my way of understanding it, goes much further.

It is not simply a matter of labeling a chart almost robotically and that's it. We've learned what's behind each event; how it's formed, how it's represented on the chart, the psychology behind it, and so on. But as I say, the method is much richer.

I mention this because, by the very nature of the market, it is practically impossible for two completely equal structures to occur. Although it is true that every day we see book diagrams, which are very genuinely adapted to the classic examples, in most cases the market will develop less conventional structures, where the identification of such events will be more complex.

It is therefore essential not to focus on the exact search for the events (mainly the stop events that make up Phase A) and to stay with the fact that what is really important is the action as a whole. That is, in many chartics we will see that a trend movement stops and starts a lateralization process, but we are not able to correctly identify those first 4 stop events. Maybe in view of this, we discard the asset and we are missing a future operational opportunity. This is a mistake. As I say, the important thing is not that we are able to identify those 4 stop events, but that the market has objectively stopped the trend movement. It may not identify the Climax, the Reaction and the Test in a genuine way, but the objective is that the market has stopped and has started a change of character (migration from trend to lateral state).

As we see in the examples, although these structures do not look anything like the classic ones already studied; if we open the chart and we find ourselves in that point that I mark with the arrow, it is not unreasonable to think that possibly below they have developed a process of accumulation. It will be more or less difficult to identify the events of the methodology, but the objective is that we see a level where the price has rejected on several occasions (Creek) and that it has finally managed to break through and position itself above. This is the key.

Surely if we force ourselves we can label each and every movement but I repeat that this is not the important thing. What is important about the methodology is the logic behind it: that for the price to go up there must first be an accumulation; and for a distribution to go down. The way or manner in which these processes develop should not be the determining factor.

The level of open-mindedness required is very great. Some may even have their heads blown off, but this is the reality. Fortunately we often see classic structures but the continuous interaction between supply and demand means that these processes can develop in infinite ways, and we have to be prepared to see them as well.

Rather than thinking about labeling each and every price movement, let's focus on trying to identify according to the fingerprints we observe who is probably gaining market control based on the theory studied.

1.2 Price & Volume

In our way of conceiving the market analysis initially we do not value the possibility of not taking into account any of these two data, price and volume. But as you delve deeper into the ecosystem that surrounds the financial world, you begin to see some pitfalls.

Without going too far, I have to say that in my view the price data are certainly more relevant than the volume data. And I will now reason out this statement on the basis of two elements.

On the one hand, the intraday volume that we can analyse on any asset can be very misleading depending on the time of the session. For example, at the opening of the S&P500 US session in its local time (ETH), we will always see a large volume, much larger than that seen prior to that opening during the regular time (RTH). And of course, all of the previous analysis will be somewhat biased.

As we can see from the ES chart (SP500 future), the highest volatility and therefore price shift occurs during the American session, with the lack of participation during regular trading hours being very clear. It wouldn't make much sense to analyze the overall price and volume action as it could lead to confusion.

It is not that during regular hours we have identified a movement with lack of interest (low volume); but that low volume is due to an absence of traders at that time. The same would happen with other moments of the session, such as at the mid-day stop or just before the start of the day's final stretch, when there is also a significant increase in volume.

Once we know this, we have two ways to solve this situation:

If we want to continue operating in intraday time frames we must necessarily analyze price and volume in comparative terms; on the one hand that observed during local time and on the other hand that seen during regular hours.

In addition, the best way to avoid confusion is to analyze the daily chart. As this timing covers both sessions (ETH and RTH), there is no need to distinguish between them for analysis. But of course, this would already require a total change in trading style.

If there is one piece of information that already incorporates all the information, it is the price. The price is the chartic representation of all the orders already executed. We could be analyzing an asset at any time and the price action would be faithfully reflected without having to be aware of the time of the session and perform comparative analysis. This is the advantage of price.

Although without volume we lose a large part of the available information, the continuous interaction between supply and demand leaves its mark on the price and this develops patterns that are certainly repetitive (not in form but in substance).

Obviously I am not recommending trading without analyzing the volume data, it is not necessary, I simply wanted to highlight the prevalence of price over volume for our understanding and trading of the markets.

Later on we will see another drawback of the volume data due to the Over The Counter (OTC) and Dark Pools markets.

1.3 Advanced chart types

In recent times, other forms of representation of market activity have also appeared. Among these types of charts, tick, volume and range charts stand out.

The main advantage of these charts is that they reduce the noise present in the time charts. These three types of charts have the common feature that they eliminate the time variable, which can be very useful precisely for conditions such as those described above, where the market covers different activity environments.

1.3.1 Tick charts

A tick represents a transaction, a negotiation between two parties. Therefore, the tick chart will be updated (the current candlestick will be closed and a new one will be opened) when a certain number of transactions (ticks) have taken place.

The configuration of the chart (the number of ticks) will vary between markets as the volatility is different from one market to another. That's why you will have to make different tests until you find the most suitable one.

Generally the volume will be very similar in all the candlesticks generated, but there will be subtle differences that can give us interesting information since this type of chart measures activity in terms of transactions, but does not take into account the volume or amount traded in those transactions.

In other words, a chart set at 1000 ticks will generate a new candlestick when those 1000 ticks occur, but the amount traded in those thousand transactions will differ. It may be that 1 or more contracts are traded in one transaction.

1.3.2 Volume charts

The difference between tick and volume charts has to do with the amount traded. While the tick chart measures the number of transactions regardless of how many contracts, shares or units have been traded in each; the volume chart measures that number of contracts, shares or units traded before a new candlestick is generated.

For example, a chart set to 1000 volume will generate a new candlestick when that amount is traded, regardless of the number of transactions that were required to complete it.

The main negative aspect of using this type of chart is that it disables us from using volume analysis techniques

1.3.3 Range charts

While the two types previously presented based their representation on volume data, the range chart is based on price data.

This type of chart represents market activity from the point of view of price movement. All of your bars will be displayed with the same size, regardless of how long it took for them to form. In high volatility environments more bars will appear and vice versa for low volatility environments.

If you set the chart to range 15, new bars will appear when the price moves 15 ticks in one direction or the other.

1.4 Accumulation or distribution failure

When the analysis of all the traces that are observed on the chart suggest that the imbalance is occurring on one side but at the moment of truth the opposite side is pressing more aggressively, we are talking about a failed structure.

During the development of the structures, the control of the market is at stake and it can change sides (in favour of buyers or sellers) continuously, depending on the types of operators and the valuations they make of the asset.

Since we know that until the effect of a cause is visualized we cannot determine what it is (accumulation or distribution), it would almost be logical to avoid using this term of failed structure since really a failed accumulation will always be a distribution structure and vice versa. But it is a very interesting concept that helps us to understand an important dynamic of the market, which is none other than the knowledge of the different types of operators and how they intervene on the basis of temporality.

When the price makes a potential Spring at the low of the structure and from there it manages to reach again the high part of the same one, it is obvious that down there the buyers have entered with certain aggressiveness; but we do not know when these will decide to close their positions. It could be that they are simply very short term traders who take advantage of visiting some liquidity zone (either at the top of the structure or in an intermediate zone) to find the counterpart with which to match their orders and close their positions there obtaining benefits. This closing of buy positions would cause a loss of upward momentum and possibly a new downward turn.

Or, traders who have bought in the Spring may have a longer term perspective and do their best to stay in the market and defend their position if necessary, resulting in the full development of the build-up.

Also, we do not know if there can be longer term traders, with a greater capacity to move the markets pending that upward movement to take advantage of it and go short aggressively.

On the other hand, we also have to remember that not all the big operators win in a systematic and recurrent way over time. Sometimes many of them are forced to assume losses and this context of failed structure could be a perfect example. As Al Brooks says in his books on Price Action, in liquid markets every single price movement is generated because one big trader is buying and another one is selling. It is a battle between these big capitals and therefore there will be part of them that will generate losses in some of their operations.

The key to determining that we are facing a failed structure is that it has absolutely all the traces in favor of one direction but at the decisive moment (in the test after the break), it fails and generates an imbalance in favor of the opposite side.

For the example of failed accumulation, we would have to see that all the traces suggest that the control of the market is in the hands of the buyers, that in addition the price has to develop a potential spring, that the upward break is genuine from the point of view of the price and volume action; but that finally in the position of potential BUEC the price does not manage to continue rising, and an imbalance is caused in favor of the sellers, leaving the structure as distributive.

Exactly the same but in reverse we would need to see to determine a failed distribution: traces in favor of sellers, development of potential Upthrust, genuine downward breakage and in test position after breakage aggressive buyiung that rotate the structure as accumulation.

It is important to be aware that we do not know the capacity that the operators have to continue controlling the market since at any moment a operator with a higher capacity can appear and cause the rotation. What at first seemed to be unbalanced towards one side, finally with this new appearance makes the imbalance to be confirmed towards the opposite side.

So we have these two very important casuistries to evaluate:

We do not know the intention of the operators who are supporting the current