The Wyckoff Common Sense Approach to Volume As most of you know, I have been studying Richard Wyckoff for many years and have incorporated several of his methods in my trading. However, the one elusive technique that he used, volume, has always eluded me. Although I fully understand the concepts of accumulation and distribution, as well as the low volume test, on the live edge of the market, the volume analysis was quite hard, if not impossible for me to grasp. Back in April of this year, I partnered with FulcrumTrader.com, a company that specializes in Cumulative Delta. The reason was quite simple -- their approach to volume was easier for me to understand, see, and use on the live edge of the market. Their approach to volume was very reminiscent of what I had read in the Wyckoff books but with an easier visual format to identify the patterns. In fact, I began to believe that Wyckoff used the cumulative delta approach so I pulled out all my Wyckoff books and began to study again. Wyckoff has long been credited with using volume spread analysis. And, he did but much differently than what we know volume spread analysis to be. Most of us believe that volume spread analysis is the measurement of who is controlling price and the calculation used is often some sort of average of the up volume versus the down volume (buyers versus sellers) with price movement added in to the calculation, i.e. how far price moved upwards versus downwards (often measuring close to close). Wyckoff actually looked at it quite differently. To understand how he looked at volume, let me first remind you that Wyckoff was a "tape reader". Before we had the luxury of having instant access to data, traders used the ticker tape to get their information. The ticker tape sent out notices which included the symbols, number of shares traded, and the last traded price. Each time a symbol was bought or sold, the ticker tape buzzed. By following the price and shares traded (volume), Wyckoff could make a decision as to whether to buy or sell. Wyckoff describes the importance at looking at each the orders on the ticker tape in his book, The Day Trader's Bible Or.... My Secrets of Day Trading in Stocks, which was originally published by Ticker Publishing, 1919. In Chapter 5, Volumes and Their Significance, Wyckoff states: "First of all we must recognize that the market for any stock -- at whatever level it may be -- is comprised of two sides, represented by the bid and the asking price. Remember that the "last sale" is something entirely different from the "market price". If Steel has just sold at 50, this figure represents what has happened. It's history. The market price of Steel is either 50 shares at 49 1/8 or 50 shares at 50 1/8. The bid and asked prices combined form the market price.
The market price is like a pair of scales, and the volume of stock thrown out by sellers and reached for by purchasers, shows toward which side the preponderance of weight has momentarily shifted." Herein lies the difference. Tape readers, like Richard Wyckoff, were always watching the tape and calculating the difference between orders that went off at the bid versus orders that went off at the ask. Wyckoff goes on to explain that by using the ticker tape readers, traders can surmise the balance between supply and demand. He gives the following ticker tape example for Union Pacific: Movement Down Down Up Down Down
Shares 500 200 500 200 500
Price 183 182 7/8 183 182 7/8 182 3/4
Using the Wyckoff method, the tape reader would be calculating who was controlling price with each new ticker. Therefore, sellers sold 500 shares at 183, then another 200 at 182 7/8. Buyers then bought 500 shares (still 200 shares ahead for sellers), then another 200 shares for sellers (sellers now at 400), and then another 500 shares for sellers (total now at 900). While the total volume traded was 1900, there are only 900 shares outstanding and they are on the short side of the market. Therefore, the tape reader could surmise that supply had overcome demand and price would continue downwards. (Wyckoff coined this as the "rapid-fire common sense" approach to tape reading.) Now, let's look at an example of a ticker tape reading for Microsoft. Symbol MSFT MSFT MSFT MSFT
Shares 100 200 300 500
Price $25.00 $25.25 $25.50 $25.25
There are four trades with a total volume of 1100 shares. There were 600 buyers and 500 sellers. Buyers controlled the volume by 600 shares, therefore, buyers controlled price. This is typical volume analysis (although it would be an average of the volume with a comparison of where the close was and since the close on the down bar was only one tick, it would be safe to assume that buyers controlled the bar). The typical volume spread analysis bar would be very similar to Figure 1 below.
Figure 1: Volume Spread Analysis Bar Now let's use the same data for a cumulative delta volume analysis. The bid was hit three times and the total volume at the bid was 600 shares. The ask was hit on the last trade at 25.25 and the total volume at the ask was 500. The difference is 100 shares at the bid price (showing that although buyers outnumbered the sellers, sellers did come in strong on the bar). We can further deduce that there are only 100 shares controlled by the buyers still in the market. Visually the representation is quite different. Cumulative delta is often displayed as a candlestick bar. The cumulative delta bar visual representation is shown in Figure 2 below.
Figure 2: Cumulative Delta Bar
In the next two examples, prices are along the bottom of the chart and the volume bars are in the center (each horizontal line represents one share). To simplify this, we are not going to consider the open, high, low or close of the price bar, just volume, plain and simple. If there were more contracts sold, then the volume bar is red and if there were more contracts bought, then the volume bar is green. Figure 3 shows the display of a typical volume study. Figure 4 shows the Cumulative delta bars, based on the same information.
Figure 3: Typical Volume Study
Figure 4: Cumulative Delta Study In Figure 3, we can see the total volume and based on the color of the bar, we can tell if buyers or sellers controlled the bar. We could also surmise that a large number of sellers came in at 54 (buyers taking profits perhaps). Now let's look at Figure 4. We can see that buyers came in at 50, sellers took control at 51 but could not push price lower -- forming an area of support for price to go up and it does. At 54, sellers appeared and although price went to 55, sellers still dominated.
However, since cumulative delta shows us the accumulated shares, we also know that although sellers are in the market, there are still buyers holding contracts and, therefore, this may just be a pullback in the trend. And, how do we know that buyers are still in the market? As I stated before, Cumulative Delta shows the accumulated shares. Therefore, in Figure 4, the Cumulative Delta began at zero. Looking at Figure 4, we can see there are a total of 35 shares that were purchased. Out of the 35 shares, only five shares were actually sold at the top. Therefore, there are still 30 shares being held. However, referring back to Figure 3, we do not have this information. And, more importantly, does this information make a difference? Well, ask any of the floor traders who have made the change to trading from home. I have talked with a lot of them and the one comment they always make is: "I am struggling because I can no longer feel the market". In September, TradersHelpDesk.com and FulcrumTrader.com will have a series of cumulative delta indicators available that, when combined with our THD ADX and THD RSI, will give traders the edge that they have been searching for.
