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 Shares Price

Down 500 183

Down 200 182 7/8

Up 500 183

Down 200 182 7/8

Down 500 182 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 Shares Price

MSFT 100 $25.00

MSFT 200 $25.25

MSFT 300 $25.50

MSFT 500 $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.