Market Cycle theorytheorem was constructed by Richard Wyckoff, a pioneer in technical analysis. It is a method to extract buying and selling convictions of very large traders, by looking at the patterns of their activity that is imprinted on stock prices. This method is very powerful and as relevant today as it was decades ago due to the how it was constructed. The basis of the method is reflective upon the general concentration of stocks in the hands of a few institutions. In 2013, the top 10% of people in USA have ownership of 81.4% of all traded stocks within the country, whereas the other 90% only have access to the remaining 20% of stocks. It produces the effect of which only few people have the capacity to significantly move the stock market’s supply and demand. The sheer volume and money being passed around when they trade exerts large buying and selling pressures, and hence the stock market moves with them.
Since they are the main “market movers”, it is a smart position to swim with them rather than against them. It can be seen why by knowing their trading convictions, a small player can align himself with their activity and interest, of which by default, aligning himself with the market.The Market Cycle proposed a 4-stage cycle. Wyckoff’s idea was that these cycles exist to take advantage of uneducated public’s inappropriate reactions to price movements, with the perpetrator being the few large institutions making the gains. For each phase of the cycle, 3 assumptions will be considered:- Market is understood using a simplified model focusing in the psychology of two major groups: the smart money players who are the market drivers, and the general uninformed public.- Crowd psychology of the public (the 90%) inclined the individuals in it to naturally make mistakes that are in favor of the smart money.- Distinctions and patterns of each cycle are considered through purely price perspective. This is important due to it provides excellent context for many trading patterns and methodsThe 4-stages are summarized below:AccumulationAccumulation is a sideways range where large players buy carefully without moving the price.
The public is not alarmed of what is going on; the market is off the radar and out of the public focus under this cycle. Although, sometimes the some circle of large players would make a mistake or impatient by large buying the stocks, spiking the trade volume on that moment in time. This is called “fat-finger” error.MarkupMarkup is the classic uptrend. The public is now aware of the price movement and starts buying the stock, which elevate the prices further. Smart money players who were in accumulation phase may sell some of their bough stocks due to the uptrend, or hold and wait for higher prices later.
DistributionDistribution is a point where the uptrends ends and flattens out. Smart money players sell the remainder of their stock to the public, who are generally still anticipating higher prices. Really smart money may even sell stocks more than their own, going into short in this range.MarkdownMarkdown is the classic downtrend that follows distribution. Smart money players who are in short will buy back some of their initial shorts. At some point, the public realizes that higher prices are not possible.
Hence, they often panic and sell their position. The existence of this panic, more often than not marks the end of the downtrend.