Analysis of supply and demand on bar charts, through examination of volume and price movements, represents one of the central pillars of the Wyckoff method. For example, a price bar that has wide spread, closing at a high well above those of the previous several bars and accompanied by higher-than-average volume, suggests the presence of demand. Similarly, a high-volume price bar with wide spread, closing at a low well below the lows of prior bars, suggests the presence of supply. These simple examples belie the extent of the subtleties and nuances of such analysis. For instance, labeling and understanding the implications of Wyckoff events and phases in trading ranges, as well as ascertaining when the price is ready to be marked up or down, is based largely on the correct assessment of supply and demand.
Wyckoff’s first and third laws described above (Supply and Demand and Effort versus Result) embody this core approach. Conventional wisdom of much technical analysis (and basic economic theory) accepts one of the obvious insights of the law of Supply and Demand: when demand to buy shares exceeds sell orders at any time, price will advance to a level where demand decreases and/or supply increases to create a new (transient) equilibrium. The converse is also true: when sell orders (supply) exceed buy orders (demand) at any time, equilibrium will be restored (temporarily) by a price decline to a level where supply and demand are in balance.
Wyckoff’s third law (Effort versus Result) involves identifying price-volume convergences and divergences to anticipate potential turning points in price trends. For example, when volume (Effort) and price (Result) both increase substantially, they are in harmony, suggesting that Demand will likely continue to propel price higher. In some instances, however, volume may increase, possibly even substantially, but the price does not follow, producing only a marginal change at the close. If we observe this price-volume behavior in a reaction to support in an accumulation trading range, this indicates absorption of supply by large interests, and is considered bullish. Similarly, huge volume on a rally with minimal price advance in a distribution trading range demonstrates a stock’s inability to rally because of the presence of significant supply, also from big institutions.
“May your longs go up, your shorts go down and your flat positions stay sharply unchanged. Safe trading.”
Nick