Wyckoff's three laws and the Composite Man

What it is

Richard Wyckoff, writing in the early twentieth century, built his method on three laws. The law of supply and demand: price rises when demand is greater than supply and falls when supply is greater. The law of cause and effect: a trading range (the cause) builds up the energy for the trend that follows (the effect), and a bigger range supports a bigger move. The law of effort versus result: volume (effort) should match price movement (result); when heavy volume produces little movement, or a big move comes on little volume, a change may be coming.

He also suggested studying the market as if one large operator, the Composite Man, were behind it: buying quietly in ranges, marking price up, selling into the public's buying, and marking it down. It's a way of thinking, not a claim that one person runs the market, and it is the ancestor of today's 'smart money' idea.

How to spot it

• Effort versus result: a wide, high-volume bar that barely moves price, or a push to a new high on shrinking volume.
• Cause: a long, wide range after a big move.

How to use it

• Use effort versus result as a warning at the edges of a range or the end of a trend.
• Expect bigger trends out of longer ranges, and use the point-and-figure count for a rough target.

Common mistakes

• Treating the Composite Man as a real person you can predict.
• Reading effort versus result on forex tick volume as if it were exchange volume.

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