Follow The Smart $$: Let Candles & Volume Guide The Way

[brownsfan019 17]

Follow The Smart $$: Let Candles & Volume Guide The Way

 

January 2009

By Todd Krueger

 

Compared to the common bar chart, candlestick charts are visually more capable of revealing the psychology and sentiment behind a price movement. This occurs as a result of the techniques used to create the candlestick. Each candle clearly shows the relationship of the open versus the close price. For example, when the close is higher than the open, a hollow body is displayed (to make the charts easier to see, hollow candles are replaced by green bodied candles for this article), when the close is lower than the open, a filled in, or solid body is assigned (these will appear as red bodies in this article).

 

 

To show the overall range of the bar, the high and low are displayed with a line that emerges from the body of the candle, these are known as the upper and lower shadows. It is the interrelationship between the size and position of the body, large or small, and the size and position of the upper and lower shadows, long or short, that create various candle patterns. For this article, I focus on one popular pattern called the doji. But first, let’s talk about Western methodology.

 

 

WYCKOFF’S WORK

 

Nearly a century ago while Japanese candlestick charts remained a closely guarded secret in Asia, an American trader by the name of Richard D. Wyckoff began to publish his methods of detecting supply and demand imbalances in the market. In his 1909 book, Wall Street Ventures and Adventures through Forty Years, Wyckoff introduced his discovery that it was possible to measure the force of buying and selling pressures in any freely traded market.

 

 

Wyckoff’s research revealed that a trained chart reader could determine, with a high degree of accuracy, the cause behind price movement, whether it was to buy without moving the price up (accumulation), or to mark the price up/down or even to discourage buying or selling by the mass public (the herd).

 

 

A BIG FOOTPRINT

 

Wyckoff’s lifetime of research proved that future price moves were foreshadowed on the price chart because the “composite man” or “smart money” must leave its trading footprint on a price chart due to the sheer size of its trading volume. It is the supply and demand imbalances created by smart money that is the cause of price movement. Their activity is measured with four simple variables:

 

 

• Price movement (high, low and closing price).
  
• Trading volume.
  
• The relationship between price movement and volume.
  
• The time it takes for the price movement to run its course.
  

 

 

PUTTING IT TOGETHER

 

Imagine if you will that Wyckoff and the Japanese rice traders had lived in today’s society where global information is easily shared. By sharing his research with the rice traders, Wyckoff would have discovered that he was

leaving out an important piece of the puzzle in his analysis: the relationship of the opening price to the closing price and its relationship to the overall trading range. Because he only looked at the high, low and close on a bar chart, his already good analysis could have been greatly improved by adapting his analysis to the candlestick chart. This enhanced view of the market would have further identified and refined the true sentiment and psychology of the smart money, which Wyckoff was measuring.

 

 

Also, imagine the true amazement that the rice traders would have experienced when they learned how to apply Wyckoff‘s volume analysis techniques that identify supply and demand imbalances from the smart money. It is debatable whether these early rice traders even incorporated volume into their candlestick analysis, but even if they had, it would not have been as accurate or revealing as the techniques applied by Wyckoff in his analysis of the price and volume relationship.

 

 

When these two East and West methodologies are combined, a powerful synergy is formed. Each methodology contributes precisely what the other lacks. This new combined methodology is known as Wyckoff candle volume analysis (WCVA).

 

 

VOLUME AND CANDLES IN ACTION

 

For this article, I apply WCVA on a one-bar reversal pattern known as the doji. This is a candlestick pattern that occurs when the opening and closing prices are the same or very close to each other. The shadows can be either long or short, and there can be various types of doji bars. But for the following examples it is not important to distinguish the type of formation, it is only important to be able to recognize what it looks like on a chart (see Figure 1).

 

 

This formation is said to represent market indecision because the market opens, trades throughout the charted period, then closes at or near the opening price. It represents a battle between bulls and bears that neither won. It is widely believed that it represents a better reversal pattern at the top of the market than at the bottom, although you will learn that this is not correct under the proper circumstances. By applying WCVA, you will learn how to distinguish when there is no indecision in a doji formation.

 

 

At the bottom of a market, a Wyckoff technician is looking for tests of supply in the market. A test occurs when the price is marked down to see if greater volume comes in at the lower price. If it does, this signifies supply is in the market. This supply must be removed before the market can begin any substantial up move. However, if the market is marked down and no sellers emerge at these lower prices, the price will come back up to close off the low, volume is lower relative to the prior candles. With no supply present at the current price level, the price should rise.

 

 

The “doji test” bar must exhibit the following parameters to be valid:

 

1. It must have a low that is lower than the previous candle’s low.

 

2. It has to display lower volume than at least several of the prior candles. The lower the volume, the stronger the indication of no supply being present.

 

 

Let’s take a look at the first of two examples that are defined as “doji test” bars. Figure 1 is a 15-minute chart of the E-mini S&P. Notice the nice downtrend in the near background. Looking left on the chart, five candles prior to the highlighted doji, the high was 1,234.25. Then the market dropped 17.25 points in 75 minutes to the low on the doji of 1,217. This sets up the ideal conditions for this formation to occur. Remember what I wrote earlier, the test candle makes a new recent low, and if there is reduced volume, it shows that no supply is present.

 

 

FEW INTERESTED SELLERS

 

You can see that this doji is making a new low on the chart, and the volume is lower than all of the previous candles. By standard candlestick analysis measures, one would come to the conclusion that this bar represents indecision on the part of the market participants. However, when viewed from a WCVA perspective, it is clear that no indecision exists here. The chart shows that there are few interested sellers at this lower price and the price comes back to close near the open. Within the next four hours of trading this market jumped more than 25 points.

 

 

With this formation, it is important to understand that the smart money, which represents a large percentage of the overall trading volume, is not selling as lower price levels are explored. This is clearly evident and is shown by the reduction in total volume. If the smart money is not selling, retail traders need to be aware of this. This will prevent them from selling at market bottoms and allow them the opportunity to establish a long trade into the path of least resistance.

 

 

Figure 2 shows a daily chart of Ryder stock. Again, in the near background is a nice downtrend. Because of the size of the chart, it may be hard to see the price scale, but just 10 candles prior to the highlighted candle, the high price was $61.19 per share. The low of this doji test was $54.95, which represents more than a 10 percent drop in the value of the stock in just 10 trading days. Once again, notice how the volume gets lower as the doji candle tests for supply but does not find an increase in interested sellers at these lower price levels.

 

 

If there are no sellers, the price should increase. The price of this stock rose nearly 19 percent in the next nine trading days, as there were no sellers present to stop it from increasing in value. In fact, you can see from the gap-up opening the next day at $57 that the specialists marked the stock up as there were no sellers of size on their books. The price closed on the very high of the day at $59.08 demonstrating the built-in demand that this WCVA formation represents.

 

 

WANING DEMAND AT TOPS

 

Now let’s look at a doji at the top of a market. This formation is called “doji demand drying up.” At the top of a market, a Wyckoff technician is looking for signs that demand is waning. A lack of demand occurs when the price is marked up to see if there are willing buyers at these higher price levels, but as the price moves up, trading volume decreases. This is a telling sign that there is no interest in higher prices from the smart money.

 

 

With no professional buying interest at the current price level, the price should fall. The “doji demand drying up” must exhibit the following parameters to be valid:

 

1. This candle’s close must be higher than the previous candle’s close.

 

2. It has to display lower volume than at least several of the prior

candles. The lower the volume, the stronger the indication that demand has dried up.

 

 

Figure 3 is a daily chart of the big S&P contract. Preceding the doji marked on the chart, you can see that the market has been in an uptrend for the past 23 trading days. As the market moves up to the highest reached in the last month and a half, the amount of interested buyers is drying up. We know this because the volume is reduced relative to the previous candles, even though the S&P is making a new recent high—strong markets don’t behave this way.

 

 

This occurs at the top of the market, and when we apply WCVA, the “doji demand drying up” indicates that at least this phase of the up move is either close to or at the end.

 

 

The close of the doji candle occurred at 1,425.8. Only five trading days later, the market closed at 1,373.4, a drop of more than 50 points. With this formation, it is important to understand that the smart money is not interested in supporting higher prices. This is evidenced by the reduction in overall volume. If the smart money is not interested in higher prices; retail traders can take this knowledge and refrain from buying at market tops, as well as allow them to establish a short trade into the path of least resistance.

 

 

FOLLOW THE SMART MONEY

 

By understanding these straightforward examples, you should now be capable of identifying these formations when they occur on your charts at home. I only had the space to review one candle formation in this article, but the analysis applies to every type of candle pattern.

 

 

Wyckoff candle volume analysis works in all markets and timeframes, and precisely reveals the true psychology and sentiment of the smart money. By trading in harmony with the smart money, we truly trade in the path of least resistance and increase the probabilities of success. This knowledge will empower the individual trader and help prevent buying market tops and selling market bottoms for all who apply these techniques.

 

 

 

Todd Krueger is a professional trader, creator of Wyckoff Candle Volume Analysis and is the founding president of Traders Code LLC, which provides trading tools and education for traders at all levels of expertise. For more information, please visit TradersCode.com. Reach Krueger at todd@traderscode.com.

[brownsfan019 17]

I thought this was a great article combining candles and volume for our Wyckoff friends.

 

In particular, the author is focusing on doji's which is interesting to me. It makes sense in the context of the article and would be worthwhile taking a look at on your charts. Just make sure to look for the parameters set forth:

 

1. It must have a low that is lower than the previous candle’s low.

 

2. It has to display lower volume than at least several of the prior candles. The lower the volume, the stronger the indication of no supply being present

.

[brownsfan019 17]

Also - I know nothing of the author so do your homework before purchasing anything if you visit his site (which is currently not up). Great article and easy to see on your own screens.

[DbPhoenix 42]

Krueger may be a skilled and talented trader, and the concepts and applications presented in the article may be powerful. Therefore, there's really no need to invoke Wyckoff's name in order to lend an air of legitimacy to the proposition. To the contrary, there's absolutely nothing wrong with calling this Krueger Candle Volume Analysis.

 

There's a great deal of Wyckoff wrote this and Wyckoff wrote that floating around the internet, much (most?) of which is not true. Wyckoff, for example, never used the term "smart money" in his course, much less equate it with the Composite Man or Composite Operator. In fact, he pointed out that

there is no Composite Operator, but the effect of the combined operations of bankers, pools, large operators, floor traders

and the public

[bold mine] is, when boiled down on the tape, of the same effect as if it were produced by one man’s operations. It is important that you observe the market from this standpoint, and that your trading operations are based, not on what you formerly regarded as the market’s characteristics but on the fundamental law of supply and demand, which is at the bottom of every move that is made in every stock in the market at all time. This law is working and will continue to work always and forever. There can be no getting away from it. It does not matter whether the buying and the selling, or both, are genuine or artificial, that is, manipulative, designed for a purpose.

Nor did he care much about the open, nor about bar-by-bar analysis, much less about pattern. Again, this is not to say that the concepts and applications presented in the article are not powerful and will not provide enormous clarity to those who are struggling with how to interpret price movement. But while Krueger may have been inspired by Wyckoff's work, this is Krueger (and more power to him), not Wyckoff.

 

A final note: professional money is often but not necessarily "big" money. And big money is not necessarily "smart" money (evidence would suggest, in fact, that just the opposite is true). Big money is just big, and that, in terms of the footprint, is enough for both the retail trader and the professional trader who is himself looking for footprints. For the trader who is not "big", however else he might be characterized, to equate "big" with "smart" can lead to many trading errors, often expensive. "Big" is simply "big", and nothing more. One can either trade with that flow or trade against it. But he should never assume that "big" constitutes "smart".

 

(Incidentally, Wall Street Ventures and Adventures through Forty Years was published in 1930, not 1909.)

Edited January 6, 2009 by DbPhoenix

[OAC 10]

Also - I know nothing of the author so do your homework before purchasing anything if you visit his site (which is currently not up). Great article and easy to see on your own screens.

 

Todd Krueger formerly CEO of http://www.tradeguider.com, also known as "Home of VSA" ?

[OAC 10]

Brownsfan:

I don't recall that you have ever participated in our VSA forums ?

I think they gotcha. :haha:

[brownsfan019 17]

Brownsfan:

I don't recall that you have ever participated in our VSA forums ?

I think they gotcha. :haha:

 

I actually attempted to decipher that stuff you guys talk about and found it was simply not worth my time. This article presents the idea in such a way that my simpleton mind can understand it. Something that was never able to be accomplished over pages and pages of abstract speak in that other part of the forum.

 

 

I simply posted to share the idea as it has some substance behind it being a candle trader myself. The idea presented above incorporates a different view of volume that I might use, but something to consider nonetheless.

[brownsfan019 17]

Krueger may be a skilled and talented trader, and the concepts and applications presented in the article may be powerful. Therefore, there's really no need to invoke Wyckoff's name in order to lend an air of legitimacy to the proposition. To the contrary, there's absolutely nothing wrong with calling this Krueger Candle Volume Analysis.

 

There's a great deal of Wyckoff wrote this and Wyckoff wrote that floating around the internet, much (most?) of which is not true. Wyckoff, for example, never used the term "smart money" in his course, much less equate it with the Composite Man or Composite Operator. In fact, he pointed out that

there is no Composite Operator, but the effect of the combined operations of bankers, pools, large operators, floor traders

and the public

[bold mine] is, when boiled down on the tape, of the same effect as if it were produced by one man’s operations. It is important that you observe the market from this standpoint, and that your trading operations are based, not on what you formerly regarded as the market’s characteristics but on the fundamental law of supply and demand, which is at the bottom of every move that is made in every stock in the market at all time. This law is working and will continue to work always and forever. There can be no getting away from it. It does not matter whether the buying and the selling, or both, are genuine or artificial, that is, manipulative, designed for a purpose.

Nor did he care much about the open, nor about bar-by-bar analysis, much less about pattern. Again, this is not to say that the concepts and applications presented in the article are not powerful and will not provide enormous clarity to those who are struggling with how to interpret price movement. But while Krueger may have been inspired by Wyckoff's work, this is Krueger (and more power to him), not Wyckoff.

 

A final note: professional money is often but not necessarily "big" money. And big money is not necessarily "smart" money (evidence would suggest, in fact, that just the opposite is true). Big money is just big, and that, in terms of the footprint, is enough for both the retail trader and the professional trader who is himself looking for footprints. For the trader who is not "big", however else he might be characterized, to equate "big" with "smart" can lead to many trading errors, often expensive. "Big" is simply "big", and nothing more. One can either trade with that flow or trade against it. But he should never assume that "big" constitutes "smart".

 

(Incidentally, Wall Street Ventures and Adventures through Forty Years was published in 1930, not 1909.)

 

It appears the author was influenced by Wyckoff and while it may not be necessary to mention his name, it does help clarify WHERE he is coming from as this is not traditional candlestick analysis.

 

For those of us that are not Wyckoff-aholics, I'm glad he mentioned it as it lends a base for me to understand where he is coming from. Having spent time here and seen the name plenty, but having never been interested in taking it further, this idea takes something I get (candlesticks) and combines it with something (volume analysis) in a simple and easy to understand fashion; which I've yet to see when the topic is discussed on forums.

 

Simply put, the idea presented here is one that a simple guy like me can understand and work with. It's a very easy to follow explanation and provides very clear entry parameters. It has substance.

 

If the author was influenced by Wyckoff and wants to mention it, so be it. I'm not a devoted Wyckoff follower, so I guess it has no impact on me. It just provides a background from which the idea came from.

[BlowFish 10]

Arguably reducing things down to a 'pattern' has some advantages. Most people know from candlestick literature that it represents 'indecision' or a balance between buyers and sellers. Having accepted that, it makes things simpler in real time to simply look for the pattern in appropriate places. (like at a 20 ema or new high/lows....see I have been paying attention Brown ).

 

One of the disadvantages is that there are other 'patterns' that illustrate balancing of supply and demand. Having said that they all share common characteristics but that's another story. DB puts forward a good case for focusing on the dynamics of supply and demand rather than the resultant patterns.

 

Anyway none of that was the point I originally wanted to make assuming that you are pattern orientated a good pattern (imho) is a doji (or hammer) with very high volume. To go long you ideally want a long legged doji to go short it is less important.

[brownsfan019 17]

Anyway none of that was the point I originally wanted to make assuming that you are pattern orientated a good pattern (imho) is a doji (or hammer) with very high volume. To go long you ideally want a long legged doji to go short it is less important.

 

BF - I would agree w/ you that higher volume is good, but I see where this author is coming from and it makes sense to me. The premise in my head is that you are looking for is a doji after a move on lower volume = no more interest to drive price up/down.

 

Now of course it depends on the context as well. This pattern would hold more water (my guess) the higher the timeframe.

[BlowFish 10]

Indeed. One common theme regardless of which 'school' of volume you come from is, at the end of a move, you will often see high volume 'capitulation' followed by a low volume test.

 

Also corrective moves in an established or developing trend ('pullbacks' if you like) often end with trade drying up and price just 'hanging' there for a bit. This pattern should catch those well.

[brownsfan019 17]

Couldn't have said it better myself. While I've been 'trained' to see those high volume moves you mention, I like how the author presented the idea of the low volume test.

 

For me, it was a great visual representation of the idea.

[HAKUNA 10]

Todd was pretty good at explaining price/volume relationships whilst he was with Tradeguider as well, infact he was their main "Man" , with VSA he mostly focussed on high,low and close of the bar in keeping with Tom William's book, he then introduced the concepts of "Playing field" which I believe he was going to elaborate on with his course..

[matinthehat 10]

This is coming from an absolute beginner, but it does make sense that this style of analysis would work better in a higher timeframe as higher timeframe volume are better representations of the "bigger" guys' moves.

[Sledge 13]

For anyone not aware of Todd's work with Tom Williams and his style vs Tom Williams this may help:

 

Todd has ALWAYS presented himself as a more cautious trader than Tom. Tom sees a bar form of his liking and takes a position right away. Todd had said in many VSA materials that "I'm not as agressive as Tom- I want the market to prove it to me- I want to see the proof." Thus if he saw a long legged Doji at a bottom, Tom would go long on the bar right away. Todd would wait to see the market move upward and prove it. He misses out part of the move- but he gains the "more solid" position.

 

If you play the probabilities, if you see a long legged Doji at an area of Support- chances are you are smart to go long, but how many times have you seen this doji form on a 1 hr or 4 hr chart, gone long and they test that bottom again- when you are sitting long? Todd would wait for the upward movement to confirm his stance- Tom would ride the drawdown and still be correct. Both would be right.

 

Over time I realized that I used to trade like Tom, and have adapted my trading style to be far more like Todd's. Hope this helps anyone who may not be aware of the Todd/Tom difference!

 

Aaron

[sep34 10]

Doji's by them self are not enough to confirm a trade . Ask any veteran trader that trades by price action only and they will more often then not... say what I said.

 

What eludes most is that its not the doji line by it self that is important--rather the price action that it(doji) involes; sometime the preceeding price action, somtimes the price action that follows and sometimes both.

 

FYI...most articles and books on candle patterns, give you just a hint of the information they use as their method, and thats understandable, its up to the trader to do the rest of the home work to comlete it as a trade worthy strategy.

 

Regards..

[brownsfan019 17]

Yes, as the article states and my many posts in the candlestick forum, everything is to be taken in context.

 

The author of the article clearly talks about looking for doji's after there has been some sort of move, not just playing find a doji and trade it.