1. Richard D. Wyckoff and Lyman M. Lowry: The Analysts and Their Methods
Richard D. Wyckoff
The technical approach to investment analysis dates back decades, if not centuries. In contrast to the fundamental approach to market analysis, which focuses on identifying the intrinsic value of a company and its future growth potential by utilizing such metrics as earnings, debt, and management prowess, technical analysis focuses largely on the study of price action. Technicians work under the assumption that security prices move in trends. The identification of those trends, in turn, can be used to forecast future price action. Early pioneers in the field of technical analysis include some well-known names such as Charles H. Dow, Ralph N. Elliott and William D. Gann. Perhaps lesser known are technicians Richard D. Wyckoff and Lyman M. Lowry. While icons in their own right regarding their contributions to the field of technical analysis, various writings on these two individuals indicate they were both very much students of the market. Another common thread between these two technicians was that both regarded the basic Law of Supply and Demand as the key element in their approaches to the analysis of stock market trends.
Richard D. Wyckoff began his career in 1888 as a stock runner at the young age of 15. By the age of 25, he had gained enough hands-on market experience to open his own brokerage office. From his perspective as a broker, Wyckoff was able to view the buying and selling patterns of the large market players. By doing this, he “realized it was possible to judge the future course of the market by its own action...that the action of stocks reflected the plans and purposes of those who dominated them...that the basic Law of Supply and Demand governed all price changes...that the best indicator of the future course of the market was the relation of Supply and Demand.”1 It was on this foundation, the Law of Supply and Demand, that Wyckoff based his method of forecasting the future direction of the market.
Wyckoff enjoyed great success in his forecasting technique and, as a service to his clients, published The Ticker Magazine. This publication’s name was later changed to The Magazine of Wall Street, and Wyckoff’s superior analytical and predictive abilities resulted in the largest circulation of any financial publication in the world at the time. In 1928, Wyckoff turned his business over to associates and, in 1931, his method of stock market analysis was published as a correspondence course. Wyckoff deemed this course “the cream of what I have learned in 40 years of active experience on Wall Street.”2 This course remains in existence today through the Stock Market Institute, based in Phoenix, Arizona.3 The foundation of this course is the same now as it was in the 1930s, and that foundation is the Law of Supply and Demand.
Lyman M. Lowry
Lyman M. Lowry majored in Finance at the University of Nebraska, and his first taste of the stock market came in 1925 as a junior trust officer in a Florida bank. Initially, Lowry adopted the existing investment philosophy of the bank, which relied almost exclusively on the “fundamentals” and the news developments of the day. However, as the 1929 stock market crash unfolded, he quickly became disenchanted with portfolio managers who, frozen with fear, comforted each other with assurances that they owned nothing but high quality stocks, rather than preserve what was left of their customers’ capital. Dissatisfied with the results of relying largely on fundamental analysis, Lowry left the bank in 1933 in favor of independent research.
He felt that there must be a way to analyze the condition of the market itself, rather than attempting to analyze the conditions surrounding the market. His search for a better method of analyzing the market led him to the Dow Theory. His enthusiasm for the Dow Theory was initially positive. However, he eventually found that even the so-called experts often disagreed at major turning points in the market. His conclusion was, “If the experts can’t agree, what chance have I got of coming up with the right interpretation?”
Again disillusioned, Lowry undertook his own research of the stock market. Having majored in Finance, Lowry was well aware the first chapter of nearly every basic textbook on the subject of macro economics discusses the importance of the Law of Supply and Demand. And yet Lowry could see no evidence of this principle being used in the analysis of the stock market. It was his conviction that market trends override fundamentals and that the trends were ultimately the product of the basic Law of Supply and Demand. Thus it followed that, regardless of the reasons why, if the desire to buy is stronger than the desire to sell in any given period, prices automatically rise. And if the pressure to sell exceeds the desire to buy, prices automatically decline. It was as simple as that.
However, another important question needed answering. How do stocks reflect an over-balance of buyers in one period and an over-balance of sellers in another? With this question in mind, he set out to determine a method to measure Supply and Demand as it applies to individual stocks and the equity market in general. In the end, Lowry concluded that it all came down to price and volume. If a stock ends the trading day at a price above its previous close, it seemed reasonable to assume that it was purchased with more enthusiasm than with which it was sold. And given that the desire to buy or sell can also be measured in terms of activity, the volume of trading should be a prime consideration. Thus the action of the entire market, encompassing the individual actions of insiders, specialists, tape readers, fundamentalists and all other investors, could be reduced to simply four basic components: (1) Total gains for all stocks closing higher than the previous day’s close; (2) the total volume of trading in stocks registering gains; (3) total losses for stocks closing lower than the previous day’s close, and; (4) the total volume of trading for declining stocks.
Using data from the Wall Street Journal back to January 1933, Lowry calculated these metrics for each stock traded on the NYSE. It was an enormous effort given the fact that in those days there were no computers or databases, just hand-cranked adding machines.4 Upon compiling the data, Lowry then began a series of exhaustive tests of various moving averages from 3 to 180 days run singly and in various combinations, to find the optimum way of using the data to portray Supply and Demand and measure market trends. “The studies made so much sense to me that I figured they would also be of interest to any serious student of the market.” Thus with Mansfield Mills, an old friend with vast advertising and business experience, the firm Lowry and Mills was established at 40 Wall Street, New York City, in April 1938. To this day, nearly 80 years later, Lowry Research Corporation publishes the original indicators developed by Mr. Lowry from its offices in Palm Beach Gardens, Florida.
The Wyckoff and Lowry Methodologies: A More In-Depth Look
Richard D. Wyckoff, in his studies, set out to dispel the common belief that the stock market is a complex machine. This perception of complexity largely evolves from fundamental analysis, which requires the deciphering of dense and often verbose earnings and annual reports, among other things, in order to assess the probable fair value of a company. In contrast, technical analysis, the Wyckoff and Lowry Methods in particular, uses readily available data of a stock’s own price action and volume to form logical assessments of market conditions.
The Wyckoff Method
The foundation of the Wyckoff Method of stock market analysis consists of three basic principles: The Law of Supply and Demand, The Law of Cause and Effect, and The Law of Effort vs. Result. It is a common misconception that because for every buyer in the market there is a seller, the Law of Supply and Demand does not apply to equities. To the contrary, the buyer and seller involved in every trade have different objectives, thereby causing Supply/Demand imbalances. For example, if an investor is holding shares of stock and wants to sell them, and is willing to accept a price lower than a previous seller of the stock in question, the price will fall. Simply stated, when Supply is greater than Demand, prices will fall, and when Demand is greater than Supply, prices will rise. The Supply/Demand relationship can be monitored by watching price and volume using a simple bar chart.
The Law of Cause and Effect deals with determining the degree or “effect” of an upcoming price move based on prior price action termed the “cause.” For an effort to manifest itself in the form of a change in price, there must first be a cause. The Law of Cause and Effect moves hand-in-hand with the Law of Supply and Demand, with Demand representing a period of accumulation within a trading range and Supply representing a period of distribution over a similar period of consolidation. The effect realized by a cause, or period of accumulation or distribution, will be in direct proportion to that cause. Point and figure chart counts are used in the Wyckoff Analysis to measure a cause and project the likely extent of the subsequent effect.5
The Law of Effort vs. Result brings volume into the analysis process. Although price is often thought to be the key component in technical analysis, the volume behind price action is just as, if not more, important than the price action itself. Divergences between price action and volume often signal trouble. Specifically, when the amount of effort (volume) and extent of the result (price action) are not in sync, positions should be protected against a potential reversal of trend.6
Using a combination of these three basic principles, various stages of the formation of major market tops and major market bottoms can be identified, with the objective to allow the investor to enter the market in early stages of an important move higher or exit the market and perhaps enter the short side in the early stages of a major market decline. By capturing the “meat” of major market trend and exploiting the direction of that trend, investors can reap superior returns in their investment portfolios.
The Lowry Analysis
Few investors ever buy or sell a stock because of what they know about it. It is what they think will happen to it that causes them to act. Traders and investors are constantly trying to anticipate and discount the future with the objective of realizing profits at some later date. Their conclusions could be based on many factors including estimated earnings, taxes, interest rates, inflation, news events, economic conditions, or just plain hunches. The end result is that some buy, thinking the stock price will advance. Others sell, believing prices will be lower in the course of time. Some will be right, and some will be wrong because the market trend cannot simultaneously proceed in both directions. In the final analysis, the market can only be expected to move in the direction of the greatest money influence.7
It has already been noted that the relationship between the total buying desire and the total selling desire determines the direction of the trend, and these two desires can be factually measured using four basic calculations:
• Total point gains for stocks closing higher on the day
• Total volume for all stocks closing higher on the day
• Total point losses for all stocks closing lower on the day
• Total volume for all stocks closing lower on the day
These four essential tabulations, which are factual and unbiased, provide the statistical foundation for the Lowry Analysis. These metrics are also the foundation for the two indicators Lowry Research Corporation is most known for, the Buying Power and Selling Pressure Indexes. It is the trends of these two indicators that help determine the intermediate-term trend of the broad market.
Buying Power is an intermediate to longer-term measurement of the effect buyers are producing (Demand), as evidenced by the gains and volume registered by advancing stocks. Buying Power is a multiple-time-period index which, in its final construction, not only takes into account the number of stocks registering advances, but includes and evaluates such upside action both in terms of actual points gained and related upside volume. The average time period for its several components is approximately 50 trading days. Selling Pressure is Lowry’s principal measure of the intermediate to longer-term trend of the force of Supply. It is computed in the same manner as the Buying Power Index but is constructed from the actions of declining stocks in terms of points lost and downside volume.8
The Buying Power and Selling Pressure Indexes act as leading indicators for the actions of the broad market, and the trends of these indicators can be used to identify the various stages of bull and bear markets. For example, in the strongest stage of a bull market, Buying Power will steadily rise while Selling Pressure steadily falls. Then, as the uptrend enters its latter stages, Selling Pressure will establish an uptrend, reflecting the increased profit taking that tends to occur as a bull market matures and a major topping formation begins. As the major top forms, the uptrend in Selling Pressure will eventually be joined by a turn lower in Buying Power, reflecting distribution and a lack of Demand typically seen in the early stage of a new bear market. Finally, as the bear market nears completion, the upward trend in Selling Pressure will start to wane and fail to confirm lows in the market itself, implying that the desire to sell is becoming exhausted.
In the chapters that follow, the melding of the Wyckoff and Lowry methodologies to identify major market bottoms and major market tops is presented using numerous examples dating as far back as 1966. Some supplementary indicators are also presented in the analysis in an effort to refine even further the ability to identify major market trends and turning points.
Endnotes
1. Jack K. Hutson, David H. Weis, Craig F. Schroeder, Charting the Stock Market, The Wyckoff Method (Seattle, WA: 1986), 4.
2. Hutson, 4.
3. http://www.wyckoffstockmarketinstitute.com/.
4. Chris Wilkinson, Technically Speaking (Greenville, SC: 1997), 145.
5. Hank Pruden, The Three Skills of Top Trading (Hoboken, NJ: 2007), 132.
6. Richard D. Wyckoff, Course in Stock Market Science and Technique; Introduction to the Wyckoff Method of Stock Market Analysis, Volume One, Text; The Stock Market Institute; (Phoenix, AZ: 1983) pg. 5.
7. Lowry Market Analysis Manual, Section 1–3 (North Palm Beach, FL: 2007).
8. Lowry Market Analysis Manual, Section 1–7 (North Palm Beach, FL: 2007).