The Wyckoff Legacy: 82 Years of Wall Street Profiting at Your Expense

While they may have perfected the trading strategies that use retail investors as patsies to enhance their profits, Wall Street titans like Goldman Sachs Group Inc. (NYSE: GS) and JPMorgan Chase & Co. (NYSE: JPM) didn't invent them – that honor goes to a man named Richard D. Wyckoff.

You may not have heard of Wyckoff because he died in 1934. But the book he published in 1931, "The Richard Wyckoff Method of Trading and Investing in Stocks – A Course of Instruction in Stock Market Science and Technique," became the blueprint for Wall Street's big investment banks shortly afterward, and remains so to this day.

A stock runner at age 15 (that was in 1888), Wyckoff opened his own brokerage when he was just 25. He studied the habits of the most successful traders of the day – Jay Gould, J.P. Morgan, Andrew Carnegie – with the goal of synthesizing what he learned into a comprehensive market strategy.

Wyckoff first set out his ideas in a popular 1920s newsletter, "The Magazine of Wall Street," eventually publishing them in book form.

Wall Street traders eagerly adopted Wyckoff's strategies, which emphasized technical analysis but also outlined how big players could exploit less sophisticated investors to earn huge profits.

It's been a popular Wall Street game for over 80 years.

"The truth is that Wall Street has stacked the deck against you," said Shah Gilani, Money Morning Capital Wave Strategist and editor of the Wall Street Insights and Indictments newsletter. "That's why you need to understand how the game is played. Otherwise, you'll end up a Wall Street patsy."

The Richard Wyckoff Trading Strategy

What's most striking about what Wyckoff wrote in 1931 (and said in his newsletter prior to that) is how closely it matches what we see happening on Wall Street today.

Once a big operator has identified a stock ripe for trading, Wyckoff said, it will gradually, quietly accumulate a position in it to avoid tipping off any other investors.

In this stage, the idea is to buy the shares as cheaply as possible with actions that drive the price down. So the big trader "raids the market for that stock, makes it look very weak, and gives it the appearance of heavy liquidation by sending in selling orders through a great number of brokers," Wyckoff wrote.

Mechanisms to keep the stock price from rising too high during this phase include strategically selling large blocks of shares while spreading negative news about the company in question.

This strategy also helps weed out most of those who want to sell the stock, help setting the stage for the big run-up to come.

Ideally, the big trader tries to accumulate the bulk of his position right before some major positive news breaks – news that the trader knows about or expects to happen.

"You have often noticed that a stock will sell at the highest price for many months on the very day when a stock dividend, or some very bullish news, appears in print," Wyckoff wrote. "This is not mere accident.

"The whole move is manufactured. Its purpose is to make money for inside interests – those who are operating in the stock in a large way. And this can only be done by fooling the public, or by inducing the public to fool themselves."

Just before the positive news breaks, the big trader buys even more shares, creating strong upward momentum that dupes less sophisticated investors into buying and driving the stock toward a target price.

After the news hits and the stock peaks, the big trader will sell part of the position into the frenzy of buying by retail investors who think they're getting a hot ticket.

For the weeks after, the big trader plays the earlier game in reverse, keeping the stock near its peak while unloading shares until they're gone.

And then the trader shorts the stock, slowly building his short position as he did his long position.

When it's time to cash in for the second round of profits, the big trader cancels any buy orders he had made to prop up the stock.

"The specialist in the stock then tells some of the moreimportant floor traders that the stock is in a weak technical position and that there is no support for the next 8 or 10 points and they all get together and raid it down … at which point the operator covers his shorts," Wyckoff wrote.

Of course, at this point it's the investors who bought at or near the top – mostly of the retail variety — who take a bath, while the big trader counts his profits.

It Just Happened Again

If you have any doubts this is going on every day on Wall Street, just look at what happened with Goldman Sachs and the recent sale of H.J. Heinz Company (NYSE: HNZ) to Warren Buffett's Berkshire Hathaway (NYSE: BRK.A, BRK.B) for nearly $28 billion.

Goldman had to be aware that the Berkshire deal was brewing, yet maintained a rare "Sell" rating on Heinz right up until the deal was announced Feb. 14.

In fact, Goldman went out of its way to reiterate its Sell rating in a Feb. 10 report, lowering its price target to $53 from $54 and saying it expected the stock to "underperform as top-line growth continues to disappoint."

As the Web site Zero Hedge pointed out at the time: "What does a Sell rating really accomplish? Well, in this case, and in all such cases, it merely provides the firm's prop, pardon flow, traders the opportunity to accumulate the shares its "clients' are advised by the same bank's sell-side group to Sell, preferably to the bank in question."

HNZ rocketed from just over $60 to $72.50 on the day the deal was announced.

Meanwhile, the Securities and Exchange Commission (SEC) is investigating a sudden spike in Heinz options trades that originated from a Goldman account in Switzerland one day before the deal was announced.

Whoever made the trades pocketed about $1.7 million.

The episode is a reminder to retail investors that they need to keep an eye on the Wall Street big boys to avoid becoming their trading fodder.

Gilani said investors need to abandon the buy-and-hold strategy pushed on them by Wall Street's "experts" and instead "think like a trader. Know what entry points are good places to buy. Know what points are good selling points. Trading means having a plan.

"The way to play the Wall Street game is to do what they do, not what they say you should do," Gilani said.

[Editor's Note: If you're fed up with the rampant corruption, double-dealing, and protection of Wall Street by Washington (at the expense of the taxpayers on America's Main Street), then you need to read Shah Gilani's Wall Street Insights & Indictments newsletter. As a retired hedge fund manager, Gilani is a former Wall Street insider who knows where all the bodies are buried. But unlike most insiders, he's not afraid to tell you where they are. He's also got some pretty good ideas how to fix this mess – and how to protect yourself until the cleanup takes place. Please click here to find out more. The newsletter is free.]

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• Business Insider:
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• Zero Hedge:
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