Sixty-three years. Sixty-three years and Technical Analysis of Stock Trends still towers over the discipline of technical analysis like a mighty redwood. Originally published in 1948 and now in its Tenth Edition, this book remains the original and most important work on this topic. The book contains more than dry chart patterns, it passes down accumulated experience and wisdom from Dow to Schabacker, to Edwards, and to Magee, and has been modernized by W.H.C. Bassetti.
Bassetti, a client, friend, and student of John Magee, one of the original authors, has converted the material on the craft of manual charting with TEKNIPLAT chart paper to modern computer software methods. In actuality, none of Magee's concepts have proven invalid and some of his work predated modern concepts such as beta and volatility. In addition, Magee described a trend-following procedure that is so simple and so elegant that Bassetti has adapted it to enable the general investor to use it to replace the cranky Dow Theory. This procedure, called the Basing Points procedure, is extensively described in the new Tenth Edition along with new material on powerful moving average systems and Leverage Space Portfolio Model generously contributed by the formidable analyst, Ralph Vince., author of Handbook of Portfolio Mathematics.
See what's new in the Tenth Edition:
Chapters on replacing Dow Theory
Update of Dow Theory Record
Deletion of extraneous material on manual charting
New chapters on Stops and Basing Points
New material on moving average systems
New material on Ralph Vince's Leverage Space Portfolio Model
So much has changed since the first edition, yet so much has remained the same. Everyone wants to know how to play the game. The foundational work of the discipline of technical analysis, this book gives you more than a technical formula for trading and investing, it gives you the knowledge and wisdom to craft long-term success.
Contents
Preface to the tenth edition ..........................................................................................................xv
Preface to the ninth edition ....................................................................................................... xix
Preface to the eighth edition ....................................................................................................xxiii
In memoriam ...........................................................................................................................xxxiii
Preface to the seventh edition ................................................................................................ xxxv
Preface to the fi fth edition ..................................................................................................... xxxix
Preface to the fourth edition ....................................................................................................... xli
Preface to the second edition ....................................................................................................xliii
Foreword ...................................................................................................................................... xlv
Section I: Technical theory
Chapter 1 The technical approach to trading and investing .............................................3
Defi nition of technical analysis.....................................................................................................4
Chapter 2 Charts .........................................................................................................................7
Different types of scales .................................................................................................................8
Chapter 3 The Dow Theory ....................................................................................................11
The Dow Averages ........................................................................................................................12
Basic tenets .....................................................................................................................................12
Tide, wave, and ripple .............................................................................................................. 14
Major trend phases ................................................................................................................... 14
Principle of confi rmation ........................................................................................................ 16
Chapter 4 The Dow Theory’s defects ...................................................................................21
The Dow Theory is too late ......................................................................................................... 21
The Dow Theory is not infallible ................................................................................................23
The Dow Theory frequently leaves the investor in doubt .................................................23
The Dow Theory does not help the Intermediate Trend investor .....................................23
The Dow Theory in the 20th and 21st centuries ....................................................................... 24
Chapter 5 Replacing Dow Theory with John Magee’s Basing Points Procedure ........31
The fractal nature of the market ................................................................................................. 31
Chapter 6 Important Reversal Patterns ................................................................................41
Important Reversal Patterns ........................................................................................................42
vi Contents
Time required to reverse a trend ................................................................................................43
The Head and Shoulders .........................................................................................................44
Volume is important .....................................................................................................................45
Breaking the neckline ...................................................................................................................47
Variations in Head-and-Shoulders Tops ....................................................................................49
Price action following confi rmation: the measuring formula ................................................53
Relation of Head and Shoulders to Dow Theory .....................................................................55
Chapter 7 Important Reversal Patterns: continued ...........................................................57
Head-and-Shoulders (EN: or Kilroy) Bottoms ..........................................................................57
Multiple Head-and-Shoulders Patterns .....................................................................................59
Tendency to symmetry ................................................................................................................. 61
A leisurely pattern .........................................................................................................................65
Rounding Tops and Bottoms .......................................................................................................66
How Rounding Turns affect trading activity ............................................................................ 70
The Dormant Bottom variation ...................................................................................................73
Volume pattern at Tops ................................................................................................................75
Chapter 8 Important Reversal Patterns: the Triangles .....................................................77
Symmetrical Triangles ..................................................................................................................78
Some cautions about Symmetrical Triangles ............................................................................80
How prices break out of a Symmetrical Triangle .....................................................................80
A typical Triangle development ..................................................................................................82
Reversal or Consolidation ............................................................................................................86
The Right-Angle Triangles ...........................................................................................................92
A planned distribution .................................................................................................................92
Descending Triangles ...................................................................................................................94
Volume characteristics same as the Symmetrical type ............................................................95
Measuring implications of Triangles ..........................................................................................98
Triangles on weekly and monthly charts ...................................................................................99
Other Triangular formations ..................................................................................................... 100
Chapter 9 Important Reversal Patterns: continued .........................................................103
The Rectangles, Double and Triple Tops ................................................................................. 103
Pool operations ............................................................................................................................ 105
Relation of rectangle to Dow Line ............................................................................................ 108
Rectangles from Right-Angle Triangles ................................................................................... 109
Double and Triple Tops and Bottoms ....................................................................................... 111
Distinguishing characteristics ................................................................................................... 113
Double Bottoms ........................................................................................................................... 116
Triple Tops and Bottoms ............................................................................................................ 117
Chapter 10 Other Reversal phenomena ...............................................................................121
The Broadening Formations ...................................................................................................... 121
Volume during Broadening Formations ..................................................................................122
A typical example ........................................................................................................................123
The Orthodox Broadening Top ................................................................................................. 124
Why no Broadening Bottoms?................................................................................................... 126
Right-Angled Broadening Formations ..................................................................................... 128
Contents vii
The Diamond ............................................................................................................................... 129
Wedge Formations ...................................................................................................................... 130
The Falling Wedge ...................................................................................................................... 134
Wedges on weekly and monthly charts ................................................................................... 135
Rising Wedges common in Bear Market Rallies ..................................................................... 136
The One-Day Reversal ................................................................................................................ 136
The Selling Climax ...................................................................................................................... 140
Short-term phenomena of potential importance .................................................................... 144
Spikes ............................................................................................................................................ 145
Runaway Days ............................................................................................................................. 147
Key Reversal Days ...................................................................................................................... 148
Chapter 11 Consolidation Formations ..................................................................................151
Flags and Pennants ..................................................................................................................... 151
The Pennant: a pointed Flag ...................................................................................................... 153
The measuring formula .............................................................................................................. 154
Reliability of Flags and Pennants ............................................................................................. 156
Where they may be expected .................................................................................................... 157
Flag pictures on weekly and monthly charts .......................................................................... 158
Rectangular Consolidations: an early phase phenomenon .................................................. 159
Head-and-Shoulders Consolidations ....................................................................................... 160
Scallops: repeated Saucers ......................................................................................................... 162
Modern versus old-style markets ............................................................................................. 166
Chapter 12 Gaps ........................................................................................................................171
Which gaps are signifi cant? ....................................................................................................... 171
Closing the gap ............................................................................................................................ 171
Ex-dividend gaps ........................................................................................................................ 172
The common or area gap ....................................................................................................... 173
Breakaway gaps ...................................................................................................................... 174
Continuation or runaway gaps and the measuring rule .................................................. 177
Two or more runaway gaps .................................................................................................. 179
Exhaustion gaps ..................................................................................................................... 181
The Island Reversal ..................................................................................................................... 184
Gaps in the Averages .................................................................................................................. 186
Chapter 13 Support and Resistance ......................................................................................189
Normal trend development ....................................................................................................... 190
The explanation ........................................................................................................................... 191
Estimating Support–Resistance potential ................................................................................ 193
Locating precise levels ................................................................................................................ 196
Signifi cance of Support failure .................................................................................................. 197
Popular misconceptions ............................................................................................................. 198
The round fi gures ........................................................................................................................200
Repeating historical levels .........................................................................................................200
Pattern Resistance ....................................................................................................................... 202
Volume on breaks through Support .........................................................................................205
Support and Resistance in the Averages ..................................................................................206
viii Contents
Chapter 14 Trendlines and Channels ...................................................................................207
The Trendline ............................................................................................................................... 207
How Trendlines are drawn ........................................................................................................208
Arithmetic versus logarithmic scale ......................................................................................... 211
Tests of authority ......................................................................................................................... 211
Validity of penetration ................................................................................................................ 214
Amendment of Trendlines ......................................................................................................... 216
Double Trendlines and trend ranges ........................................................................................ 216
Trend Channels ............................................................................................................................ 218
Experimental Lines ..................................................................................................................... 219
Consequences of Trendline penetration: Throwbacks ...........................................................220
Intermediate Downtrends .......................................................................................................... 221
Corrective trends: the Fan Principle .........................................................................................225
Chapter 15 Major Trendlines..................................................................................................229
Major Downtrends ...................................................................................................................... 237
Major Trend Channels ................................................................................................................238
Trendlines in the Averages .........................................................................................................244
Trading the Averages in the 21st century ................................................................................244
Chapter 16 Technical analysis of commodity charts .........................................................247
Technical analysis of commodity charts, part 2: A 21st-century perspective ..................... 251
Rocket scientists .......................................................................................................................... 252
Turtles? ..........................................................................................................................................253
The application of Edwards and Magee’s methods to 21st-century futures markets .......254
Stops .........................................................................................................................................258
A variety of methods .................................................................................................................. 261
Everything you need to know as a chart analyst trading futures ........................................ 261
The return of the great markets of the 1970s ........................................................................... 262
Chapter 17 A summary and concluding comments ...........................................................263
Technical analysis and technology in the 21st century: the computer and the
Internet: tools of the investment/information revolution .................................................... 267
The importance of computer technology ................................................................................ 269
Summary 1 .............................................................................................................................. 270
Other technological developments of importance to the technical Magee analyst
and all investors .......................................................................................................................... 270
The Internet: the eighth wonder of the modern world (EN9: Appendix B,
Resources, for the ninth edition has been enormously expanded and is of
paramount importance to modern investors.) ................................................................... 270
Marking-to-market ................................................................................................................. 271
Separating the wheat from the chaff ...................................................................................272
Chaff .........................................................................................................................................272
Summary 2 ..............................................................................................................................272
Advancements in investment technology, part 1: Developments in fi nance theory
and practice .................................................................................................................................. 273
Options .................................................................................................................................... 273
Quantitative analysis ............................................................................................................. 274
Options pricing models and their importance .................................................................. 275
Contents ix
Futures on indexes ................................................................................................................. 275
Options on futures and indexes ........................................................................................... 276
Modern Portfolio Theory .....................................................................................................277
The wonders and joys of investment technology ..............................................................277
Advancements in investment technology, part 2: futures and options on futures on
the Dow–Jones Industrial Index at the CBOT .........................................................................277
Investment and hedging strategies using the CBOT® DJIASM futures contract ............ 278
Settlement of futures contracts ............................................................................................. 278
Marking-to-market ................................................................................................................. 278
Fungibility ............................................................................................................................... 278
Differences between cash and futures ................................................................................. 279
Dow Index futures ................................................................................................................. 279
Using stock index futures to control exposure to the market .......................................... 279
Investment uses of Dow Index futures ............................................................................... 281
Situation 1: Portfolio protection .................................................................................. 281
Situation 2: Increasing exposure with futures ......................................................... 282
Situation 3: Using bond and index futures for asset allocation ............................. 282
Perspective ..............................................................................................................................284
Options on Dow Index futures .............................................................................................284
Option premiums ...................................................................................................................285
Volatility ...................................................................................................................................285
Exercising the option .............................................................................................................286
Using futures options to participate in market movements ............................................286
Profi ts in rising markets ........................................................................................................286
Exploiting market reversals .................................................................................................. 287
Using puts to protect profi ts in an appreciated portfolio ................................................. 287
Situation 1 ...................................................................................................................... 287
Improving portfolio yields .................................................................................................... 287
Situation 2 ...................................................................................................................... 287
Using option spreads in high- or low-volatility markets .................................................288
Situation 3 ......................................................................................................................288
Situation 4 ......................................................................................................................289
Perspective ..............................................................................................................................289
Recommended further study ....................................................................................................289
Section II: Trading tactics
Midword ....................................................................................................................................... 291
Chapter 18 The tactical problem ............................................................................................ 295
Strategy and tactics for the long-term investor. What’s a speculator, what’s
an investor? ..................................................................................................................................299
One defi nition of the long-term investor ................................................................................. 301
The strategy of the long-term investor..................................................................................... 301
Rhythmic investing .....................................................................................................................302
Summary ......................................................................................................................................304
Chapter 19: The all-important details ...................................................................................305
The simplest and most direct way to use a computer for charting analysis .....................306
Summary ......................................................................................................................................307
x Contents
Chapter 20 The kind of stocks we want: the speculator’s viewpoint ............................309
The kind of stocks we want: the long-term investor’s viewpoint ....................................... 310
Changing opinions about conservative investing .............................................................310
The kinds of stocks long-term investors want: The long-term investor’s viewpoint ....... 311
Construction of the Index Shares and similar instruments .................................................. 312
An outline of instruments available for trading and investing ....................................... 313
The importance of these instruments: diversifi cation, dampened risks, tax, and,
most important, technical regularity ........................................................................................ 314
Summary ...................................................................................................................................... 316
Chapter 21 Selection of stocks to chart ................................................................................317
Chapter 22 Selection of stocks to chart: continued ............................................................321
Chapter 23 Choosing and managing high-risk stocks: tulip stocks, Internet
sector, and speculative frenzies ........................................................................327
Managing tulipomanias and Internet frenzies ....................................................................... 328
Detailed techniques for management of the runaway issues ...............................................330
Hope springs eternal and there is one born every second ....................................................334
Chapter 24 The probable moves of your stocks ..................................................................343
Chapter 25 Two touchy questions .........................................................................................347
The use of margin ........................................................................................................................347
Short selling .................................................................................................................................348
Chapter 26 Round lots or odd lots? .......................................................................................353
Chapter 27 Stop orders ............................................................................................................355
The progressive stop ................................................................................................................... 357
Stop systems and methods ........................................................................................................ 359
A brief survey of stop methods .................................................................................................360
Some other stop methods...........................................................................................................360
Average True Range ...............................................................................................................360
Parabolic stop and reverse .................................................................................................... 361
Target stops ............................................................................................................................. 361
A natural method used by the Turtles...................................................................................... 361
Chapter 28 What is a bottom, what is a top? .......................................................................363
Basing Points ................................................................................................................................364
Basing Points: a case analyzed ..................................................................................................366
The Basing Points paradigm ...................................................................................................... 367
Key to Figure 28.2 analysis ..................................................................................................368
A narrative of the events in the chart .................................................................................. 369
The complete Basing Points Procedure: taking into consideration the setting of
Basing Points on both wave lows and new highs .................................................................. 370
The complete Basing Points procedure .............................................................................. 371
Two charts giving a long-view perspective on the complete (Variant 2) procedure .... 372
The representative case fully analyzed using wave lows and new highs ..................... 372
A narrative of the events in the chart ....................................................................................... 373
Contents xi
Chapter 29 Trendlines in action.............................................................................................375
Buying stock, “going long”........................................................................................................ 376
Liquidating, or selling a long position .....................................................................................377
Selling stock short .......................................................................................................................380
Covering short sales ................................................................................................................... 381
Additional suggestions .............................................................................................................. 381
General outline of policy for trading in the Major Trend ...................................................... 382
Chapter 30 Use of Support and Resistance..........................................................................385
Chapter 31 Not all in one basket ...........................................................................................391
EN: diversifi cation and costs ..................................................................................................... 392
Chapter 32 Measuring implications in technical chart patterns ....................................393
Chapter 33 Tactical review of chart action ..........................................................................395
The Dow Theory .......................................................................................................................... 395
Head-and-Shoulders Top ...........................................................................................................402
Head-and-Shoulders Bottom .....................................................................................................403
Complex or multiple Head-and-Shoulders .............................................................................405
Rounding Tops and Bottoms .....................................................................................................405
Symmetrical Triangles ................................................................................................................408
Right-Angle Triangles ................................................................................................................. 410
Broadening Tops .......................................................................................................................... 410
Rectangles ..................................................................................................................................... 410
Double Tops and Bottoms .......................................................................................................... 411
Right-Angled Broadening Formations ..................................................................................... 411
The Diamond ............................................................................................................................... 411
Wedges .......................................................................................................................................... 412
One-Day Reversals ...................................................................................................................... 412
Flags and Pennants ..................................................................................................................... 412
Gaps ..............................................................................................................................................413
Support and Resistance .............................................................................................................. 416
Trendlines ..................................................................................................................................... 416
Chapter 34 A quick summation of tactical methods .........................................................419
Get out of present commitments .............................................................................................. 419
Make new commitments ............................................................................................................420
Chapter 35 Effect of technical trading on market action ..................................................421
Chapter 36 Automated trendline: The Moving Average ..................................................423
Sensitizing Moving Averages .................................................................................................... 424
Crossovers and penetrations ..................................................................................................... 424
The PENTAD Moving Average system from Formula Research .........................................426
Chapter 37 The same old patterns .........................................................................................429
Not all the same ...........................................................................................................................430
xii Contents
Chapter 38 Balanced and diversifi ed ....................................................................................483
September 28, 1985: an oversold market .................................................................................488
Chapter 39 Trial and error .......................................................................................................489
Chapter 40 How much capital to use in trading .................................................................491
Chapter 41 Application of capital in practice ......................................................................493
Put and call options .................................................................................................................... 495
Chapter 42 Portfolio risk management ................................................................................497
Overtrading: and a paradox ...................................................................................................... 498
Risk of a single stock ..................................................................................................................500
Risk of a portfolio ....................................................................................................................... 501
EN9: Risk and trend ................................................................................................................... 501
Value-at-Risk Procedure ............................................................................................................. 501
Pragmatic Portfolio Theory (and practice) .............................................................................502
Pragmatic portfolio risk measurement ...................................................................................502
Determining the risk of one stock ......................................................................................502
Determining the risk for a portfolio ...................................................................................503
Measuring maximum drawdown, or maximum retracement ............................................504
Pragmatic portfolio analysis: measuring the risk ..................................................................504
Portfolio Ordinary or Operational Risk ..............................................................................504
Portfolio risk over time ..........................................................................................................505
Portfolio extraordinary or catastrophic risk .......................................................................505
Controlling the Risk ...................................................................................................................505
Summary of Risk and Money Management Procedures ......................................................505
Infi nitely more sophisticated risk and money management procedures—Ralph
Vince and optimal f .....................................................................................................................506
Chapter 43 Stick to your guns ................................................................................................507
Appendix A The Dow Theory in practice ............................................................................509
Five years of Dow interpretation ..............................................................................................509
The fi rst severe test ..................................................................................................................... 510
Failure to confi rm ........................................................................................................................ 512
Signs of Major Turn ..................................................................................................................... 513
The Bull signal ............................................................................................................................. 515
The fi rst correction ...................................................................................................................... 516
Bull Trend reaffi rmed ................................................................................................................. 517
The Rails falter ............................................................................................................................. 518
The spring of 1946 ....................................................................................................................... 519
Final Up-Thrust ........................................................................................................................... 521
The Bear Market signal............................................................................................................... 521
Appendix B Resources .............................................................................................................525
Section 1: important and indispensable sites .......................................................................... 525
Section 2: references for further study ..................................................................................... 526
On risk ..................................................................................................................................... 526
Contents xiii
On candlesticks ..................................................................................................................... 526
On futures .............................................................................................................................. 526
On portfolio management .................................................................................................... 526
Section 3: investment-oriented sites ......................................................................................... 526
Brokerage Houses ................................................................................................................... 528
Section 4: the Sharpe Ratio ......................................................................................................... 529
Section 5: calculating volatility.................................................................................................. 529
Section 6: the essence of fundamental analysis ......................................................................530
The Elliott Wave Theory: perspective and comments ......................................................530
Section 7: software packages and Internet technical analysis sites ......................................533
AIQ: TRADING EXPERT PRO .............................................................................................533
METASTOCK 9.0 ....................................................................................................................533
Tradestation 2000i and Tradestation 8 .................................................................................534
The Internet: prophet (http://www.thinkorswim.com) ...................................................534
The Internet: http://www.stockcharts.com ........................................................................534
A brief summary ....................................................................................................................534
Section 8: the Leverage Space Portfolio Model .......................................................................534
Glossary ........................................................................................................................................ 539
Bibliography .................................................................................................................................565
Index ............................................................................................................................................. 567
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