Add training workflow, datasets, and runbook

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+Major Downtrends
+From the technical analyst's point of view, it is regrettable that few Bear Markets have produced Major Trendlines of any practical significance on the charts of individual stocks. A notable exception was the long Bear Market of 1929-1932, which produced magnificently straight trendlines on the arithmetic plotting of a host of issues (as well as in the Averages, to which we shall refer later). But it is almost impossible to find other instances in which a Bear Trendline having any forecasting value can be drawn on either arithmetic or semilogarithmic scale.
+The
+normal
+Major Bear Market Trend is not only steeper than the normal Bull Trend (because Bear Markets last, on the average, only about half as long as Bull Markets), but it is also accelerating or down-curving in its course. This feature is accentuated and, hence, particularly difficult to project effectively on the semilogarithmic scale.
+The technician cannot expect to obtain much in the net of it, help from his
+Major
+Trendlines in determining the change from a Primary
+Downswing
+to a Primary
+Upswing.
+This should not be taken, however, as advice to not draw trendlines on a Major Down Move, or to disregard entirely any trendlines that may develop with some appearance of authority. If you do not expect too much of them, they may, nevertheless, afford some useful clue as to the way in which conditions are tending to change.
+The student of stock market action who is not altogether concerned with dollars and cents results from his researches will find Bear Market Trendlines a fascinating field of inquiry. They do some strange things even though they fail in the practical function of calling the actual Major Turn and go shooting off into space, they sometimes produce curious reactions (or, at least, appear to produce what would be otherwise inexplicable market action) when the real price trend catches up with them months or years later. But such effects, interesting as they may be, are, in our present state of knowledge, uncertain and unpredictable.
+(EN: This fact may persist into the mists of the future and be thought of like Fermat's Last Theorem. Our present state of knowledge in the twenty-first century is no further advanced than it was in Magee's time.)
+We must dismiss this rather unfruitful topic with the reminder that one clue to the end of a Primary Bear Market is afforded by the Intermediate Trendline of its final phase, which we cited in the preceding chapter.
+Major Trend Channels
+Another difficulty is met when trying to draw Return Lines and construct channels for Major Trends on an arithmetic chart. Owing to the marked tendency for prices to fluctuate in ever-wider swings (both Intermediate and Minor) as they work upward in a Primary Bull Market, their channel grows progressively broader. The Return Line does not run parallel to the Basic Trendline (assuming there is a good Basic Trendline to begin with) but diverges from it. Occasionally, a stock produces a clear-cut Major Channel Pattern, but the majority do not.
+A large Rectangle base was made on this weekly chart in April, May, and June 1937, but observe the poor volume that accompanied the breakout and rise from that formation—an extremely Bearish indication for the Major Trend. The “measurement” of the Rectangle was carried out by August, but that was all.
+As is usually the case, it was impossible to draw a Major Down Trendline that had any forecasting value on this chart. The beautiful straight trendlines that appeared in the 1929-1932 Primary Bear Market led many chart students to expect similar developments in every Bear Market, but the fact is that 1929-1932 was unique in that respect.
+Semilogarithmic scaling will correct, in many cases, for the Widening Channel effect in Bull Trends, but then we run into the opposite tendency in Primary Bear Markets, and for that, neither type of scaling will compensate.
+Trendlines in the Averages
+Practically everything stated in the preceding chapter regarding Intermediate Trendline development in individual stocks applies, as well, to the various Averages. The broad Averages or Indexes, in fact, produce more regular trends and, in consequence, more exactly applicable trendlines. This may be partly due to the fact most Averages are composed of active, well-publicized, and widely owned issues whose market action individually is “normal” in the technical sense. Another reason is the process of averaging smooths out the vagaries of component stocks, and the result more truly reflects the deep and relatively steady economic trends and tides.
+In any event, it is a fact that such averages as the Dow-Jones Rails, Industrials, and 65-Stock Composite,
+The New York Times
+50, and Standard & Poor's Average of 90 stocks (the last two named being probably the most scientifically composed to typify the entire broad market) do propagate excellent trendlines on their charts.
+(EN: As the reader will note, most of these indices are obsolete. In the modern age, the S&P 500 probably best fulfills this function.)
+The very accuracy of their trends, particularly their Intermediate Moves, permits us to construe their trendlines more tightly. Less leeway need be allowed for doubtful penetrations. Thus, although we ask for a 3% penetration in the case of an individual stock of medium range, 2% is ample in the Averages to give a dependable break signal.
+Experienced traders know it pays to heed the Broad Market Trend. It is still easier to swim with the tide than against it.
+EN: Trendlines in the Averages and Trading in the Averages
+Numerous averages and indexes have come online since the fifth edition, including the S&P 100, S&P 500, Russell 2000, and so on. It would be an exercise in daily journalism to attempt to list all the indexes now available, as new ones spring up like weeds after the spring rain. This is because the invention of a widely adopted index can be very lucrative for its creator S&P and Dow-Jones collect licensing fees from the “use” of their indexes by the exchanges. The constant addition of new trading instruments requires that current lists be kept in Resources, and the reader may also consult the
+Wall Street Journal, Barron's,
+and the
+Investor's Business Daily
+where prices of indexes and averages are reported. Online brokerages and financial news sites also offer up-to-the-minute lists and quotes on virtually all trading instruments. A list and links to these sites may also be found in Appendix B, Resources, and at
+http://www.edwards-magee.com
+.
+As of the turn of the century, the most important of these indexes joining the Dow are probably the S&P 500, the S&P 100, and the NASDAQ. In fact, these are probably sufficient for economic analysis and forecasting purposes, and certainly good trading vehicles by means of surrogate instruments, options, and futures. Some would include the Russell 2000 in this list. These indexes and averages have been created to fill needs not addressed adequately by the Dow-Jones Averages.
+With this proliferation of measures of the market and various parts of it, a different question arises questioning the value of the Dow alone in indicating the Broad Market Trend. Limited research has been done on this question; however, my opinion is the Broad Market Trend must now be determined by examining the Dow Industrials, the S&P 500, and the NASDAQ Composite.
+Trading the Averages in the 21st century
+As pointed out in other new chapters and notes in the eighth edition, the ability to trade the Averages instead of individual stocks is a powerful choice offered by modern markets. The index ETFs offer ideal vehicles for investing: The DIA, SPY, QQQ and IWM give the modern investor unparalleled flexibility and convenience. Magee was of the opinion that the Averages offered technical smoothness often lacking in individual issues. This would seem to be true intuitively. After all, just as a moving average smooths data, the average of a basket of stocks should dampen price volatility. Of course, as Mandelbrot pointed out, in a 10-sigma market storm everything sinks.
+Illustrated in this chapter are several detailed cases following Magee's suggestion of Average trading. I attempt to demonstrate here two perspectives: one, the horror of the immediate, what the crash and panic look like as they occur; and two, what the crash and panic look like in retrospect. We all live in the present, except for the great billionaires who can afford to doze through horrific Bear Markets. Bill Gates' net worth varied by $16 billion or $17 billion in early 2000. This would put the ordinary investor out of business.
+So the ordinary investor, you and I, have to respect the great yawning Bear Market. We must step to the sidelines and let the bear eat the foolish virgins, to borrow a Biblical metaphor.
+You will remember Magee opined that a trendline break of 2% was sufficient to cause liquidation of longs when analyzing the Averages. In the accompanying figures, this hypothesis is examined.
+EN9: In respect to the breaking of trendlines (by 2% or 3%), I should note the breaking of a trendline is as much a
+warning
+as a signal to act. The break, instead of a change of trend to the reverse, may indicate a change of trend to the sideways—into a reversal or continuation pattern.
+chapter sixteen
+Technical analysis of commodity charts
+(EN9: Following the practice of allowing the reader to discriminate between the work of Edwards and Magee and that of the editor, a section on commodity trading,
+Chapter 16
+, has been added to the ninth edition. See same.)
+A little thought suggests the variously interesting and significant patterns we have examined in the foregoing chapters on stock charts should logically appear as well in the charts of any other equities and commodities that are freely, constantly, and actively bought and sold on organized public exchanges. In general, this is true. The price trends of anything for which market value is determined solely (or for all practical purposes within very wide limits) by the free interplay of supply and demand will, when graphically projected, show the same pictorial phenomena of rise and fall, accumulation and distribution, congestion, consolidation, and reversal that we have seen in stock market trends. Speculative aims and speculators' psychology are the same whether the goods dealt in are corporate shares or contracts for the future delivery of cotton bales. (For illustrations in this chapter, see Figures
+16.1
+through
+16.13
+.)
+It should be possible in theory, therefore, to apply our principles of technical analysis to any of the active commodity futures (wheat, corn, oats, cotton, cocoa, hides, eggs, etc.) for which accurate daily price and volume data are published. It should be, that is, if proper allowance is made for the intrinsic differences between commodity futures contracts and stocks and bonds.
+In previous editions of this book
+(EN9: up to the eighth)
+, traders who cast longing eyes on the big, quick profits apparently available in wheat, for example, were warned that commodity charts were “of very little help,” as of 1947.
+It was pointed out that successful technical analysis of commodity futures charts had been possible up to about 1941 or 1942, but the domination of these markets thereafter by government regulations, loans, and purchases completely subject to the changing (and often conflicting) policies and acts of the several governmental agencies concerned with grains and other commodities had seriously distorted the normal evaluative machinery of the market. At that time, radical reversals of trend could and did happen overnight without any warning so far as the action of the market could show. The ordinary and orderly fluctuations in supply-demand balance, which create significant definite patterns for the technician to read, did not exist. Yet, while fortunes were made (and lost) in wheat, corn, and cotton futures during the World War II period, it is safe to say they were not made from the charts.
+During the past five or six years, however, the application of technical methods to commodity trading has been reexamined. Under 1956 conditions, it appears that charts can be a most valuable tool for the commodity trader. The effects of present government regulation have apparently resulted in “more orderly” markets without destroying their evaluative function. Allowing for the various essential differences between commodities and stocks, the basic technical methods can be applied.
+104
+96
+88
+80
+76
+72
+68
+64
+60 Sales 100's
+SEPTEMBER OATS
+Chicag<
+sir
+1118'25 11 8 15'22T 8 15'22295112119263 W17
+1
+24W7
+r
+142r28''5
+T
+i219
+l
+26
+t
+2
+1
+9
+Figure 16.1
+Oats, for obvious reasons, traced more “normal” patterns than Wheat during the 1940s. This chart contains an H & S bottom, a Symmetrical Triangle that merged into the Ascending form, a gap through a former top level, and an interesting trendline. The Island shake-out through the trendline was an extremely deceptive development.
+It may be in order here to discuss briefly some of the intrinsic differences between commodity futures and stocks referred to above and to some of the special traits of commodity charts. First, the most important difference is the contracts for future delivery, which are the stock-in-trade of the commodity exchange, have a limited life. For example, the October cotton contract for any given year has a trading life of about 18 months. It comes “on the board” as a “new issue,” is traded with volume increasing more or less steadily during that period, and then vanishes. Theoretically, it is a distinct and separate commodity from all other cotton deliveries. Practically, it seldom gets far out of line with such other deliveries as are being bought and sold during the same period, or with the “cash” price of the physical cotton in warehouses. Nevertheless, it has this special quality of a limited independent life, as a consequence of which long-term Support and Resistance Levels have no meaning whatever.
+(EN10: This absolute may not be absolute. Evaluate the longterm charts for your issue to see whether influence is evident.)
+Second, a very large share of the transactions in commodity futures—as much as 80% certainly in normal times—represents commercial hedging rather than speculation.
+(EN10: Less true in the twenty-first century.)
+It is, in fact, entered in to obviate risk and to avoid speculation. Hence, even near-term Support and Resistance Levels have relatively less potency than with stocks. Also, because hedging is to a considerable degree subject to seasonal factors, there are definite seasonal influences on the commodity price trends that the commodity speculator must keep in mind, even if only to weigh the meaning of their apparent absence at any given period.
+A third difference is in the matter of volume. The interpretation of volume with respect to trading in stocks is relatively simple, but it is greatly complicated in commodities by the fact that there is, in theory, no limit to the number of contracts for a certain future delivery that may be sold in advance of the delivery date. In the case of any given stock, the number
+Figure 16.2
+In contrast with the grains, the technical action of the Cotton futures markets has been fairly consistent with normal supply-demand functioning ever since prices rose well above government support levels. In this daily chart of the 1947 October delivery (New York Cotton Exchange), the reader will find a variety of familiar technical formations, including critical trendlines, a Head-and-Shoulders top that was never completed (no breakout), and Support-Resistance phenomena much the same as appear in stock charts. Double trendlines are not at all unusual in Cotton charts.
+of shares outstanding is always known. As this is written (1956), there are in the hands of stockholders 13,700,203 common shares of Consolidated Edison, and that quantity has not varied for many years nor is it likely to change for several years to come. Every transaction
+In the case of commodity future contracts—say, September wheat—trading begins long before anyone knows how many bushels of wheat will exist to be delivered that coming September, and the open interest at some time during the life of the contract may exceed the potential supply many times over, and all quite legitimately.
+(EN9: As always, volume data is a supplementary indicator to price. No one makes a profit on it.)
+One more important difference may be mentioned. Certain kinds of news—about weather, drought, floods, and so on that affect the growing crop, if we are dealing with an agricultural commodity—can change the trend of the futures market immediately
+1997      1998      1999      2000      2001      2002      2003      2004
+Created with TradeStation
+Figure 16.3
+A
+Rounding Bottom in Gold 1997-2004. “These patterns, when they occur
+after an extensive decline
+, are of outstanding importance, for they nearly always denote a change in Primary Trend and an extensive advance yet to come. That advance, however, seldom carries in a ‘skyrocket' effect, which completes the entire Major Move in a few weeks. On the contrary, the uptrend that follows the completion of the pattern itself is apt to be slow and subject to frequent interruptions, tiring out the impatient trader, but yielding eventually a substantial profit.” So said Robert Edwards in remarking on Rounding Bottoms in stock charts. As may be seen here, this Rounding Bottom consists of a downtrend, a false signal off the Double Bottom (upon which a pretty penny might have been made by the agile trader), and a handsome uptrend—and it all looks like a huge Rounding Bottom.
+and drastically and are not foreseeable given the present stage of our weather knowledge. Analogous developments in the stock market are extremely rare.
+(EN: Except for acts of God and Alan Greenspan [and Ben Bernanke])
+.
+It is not the purpose of this book to explain the operation of commodity futures markets, nor to offer instruction to those who wish to trade therein. This brief chapter is included only as a starter for readers who may want to pursue the study further. They should be advised that successful speculation in commodities requires far more specialized knowledge and demands more constant daily and hourly attention. The ordinary individual can hope to attain a fair degree of success in investing in securities by devoting only his spare moments to his charts, but he might better shun commodity speculation entirely unless he is prepared to make a career of it.
+(EN: The editor has been, during his checkered career, a registered commodity trading advisor. At the beginning of that career, I discussed these subjects with Magee and received essentially the above comments, which are here reproduced from the fifth edition. Subsequently, I observed among my associates and partners, and on my own, that futures are eminently tradable with the
+adaptation
+of techniques and methods described in this book. It is also true, as Magee says, that futures trading is so different in tempo, leverage, and character that the novice risks life, limb, and capital in entering the area unescorted. Resource references are essential reading, but the beginner is urged to educate himself
+before
+beginning trading with extensive study and paper trading.)
+Figure 16.4
+Gold, October 2011. The momentous earth-shaking power of a massive rounding bottom is vividly dramatized by the gold chart since 2005, as well as the power of chart analysis to anticipate it. Regrettably, the editor did not compute the price target implications of the pattern in the ninth edition in 2005. That computation was made at the
+http://www.edwards-magee.com
+website at the time. There it was computed as follows (and the reader can do it for himself): depth of pattern, 248.20 plus neckline 507.40, target 755.60. In fact, the possibility was entertained that the entire formation from 1980 to 2008 might be a Rounding Bottom. In which case, the depth was 700.70, added to the neckline of 959 and resulted, actually achieve, in a target of 1,660. Remember Edwards said these were probable minimum measurements.
+Technical analysis of commodity charts,
+part 2: a 21st-century perspective
+In the search for the Philosopher's Stone, more sweat and money have been put into the area of commodities and futures than were ever expended in the securities arena. There is a simple reason for this—great fortunes are made and lost with much greater rapidity in the futures area than in securities. Of all the great dramatic moments in stock market history, few are so memorable as the great Hunt silver market, or Soros facing off against the Bank of England, or of gold soaring to $1,000 an ounce (deferred contracts). And the saga continues in 2005: $50 oil? $60? $70? $100? And the effects, economic and psychological! In dimly lit garrets and brightly lit computer rooms thousands of researchers concoct systems to trade these markets—corn, soybeans, silver, copper ...
+Rocket scientists
+At times, individual traders and groups of traders have plundered (harvested?) these markets for fairy tale profits. I know whereof I speak, having been a principal in California's first licensed commodity trading advisor that was founded by the NASA rocket scientist R. T. Wieckowicz. During the 1970s, as the stock markets ground futilely around the 1,000 level on the Dow, the futures markets returned yearly gains in the 100% range. Consistently. For years. Those were the years of the California systems traders and the beginning of computerized trading. From the primeval slime of NASA, rocket scientists emerged to create a renaissance in market technology. At the time it seemed clear that science and genius had at last conquered the markets and that clients would come buzzing from the world over like bees to a honey
+@SI.P(D) - Weekly COMEX L = 7.035 +0.077 +1.11% B = 0.000 A = 0.000 O = 6.985 Hi = 7.085 Lo = 6.980 C = 7.045 V = 145
+N
+1998     1999     2000     2001     2002     2003     2004     2005
+Created with TradeStation
+Figure 16.5
+A
+Rounding Bottom in Silver, 1998-2005. The apparent Rounding Bottom in silver, combined with the same pattern in gold, would seem to cast a pall over the economic situation for some time to come in 2005. This coincides with the apparent long-term patterns setting up in the securities markets. If the best that can be hoped for in securities is a 1965-1982 kind of widely whipping market, commodities may react as they did in the 1970s—with tidal wave markets. These markets can be traded by the well-capitalized chart analyst who is well seasoned. Tyros will lose money learning the game whatever markets they trade. Their chances will be immeasurably improved by applying the techniques taught in this book. In addition to the technical pattern pictured here, there is every reason to suspect that a large fundamental shortage of silver bullion exists and will worsen. Ted Butler, at
+http://www.doomgloom.com
+, is a long-term silver analyst (and associate of the editor) who anticipates a new silver blow-off is coming. One wonders what Nelson and Bunker Hunt are doing at present. A very cautious investor (like Warren Buffet who is reported to have invested $1 billion in silver bullion) may defeat futures silver volatility by buying the bullion.
+pot and that the rivers of profits would last forever. They did last for some time, and then the markets changed. Mechanical systems that cut through the markets like a reaper in a wheat field in Bull Markets grind up capital like sausage in sideways markets. Science and genius were revealed as the happy combination of man, moment, system, and market.
+Turtles?
+During the 1980s from the sea came crawling the Turtles. Progeny of the protean trading wizard, Richard Dennis, the Turtles again harvested outsize profits from the markets, reportedly running in the 80% yearly range. The so-called Turtles got their name from a comment that Dennis is reported to have made that traders were made not born, and he was going to raise traders like turtles. Additional reading about the Turtles is available in Jack Schwager's fascinating books, including
+Market Wizards
+and others. Schwager's books are required reading for aspiring futures traders. Additionally, the trading manual of the Turtles will be found online at
+http://www.originalturtles.org
+. This workbook, written by
+S
+K05(D) -
+n
+Daily COM
+4EX L =
+6.900 -0.C
+C3 -0.04%
+B = 6.92
+C A = 6.93
+5 O = 6.9CC Hi =
+6.9C5 Lo
+= 6.9CC C
+= 6.9CC V
+/ = 6
+A'
+1
+1
+A
+’ 8.CCC
+. "7 cnn
+0
+s
+A
+A
+7.500
+, n c\c\c\
+A
+11
+c
+V
+1 I
+7.000
+3H9CH
+< cnn
+(
+1
+1
+. -1
+Y
+T
+1/
+0.500
+. 6 000
+h
+r
+A
+M    J
+J     A
+S
+O
+N
+D    05
+F
+M
+A   M
+Created with TradeStation
+Figure 16.6
+Silver, May 2005. Although the long-term silver outlook may be Bullish, the short term will be very volatile, especially for the thinly capitalized trader. Then short-term tactics must be adopted. The Island Top here at 1 is a gentle invitation to the trader to take his profits and be gone. Even to short, with a stop just above the high. The run day after 1 adds a note of urgency to the invitation. The gap is punishment for the hard of hearing and a bonus for the quick-witted (everybody who survives in futures is either quick witted or extremely well financed). The stop moves down to the top of the gap day, then to the top of the next gap day, and for the very apt profits are taken on the next run day down, on the principle of sell weakness, buy weakness. The tight trendline at 2 crossed by the heavy run day is a buy signal with the stop moving to the bottom of the gap at 3, where it is taken out a few days later by the long-range day down. The run day at 4 is a short signal with the stop being at the day's high. Is it necessary to say short-term futures trading can be quite rapid? There is always bullion or associated stock plays.
+Curtis Faith, an original Turtle, contains virtually all of the elements necessary in a trader's systems and procedures manual. The manual was prepared according to the training Dennis gave his Turtles. Serious traders do not operate without some such document. Certainly all of the serious traders I have known (a considerable number) have had fully developed manuals like the Turtle workbook. I cite the Turtle workbook rather than others in my possession because it is publicly available at
+http://www.originalturtles.org
+(as well as in the 9th edition of this book) and because it is beautifully articulated.
+In the late 1990s, the Turtles were made into turtle soup in the futures markets as the majority of systems traders wound up as hamburger meat.
+Is there a moral? Yes. The markets giveth and the markets taketh away. Science and genius are again revealed to be the happy combination of man, method, moment, and market.
+The Turtle system is basically an adaptation of Richard Donchian's channel breakout system. In the Donchian system, the trader goes long when the 20-day high is broken and sells and goes short when the 20-day low is broken. In the 1970s, Dunn and Hargitt evaluated a number of mechanical trading systems and found that Donchian's system was superior to the others evaluated at that time. Will Donchian's system still work? Yes,
+Figure 16.7
+Silver, October 2011. Here is what happened in silver after the ninth edition was published. Could there be any greater vindication of the value of charts looking at the issue six years later? Just as in the case of gold, the analysis allowed the analyst to anticipate a monster Bull Market. On
+http://www.edwards-magee.com
+, the authors wrote letters all during this time pointing out the silver Bull. Measuring the entire formation, the depth is 33.96, added to the neckline of 37.5 equals 71.46. This seems quite fanciful to us, but that is the measurement.
+in broadly trending markets. Will the Turtle system still work? Yes, in broadly trending markets. Plus, like virtually all mechanical systems, they do not know whether they are in a broadly trending market or not. They are blind—all they see are ones and zeros. The addition to these systems of prudently applied chart analysis will immeasurably improve their performance and risk characteristics.
+The application of Edwards and Magee's
+methods to 21st-century futures markets
+During my career as a commodity trading advisor, I have known a number of successful traders and advisors who used what I would describe as Magee-type chart analysis to make their trades. Often, other elements were input into their decision-making process, but manual charting was a key factor in their operations. Some of these traders used simple trendline analysis with price or volume filters and some used a combination of trendlines and support and resistance.
+All were trend followers.
+Having looked at the futures markets with some attention over the past several years, it seems to me there is no reason why chart analysis should not work as well now in futures as it has always worked in stocks. Essentially, the questions raised by securities trading are the same as those presented by futures trading in the analysis of a chart. Is there a trend? Where are support and resistance? Is there a breakout? Are there waves and wavelets? How do you enter and how do you exit?
+The great bug-a-boo of securities traders coming to the futures trading is the speed of the game. Like college football players stepping up to the NFL, there is a brutal learning curve and rookies are the most likely to get killed. I am not going to make any effort here to present a primer for new futures traders, but rather, I will look at some futures charts at the end of this chapter to show the journeyman that chart analysis can be used
+Figure 16.8
+Treasury Bonds. The double-pump triple-nod head fake is a specialty of futures markets. The fear and greed factor are multiplied by 10, like the leverage. But here in September 2004 Bonds, we can see how simple chart analysis can serve the trader. The downtrend from March (1) is completely manageable with a simple trendline and trend analysis. The end of the downtrend in May is marked by two strong run days. At any rate, the stop would have been at May 1, using a Basing Point kind of analysis. If we were going to trade it long, this would have been traded for a scalp (because we do not know whether or not there is a bottom). The break of the trendline at 2 is an engraved invitation to get long and the trendline at 3 keeps us long until broken by the signal day at the end of July. This would put us short again, whereas a two-day trade as the signal day on the trendline at 4 puts us long again. Obviously, we are using very tight, short trendlines and long-range days (or run days) as signals. The use of the run day as a signal, combined with other indicators, is common in my experience among traders.
+as a decision-making method in these dramatic markets. Again, chart analysis has the weakness (or strength) of being a qualitative process. It will not make decisions for the average trader, as a mechanical system will.
+On the other hand, a breakout is a breakout. A gap is a gap, leaving aside the question of limit move gaps for the moment. A trend is a trend. And here is the great advantage that a firm grasp of charting methods can give the practitioner.
+It can give him the perspective to recognize the essential nature of the market at hand and choose to wait or to enter.
+Mechanical methods not having the qualitative discrimination of an experienced chartist will blindly take every trade until they are out of money. The experienced chart analyst can sit back and say, this market has not yet made a bottom and the time to begin trading it long has not yet come. Or, he can recognize the essential differences between a trading and a trending market and adjust his tactics accordingly. As Magee noted in
+Chapter 16
+:
+Under what might be called normal market conditions, those chart patterns which reflect trend changes in most simple and logical fashion work just as well with commodities as with stocks. Among these we would list Head-and-Shoulders formations, Rounding Tops
+306
+303
+300
+297
+294
+291
+288
+285
+282
+279
+276
+273
+270
+Isi 1998-2004 Prophet Financial Systems, Inc. I Terms of use apply.
+Figure 16.9
+Commodity Research Bureau Index, April 2005 Futures. Just as Triangles often work in securities, they often work in futures. Breakaway gap, second breakaway gap, runaway gap, second runaway gap—this is the formation before the second runaway gap is somewhat quizzical—it might be considered a flag, but it has the same effect, and depending on the trader's operating methods, the stop would be just under the gap/run day anyway. It will not take much study for the reader to see the principles of chart analysis used in this entire book are validated here. The main difference is in the setting of stops, and in fact, the same stop methods may be used if the trader is sufficiently well financed.
+and Bottoms, and basic trendlines. Trendlines, in fact, are somewhat better defined and more useful in commodities than in stocks. Other types of chart formations which are associated with stocks with short-term trading or with group distribution and accumulation, such as the Triangles, Rectangles, Flags, etc., appear less frequently in commodities and are far less reliable as to either direction or extent of the ensuing move. Support and Resistance Levels, as we have already noted, are less potent in commodities than in stocks; sometimes they seem to work to perfection, but just as often they don't. For similar reasons, gaps have relatively less technical significance.
+These words remain true today, as do virtually all the principles enunciated in this book by Edwards and Magee and myself. In fact, if most futures charts were given to an
+Figure 16.10
+Commodity Research Bureau (CRB), long-term view. It does not take much analysis of this 10-year CRB chart to see a huge Double Bottom and to consider its implications. If China and India are going to compete with us for natural resources, we could see an entirely new economic paradigm, if the reader will excuse the term. Clearly, there is a Bull market in commodities. In
+Chapter 42
+, Pragmatic Portfolio Management, it is suggested that capital should flow to markets that are moving, rather than remaining committed to markets that are mired in mulish trends. Furthermore, it is suggested in that chapter that a good natural hedge is to go long on the uptrend of an index and short the components of it that are in downtrends. The CRB is somewhat thin but might lend itself to this strategy.
+Figure 16.11
+The 20-year bonds as expressed in the TLT; ETF Bonds display classical signals of absolute clarity.
+Figure 16.12
+September, 1994. Coffee was so easy in retrospect that it should be engraved on a brass plate. The long is taken on the breakout of the horizontal trendline. The position is never in any danger, as there is no down-wave of significance until May when stops are advanced to stay 5% under lows (Basing Points). The May down-wave allows a Basing Point stop to be established. The breakaway gap is a windfall profit. The flag tells us that more is coming—as it does with another gap and run days—until the spike reversal, which is a clear signal to be out on the close. A gap up on the open, an exploration up, and a close down—an absolutely clear message of reversal from the market.
+256                                                       Technical Analysis of Stock Trends
+Figure 16.13
+The May 11 top in silver. In the first quarter of 2011, silver took off in a roaring uptrend. Any surprise here, after looking at the Bounding Bottom? As seen in the chart, it came near to going parabolic. The top notice came on April 25—interestingly on a reversal bar. Reading the Candlestick, the market gapped wide on the opening and took a long excursion down to close the opening gap. Then bargain hunters thought they were getting a good price on silver and drove the price back up, so it did not close on the lows. The next day, it gapped down on the open and basically wandered down all day long—the party was over. The signs were subtle.
+Chapter sixteen: Technical analysis of commodity charts                                  257
+analyst, without issue identification and dates would not be identifiable as commodity charts. When limit moves appear, the difference slaps one in the face. On this point I might differ from Magee slightly as regards to gaps. Obviously, limit move gaps have breathtaking significance. All in all, it seems to me gaps often say the same thing to futures analysts as they do to stock analysts.
+Another mathematical reason might be adduced for the practicality of using simple chart analysis to trade futures. That is the tautological nature of the method. A trend is a trend, and a trendline is a trendline. If you enter a suspected trend (setting a protective stop at a technically analyzed place) and follow the trend using Basing Points or observing the trendline and exiting on a break and reversal there will be no difference from doing the same with a stock. Well, some difference. Due to the leverage, you will be required to be hyperaware of risk. In futures, the penalty for holding a position through “a normal reaction” can be extremely harsh. That is why stops are so important.
+The TLT chart from late 2008 is a spectacular display of patterns and signals. This pattern has appeared many times before and will appear again in the future.
+Prices break out of a sideways pattern on a strong gap. The gap is across the trendline, which is what makes the signal significant. Every gap is not a signal. In this case, the gap is extra significant because there is a power bar on the gap day—it should be bought. This is called a breakaway gap. Prices continue to progress, and a few days later another gap occurs. This is a runaway gap and is another signal.
+Shortly thereafter, prices drift sideways for a few days. This is a flag. Flags are vivid messages to traders. Robert Edwards described how they are used. He said, “The flag flies at half-mast,” meaning after a rocket-like advance and this formation, prices should advance on at least as far as they had come.
+Power bars (signals) exit from the flag, and then another gap occurs. This is the exhaustion gap. This is a message to exit longs and to short the issue. The message could not have been clearer.
+The skilled trader, first of all, catches the original signal—the power bar exiting from the sideways pattern. He then pyramids on the subsequent signals. Exiting from the flag, a good trader should have a boatload of this issue, and at the top, selling after the exhaustion gap, he should have made at least a small killing.
+Stops
+Some traders set their stops using money management rules rather than technically identified points. I believe it is always better to find the technical point using a Basing Point, or support and resistance. To me it makes better sense to adjust position size to control risk as I describe in
+Chapter 26
+. The use of money management stops has been very successful for many traders.
+If some logical and disciplined method of setting and observing stops is not installed, the trader is assured of failure.
+A money management stop is, simply enough, a stop calculated by deciding to risk 2% (or 3% or 4% or x%) of capital on a trade. For example, William O'Neil says that when a stock trader enters a position, he should set a stop 8% under his entry price. This is a little crude, and not strictly speaking, a money management stop, but it is better than no risk calculation at all. In a stricter sense, if we said we wanted to limit the risk of the trade to 3% of capital, we would use the 8% rule to set the stop and the Scott Procedure in
+Chapter
+26
+to determine the number of shares or contracts. The Turtle system contains similar procedures. Numerous studies have proven the size of the risk per trade—1%, 2%, 3%—is directly correlated to equity volatility.
+The 25th looked like a reversal day. The gap down on the 26th could have been considered the closing of an exhaustion gap—not apparent here because the tails (shadows) of the candlesticks obscure the complete price behavior.
+(EN10: In the 10th edition, a new section on stops in
+Chapter 27
+examines a number of stop methods.)
+A variety of methods
+As noted above, a competent chart analyst may, in my opinion (and in Magee's opinion), perform profitably in the futures markets. There are other questions, of course, namely of character, temperament, intelligence, judgment, and so on. Let us leave those questions to Dr. Elder and confine ourselves to the method question. Chart analysts proved their abilities in the futures markets long before computers existed. In fact, long before in the case of Japanese rice traders, enlightening their efforts with candlesticks in the eighteenth century.
+In the 1970s, I saw point and figure chartists enjoy great success at Dean Witter and Merrill Lynch and other major firms in futures. I have seen least squares curve fitters, moving average calculators, and abstruse statistical analysts all enjoy profitable outings in commodities. Not to speak of the Turtles who, using naturalistic high-low systems, harvested good profits in the markets. As the saying goes, gateless is the gate and many are the ways to the great Dow. Although I have enjoyed great success myself using mechanical number-driven systems over the years, I have become more and more attracted to “natural” systems. Chart analysis is essentially natural, as is the Turtle system. The Dow Theory is a natural system in which no mathematical algorithm comes between the analyst and the data. The essential, more, quintessential, weakness of all number-driven systems is their blindness. They do not have the ability to discriminate between the forest and the trees. The experienced human chartist can
+see
+(and hear) the changing rhythms of the market and respond to them, responding to factors too subtle (and even subconscious) to program. Nevertheless, even natural systems, like the Turtle systems, can fall into this trap. When the markets learn a lot of capital is waiting just above the 20-day high, they will set a trap for it. For “markets” you may read “they.” If you apply the knowledge of this book to such situations, you may avoid the trap.
+Everything you need to know as a chart analyst trading futures
+“Jack be nimble, Jack be quick, Jack jump over the Candlestick.” Yes, it is true, as the leverage is 10 times greater and the speed is 10 times faster. I have illustrated in
+Figure 16.9
+the combination of a very tight trendline with a run day, which it seems to me is a good current (twenty-first century) combination. Otherwise, the same qualities that make a good securities trader make a good futures trader once the great leap to leveraged quick-fire markets is made. If you have been successful trading stocks, you will probably be successful trading futures, and you probably should practice on stocks while studying futures. A sobering fact I often recount to my graduate students is that Richard Wyckoff worked in the securities business for eight years before making his first investment; he studied the markets an additional six years before
+trading.
+The Magee methodology will serve as a valuable cornerstone of your futures operations and you must never cease studying. Mechanical systems have their attractions, especially when seasoned with experienced chart analysis. No method will survive unless practiced with diligence, persistence, judgment, and patience. Time and again you will hear famous traders say discipline is the secret of their success. What they mean by discipline is their ability to measure and contain the risk, set a stop based on technical or money management procedures, and
+then honor the stop.
+The most important lesson the futures trader has to learn from Edwards and Magee is the ability to see the character of the market, trading or trending, and then
+to adjust his tactics accordingly.
+In the next great Bull Market in commodities, which is inevitable, these methods and systems derived from them will once again reap windfall profits.
+I have attempted in the ninth edition of this classic book to show the book's usefulness to the intelligent futures trader. Simple classical chart analysis alone can be successful in the futures markets in the hands of an experienced competent analyst. Natural mechanical systems such as the Turtle system have been effective and will be again, perhaps with some tweaking (such as imposing a chart analysis superstructure). Wave analysis methods such as the Basing Points Procedure of
+Chapter 28
+can be used. Even number-driven systems, such as moving averages, can be successful, especially if combined with chart analysis.
+chapter seventeen