vest time
for traders who, having avoided the Bullish infection at the top of the market, have funds in reserveto pick up stocks available at panic prices.
Obviously, a cleanout day or Selling Climax radically reverses the technical condition of themarket, for in its process, shares have passed from weak hands into strong hands at very muchlower prices. The ominous weight of potential selling that has been overhanging the market hasbeen removed. Usually, the Panic has carried quotations (although only temporarily, as a rule) wellbelow even conservative values based on current business conditions.
A Selling Climax need not be completed, and the Reversal of Trend actually becomes evident,within a single day. We have classified it as a variety of One-Day Reversal, but some of them haveactually spread out over two days, with the decline exhausted and coming to a halt late on the firstday, too near the end of the session to permit much recovery. The next day sees an extensive rallyright from the opening gong, as it is immediately apparent then, if not late on the preceding day,that there are no more distress offerings.
The all-time percentage record for Selling Climaxes is held by October 29, 1929. Prices in terms ofthe Dow-Jones Industrial Average opened that day practically at their high, 252.38, which was morethan 8 points below the previous day's closing level. Panic selling flooded the Exchange from thestart; before it was over, the Industrial Average had lost 40.05 points. From that low, 212.33, itrallied in the final two hours to 230.07 for a gain of nearly 18 points and went on up another 28points the following day. This 1929 climax set the alltime record also for daily turnover: 16,410,000shares were traded in those five hours, more than twice as many as in any one day during the entirepreceding Bull Market. But the low level of October 29 was broken a week later, and the bottom ofthat particular early phase of the 1929-1932 Bear Market was not reached until November 13. EN:See comments on the following page on the Reagan Crash of 1987.
The Panic of 1937 ended with a classic Selling Climax on October 19, another “Black Tuesday” instock market annals. The Dow Industrials had closed at 125.73 the night before; prices had alreadyfallen without a rally of consequence from a high of 190 in mid-August, and margin accounts werenearly all in a precarious situation. The telephones had worked overtime the preceding day bybrokers demanding additional margin, most of which was not forthcoming. When the Exchangeopened on the 19th, quotations hit the toboggan under a flood of offerings. By 11:30 a.m., with theIndustrial Average around 115, the selling was over and offerings disappeared. An hour later, priceswere jumping a point between sales and the day closed at 126.85, recovering its entire loss. Volumeon that climax was 7,290,000 shares, double that of any day at the top of the preceding BullMarket. An intraday high of 141.22 was reached 10 days later, but the Panic Low was subsequentlybroken on November 20, 1937, and that Bear Market finally ended at 98.95 (Dow-Jones Industrials'closing level) on March 31, 1938.
EN: No wonder investors have instinctual angst on October 19. In 1987, the Bear returned tocreate another great Panic—on the very same date. From a high of 2746.65 on August 25 the Dowbungeed to a low of 1,616.21 on October 20. The actual full-blown panic took place from October14 (high 2,485.15) to October 20 (low 1,616.21) with October 19 and 20 traversing a range of547.95 points or 25% of the market at that point. Top to bottom, 1130 points were lost, comprisinga retracement of 41%. The more things change the more they stay the same, as Andre Malraux issaid to have remarked. Actually, he said it in French, which is more elegant, and expresses the sameidea: Plus ga change, c'est plus la meme chose. Readers should not assume that similar crashes willnot occur in the future.
The foregoing were general market climaxes, a phenomenon that produces (or rather is producedby) simultaneous selling in practically every actively traded individual issue. A Climax Bottom, asa matter of fact, appears in an individual stock chart, as a rule, only as a concomitant of a generalmarket cleanout, although there are cases in which some particular and completely unexpectedpiece of bad news affects one certain company and causes panicky liquidation of its shares alone,terminating with a One-Day Reversal. The Top Reversal Day, on the other hand, is normally amanifestation of an individual stock rather than of the general market average.
The two outstanding examples of Selling Climaxes (cited above) and numbers of others that haveappeared at the conclusion of various Panic Sell-offs offered extraordinary opportunities for a quickturn to the trader who was smart (or lucky) enough to get in at the bottom. He could cash in a fewdays later with exceptional profits. Professional operators capitalize on such opportunities. Theproblem is to recognize the climactic nature of the selling in time to seize the chance—and that isnot as easy as it may have sounded in our discussion. Just to emphasize the possibilities of error,there was a 30-point drop, followed by a 30-point recovery, on a turnover of nearly 13 millionshares, on October 24, 1929, but the trader who did not grab his profits within 48 hours never hadanother chance to get out even (in terms of the Averages, that is).
But it is not impossible to recognize a Selling Climax, if you have friends in the Street to keep youinformed on the condition of margin accounts and the amount of necessitous selling to be expected.EN: This information is now not difficult to come by. It is easily obtainable in the general financialpress. The climax comes after a decline approaching Panic proportions. The day usually opens witha substantial Downside Gap (opening prices considerably below the previous night's closing);offerings appear too great to be absorbed; prices collapse;


the amount of necessitous selling to be expected.EN: This information is now not difficult to come by. It is easily obtainable in the general financialpress. The climax comes after a decline approaching Panic proportions. The day usually opens witha substantial Downside Gap (opening prices considerably below the previous night's closing);offerings appear too great to be absorbed; prices collapse; volume is extreme; the market isexceptionally “broad” with nearly every listed stock crowding into the record. Then, some timeafter 11:00 a.m., perhaps not until afternoon, the selling appears to dry up; a few issues continue todecline while others begin to climb. Suddenly prices are jumping, which is the time to act. Buy astock that has been thoroughly depressed but normally has a good following at all times (e.g., U.S.Steel). Do not hang on too long; take a reasonable profit as soon as it is available and sell, in anyevent, whenever the recovery shows signs of bogging down.
Remember, a One-Day Reversal is not a dependable Major Trend indicator. Selling Climaxes donot normally occur at the final Bottoms of Bear Markets—weak holdings usually have been shakenout long before that stage is reached. Only one Primary Downtrend in all the record has, in fact,ended with the first Panic Phase, that being the five-month Bear Market of 1938-1939 that wasfollowed by an equally short Bull Market.
Occasionally, a weekly chart will produce a formation that might be called a “One-Week Reversal,”in some such conspicuous fashion as is shown above in “NC.” In this instance, the subsequent riseproves that a Major change in its technical balance occurred in December 1941. Curiously enough,no other obvious Reversal Pattern appeared on the weekly chart at this turn in the Primary Trend of“NC.” (Its daily chart showed an Ascending Triangle.) But this example of a One-Week Reversal isnot shown to give the idea that such phenomena carry important technical indications. On thecontrary, most “Reversal weeks” are followed by very disappointing moves.
One remaining Reversal Formation, the Island Pattern, involves the whole subject of Gaps, whichwill be taken up in detail in Chapter 12; thus, we will defer our discussion of the Island Reversaluntil then.
Short-term phenomena of potential importance
Very short-term phenomena—of a one-day or a few days' duration—can sometimes be indicative ofnot only short-term direction, but also give hints as to long-term price behavior. Gaps (see Chapter12) and One-Day Reversals (this Chapter) belong to this group. Other short-term patterns of interestinclude Spikes, Key Reversal Days (sometimes merely called Reversal Days), and Runaway Days(sometimes called Wide-Ranging Days).
Spikes
On the day it occurs, a Spike is not immediately identifiable for by definition it protrudes Head-and-Shoulders above days before and after if it is at or near a Top and plunges much below thesurrounding days if it occurs at a Bottom. So after a day that exhibits an unusually wide range, thesubsequent days must be observed to discriminate the day from a Runaway Day. Both are the marksof a far-ranging battle between Bulls and Bears, with the close giving a clue as to whom theeventual winner will be.
The importance of the spike is highlighted by the following:
1. The strength and length of the action that preceded it.
2. The close of the day, whether up on a Bottom or down on a Top.
3. Its prominence when compared with the days before and after it.
An extremely wide-range day at the end of a long Bull move that closes down after making unusualnew highs might even be construed as a one-day signal. Whether one trades on it or not woulddepend on his particular style and taste and the nature of his trading—long range, scalping, and soon. In fact, the Spike might also be a One-Day Reversal—that pattern in which an opening gapoften is followed by avid buying that collapses and closes below the opening or at the low of theday. Such action might be compared with an army pursuing a seemingly defeated enemy only todiscover the retreat was a ruse, then turning and fleeing the other way in a rout.
Turn this description on its head and you have a Spike Bottom. It is not infrequent that a Spike willbe followed by significant price movement in the opposite direction. Figure 10.23 illustrates amodern Spike. Figures 1.1 and 7.16 show some spikes on Edwards' and Magee's charts.
Runaway Days
A Runaway Day is a day that stands out on the chart as having an unusually long range, oftenopening at the low and closing at the high, or vice versa for Bear runaways. Here the enemy hasretreated precipitously, or treacherously, to draw the Bulls into a trap. The holders and sellerscannot or will not satisfy the eager demand of the buyers and so the price transverses perhaps twoto three times the daily range. Although the agile speculator may jump on this charging train andrealize a nice scalp, it is the following days that reveal the true significance. Nice consolidation andcontinued volume will confirm the day as significant while a tapering of volume and rounding orvolatile pullback will call into question its validity. Although these days may be taken as hair-trigger buy signals (or sell signals, depending) the return of prices to the low of the Runaway Day
will probably indicate the day was a false signal and a trade in the opposite direction is shaping up.See Figure 7.20 for runaways complete with gaps.
One such example is shown in Figure 10.24 in which a bull trap precipitated by a Runaway Daywith a subsequent collapse foretold the 50% decline in Microsoft stock in 2000.
Key Reversal Days
The Key Reversal Day pattern occurs when one sees a new high in an up-move and then a closebelow the close of the previous day. As a short-term trading signal it has much to recommend it, butlike every other technical pattern, judgment and timing are required to profit from it. In a BullMarket, there will be some if not many such interim highs marked

eBooks\Technical Analysis of Stock Trends, Eleventh Edition-CRC Press (2018).pdf


e in Microsoft stock in 2000.
Key Reversal Days
The Key Reversal Day pattern occurs when one sees a new high in an up-move and then a closebelow the close of the previous day. As a short-term trading signal it has much to recommend it, butlike every other technical pattern, judgment and timing are required to profit from it. In a BullMarket, there will be some if not many such interim highs marked by Key Reversal Days. On theKey Reversal Day at a major or important Top, the trader shorts the stock on the close with a stop atthe high of the reversal day, or slightly above. He may then exit on the profit side on the occurrenceof a Key Reversal Day in the opposite direction, or on a profit target, or a chart pattern. Ifadventurous, he may use the trade as the first of accumulating a position for an anticipated BearMarket, adding other positions as more significant patterns occur and as support levels are broken.
This pattern also is useful in trading range markets, as shown in some internet stocks from 2000,where trading with Key Reversal Days would have allowed the trader to escape unscathed in theminicrash of the NASDAQ in early 2000 (see Figures 10.25 and 10.27 for eBay and Lucent.)
Of all the Very Short-Term Patterns, Gaps, One-Day Reversals, Key Reversal Days, Spikes, andRunaway Days, it should be noted that the return of prices to the origination of the formation marksthe formation as a false signal and a reason to reverse the trade direction and look for significantprofits.
Clearly, these are the tactics of scalpers and speculators, but it profits the long-term investor toknow and understand them.
Taylor & Francis
Taylor & Francis Group
http://taylorandfrancis.com
chapter eleven
Consolidation Formations
An army, which has pushed forward too rapidly, penetrated far into enemy territory, sufferedcasualties, and outrun its supplies, must halt eventually, perhaps retreat a bit to a more easilydefended position and dig in, bring up replacements, and establish a strong base from which later tolaunch a new attack. In the military parlance with which we have all become more or less familiarthese past few years, that process is known as consolidating one's gains. Although it will not do tooverwork the analogy, there is much in the action of the stock market that may be compared to amilitary campaign. When a stock pushes ahead (up or down) too fast, it reaches a point at which theforces that produced its move are exhausted. Then it either reverses its trend (in a Major orIntermediate sense), reacts to a good Support Level, or Consolidates its position, in some sort of“sideways” chart pattern composed of Minor Fluctuations, until it has caught up with itself, so tospeak, and is ready to go on again. (For illustrations in this chapter, see Figures 11.1 through 11.18.)
We already have had occasion to refer to Consolidation Formations in our study of SymmetricalTriangles and Rectangles; exactly how those two chart formations might either reverse the previoustrend or Consolidate it in preparation for its continuation were shown. We noted about three out offour Symmetrical Triangles will turn out to be Consolidations rather than Reversals—andRectangles in about the same proportion. Even a Flat-Topped Broadening Pattern constructed at theTop of an Intermediate Advance may, despite its normally Bearish implications, be converted into aConsolidation or Continuation Formation if its Flat Top is decisively penetrated on the upside.
A Dow Theory Line in the chart of one of the Averages may be a Consolidation or ReversalFormation, but is rather more likely to be the former than the latter. A Dow Line is, of course, a sortof loose Rectangle. The fact is almost any sort of sideways price pattern, such as is often termed a“Congestion” or trading area, provided trading volume tends to diminish during its construction(and provided it does not show definite broadening tendencies), usually functions as aConsolidation. But most areas of Trend Consolidation are fairly well defined, taking on arecognizable pattern.
Flags and Pennants
We do not need to spend more time here on the Triangles and Rectangles; they have been examinedin both their Reversal and Consolidation manifestations in previous chapters. Our first twoformations, which are characteristic of Consolidation only, are the Flags and Pennants, which arecuriously related in certain aspects to Triangles, Rectangles, and Wedges.
A Flag looks like a flag on the chart. That is, it does if it appears in an uptrend; the picture isnaturally turned upside down in a downtrend. It might be described as a small, compactparallelogram of price fluctuations, or a tilted Rectangle that slopes back moderately against theprevailing trend. Let us consider the Uptrend Flag first. It usually forms after a rapid and fairlyextensive advance that produces a nearly vertical, or at least quite steep price track on the charts.On such moves, volume normally shows a progressive increase until it reaches a high rate. Thisvolume (since every transaction signifies a sale as well as
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Figure 11.1 This is a typical and practically perfect Flag, constructed May 12 to June 2, 1945, inMartin-Parry. Daily turnover diminished to a low rate as prices settled down for exactly three weeksafter their swift advance from 11 to 16 1/2 but held up away from the lower boundary line duringthe third week, and then burst out topside with high volume in another straight-line push from 15 to21. Study this chart again when you come to the Flag-measuring formula later in this chapter. Thedashes at 12 indicate the upper range of an old Resistance Level (see Chapter 13).
a purchase) is a warning that many holders of the stock are taking profits. Eventually the pressureof profit-taking halts the markup. Prices “churn” without further gain and then r


in another straight-line push from 15 to21. Study this chart again when you come to the Flag-measuring formula later in this chapter. Thedashes at 12 indicate the upper range of an old Resistance Level (see Chapter 13).
a purchase) is a warning that many holders of the stock are taking profits. Eventually the pressureof profit-taking halts the markup. Prices “churn” without further gain and then react 2 or 3 pointson reduced turnover. A new rally occurs but fails to equal the previous high or attain the previoustop volume. Another reaction carries quotations slightly below the preceding Bottom with further
diminution of activity and then follows a series of similar Minor Fluctuations, each of whose Topsand Bottoms are successively a trifle lower than its predecessor, and with volume shrinkingmarkedly and constantly as the pattern develops. On the chart, the initial, steep up-move followedby the compact, sideways, and slightly down-sloping price Congestion Area, which can be roughlybounded, top and bottom, by parallel lines, takes on the appearance of a mast (or halyard) with aflag flying from its peak, hence, the name of the formation.
Sometimes each rally and setback within the Flag takes three or four days, rarely more. In othercases, prices will skip back and forth between the upper and lower Flag boundaries in a single dayor two, in which event the pattern on the chart consists of an almost solid block of price range lines.The wider the pattern (from top to bottom) the longer time,
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Figure 11.2 Another typical Flag of three weeks' duration, August 30 to September 18. ThisNational Gypsum chart overlaps that in Figure 8.6, showing the false move at the apex of the May-June Symmetrical Triangle. A buy signal was given when prices pushed up through the old apexlevel on August 23 with increased volume. Most interesting is the second Symmetrical Triangle thatformed in October-November, an almost exact replica of the first, but with a downside false moveat its apex. The sharp increase in volume on November 27 left no doubt as to its being aConsolidation rather than Reversal Pattern. “NG” went on up to 33.
naturally, it should take for each swing within it to be completed. This process of MinorFluctuations may continue for only five days to a week if the Flag is narrow, or it can go on for aslong as three weeks. Daily turnover by that time usually will have shrunk to a relatively low ebb.Then, suddenly, prices will erupt with a new burst of activity from the end of the Flag and pushstraight up again in another advance that practically duplicates the original “mast” atop which theFlag was constructed.
We have spoken of the Flag pattern as being moderately down-slanting, but the very short and“solid” ones will frequently develop horizontally and look like small squares. (On rare occasions, apattern of the Flag type in an uptrend will even slope up a trifle.)
Flags form on steep down moves in much the same manner and with precisely the sameimplications as they do in uptrends. Down Flags, of course, tend to slope up—that is, they simplyinvert the picture presented by an Up Flag. Trading volume diminishes during their formation andincreases again as prices break down away from them.
The Pennant: a pointed Flag
The only important difference between a Pennant and a Flag is the former is bounded byconverging boundary lines rather than parallel lines. The normal Pennant, in other words, is a small,compact, sloping Triangle. It slants down when it appears in an uptrend, and it
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Figure 11.3 Flags of the “Half-Mast” type appear most often in the later and most active stages of aPrimary Advance. The above example (January) was the last Consolidation Formation before“NK's” 1937 Bull Market Top. Note the Rectangle Reversal Pattern in March and the series of step-down patterns that followed.
slants up in a downtrend. It forms, as a rule, after a rapid advance (or decline), and trading volumeshrinks notably during its construction. In fact, activity tends to diminish even more rapidly in aPennant than in a Flag (which we naturally would expect on account of the progressively shorterfluctuations that compose it), and it may drop almost to nothing before the Pennant is completedand prices break away from it in a new and rapid move.
The Pennant might also be described as a short, compact Wedge, characterized by markeddiminution of activity. When, as is usual, it slants back against the preceding trend, its forecastingimplications are similar to those of the Wedge, in that prices break out of it in a direction oppositeto its slant. But there are rarer Minor variations of the Pennant, comparable with those sometimesfound in the Flag, in which the price area is very short and “solid” and practically horizontal (like aSymmetrical Triangle), or in which the slope is actually slightly in the same direction as thepreceding trend instead of against it. When prices move out of the last-named type, they ordinarilydo so, not in a sudden straight-line breakaway, but rather in an accelerating curve with volumeincreasing gradually instead of abruptly at the break; the whole pattern resembles a curved horn thatruns to a long, slender point. Do not let these variations worry you; there is nothing deceptive abouttheir appearance; their kinship to the more common, normal form is quite apparent.
The measuring formula
The same approximate measuring formula applies to the Pennant as to the Flag. They are both“Half-Mast” Patterns that ordinarily form after a fairly steady and rapid (steep) price movement. Inapplying the measuring rule, go back to the beginni


ariations worry you; there is nothing deceptive abouttheir appearance; their kinship to the more common, normal form is quite apparent.
The measuring formula
The same approximate measuring formula applies to the Pennant as to the Flag. They are both“Half-Mast” Patterns that ordinarily form after a fairly steady and rapid (steep) price movement. Inapplying the measuring rule, go back to the beginning of that immediately preceding move, to thepoint at which it broke away from a previous Consolidation or
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Figure 11.4 Sometimes a stock will make a long series of small Consolidation Patterns in itsuptrend, one following right on the heels of another as successive groups of traders buy in whileothers take their profits on previous purchases. In this sequence of step-ups in Vanadium, the FlagPattern formed in January 1937 ran a few days over, but the volume breakout of February 4 left nodoubt the trend was still up. A final Top was made at 39 1/2 in March. Note the strong buy signalgiven on December 14. Refer to this record again in connection with Support and Resistancestudies in Chapter 13.
Reversal Formation (or through a significant trendline or Resistance Level, with which laterchapters are concerned), a point recognizable as a rule by a quick spurt in activity, and measurefrom there to the Minor Reversal level at which the Flag or Pennant started to form. Then measurethe same distance from the point at which prices break out of the Flag or Pennant, and in the samedirection. The level thus arrived at is the minimum expectation of this type of ConsolidationPattern. As a matter of fact, advances from Flags
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Figure 11.5 A Bull Flag in February and a Bear Flag in April 1936, in Briggs. The Top betweenwas a Symmetrical Triangle. April 30 was a Reversal Day. Prices recovered to 64 1/2 in November1936, making there a long-term Major Double Top with this March high. The Support-ResistanceZone at 51-53, indicated by dashed line, was still effective in 1946 (see Chapter 13).
or Pennants in an uptrend generally go farther (in terms of points or dollars) than the precedingmove, whereas declines may not carry quite so far. Hence, the formula is best applied on asemilogarithmic chart by measuring actual chart distance rather than by counting points. You cancheck this by referring to the examples illustrating this study.
Reliability of Flags and Pennants
These pretty little patterns of Consolidation are justly regarded as among the most dependable ofchart formations, both as to directional and measuring indications. They do fail occasionally, butalmost never without giving warning before the pattern itself is completed. All that is necessary toguard against such failures is to strictly apply the tests as to the authenticity of the patternincorporated in their description. These are as follows:
1. The Consolidation (Flag or Pennant) should occur after a “straight-line” move.
2. Activity should diminish appreciably and constantly during the pattern's construction andcontinue to decline until prices break away from it.
3. Prices should break away (in the expected direction) in not more than four weeks. A patternof this type that extends beyond three weeks should be watched with suspicion.
The matter of practical trading on these particular formations will be taken up in Section II of thisbook, which is devoted to tactics. Our second test deserves some further
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Figure 11.6 The down-sloping, Converging Price Formation of November 4 through December 9might be called either a short Wedge or a Pennant. Note the small Flag in October; also RunawayGaps November 4 and February 19, and the Breakout Gap December 10.
comment here though. If a pattern begins to develop on the chart—which, so far as the price picturealone is concerned, qualifies as a Flag or Pennant, but during which trading volume remains high orobviously irregular instead of diminishing—then the outcome is more apt to be a quick reactionagainst, rather than continuation of, the previous trend. In other words, such high or irregularactivity formations are characteristically Minor Reversal Areas rather than true Consolidations.Watch the volume half of your chart at all times.
Where they may be expected
Flag and Pennant Consolidations are characteristic of fast moves. Therefore, they show up mostfrequently in the later, dynamic phase of Bull Markets, after the first accumulation and the moreorderly early markup stages have passed. Hence, the appearance of these patterns may be taken as awarning that an advance is approaching its final weeks. The rapid phase of a Major Bear Trend, onthe other hand, is its second stage, often characterized by almost “vertical” Panic Declines. TheFlags and Pennants that develop therein are usually short— completed in a matter of three or fourdays rather than weeks. In the late months of a Bear Market, formations that evolve on the charts inthe Flag or Pennant similitude often will run too long (four weeks or more), begin to show anincrease in volume on the rallies, and be succeeded by only dull and limited reactions.
Figure 11.7 An example (in June 1944) of the brief and compact type of price “Congestion” thatcan be classed as a Flag. The advance here started at 5 from a 13-month Symmetrical Triangle ofwhich only the last two months appear above. The measuring implication of this tiny Flag was notfulfilled until after prices had undergone a sort of Triangular Consolidation in July.
In general, it


d reactions.
Figure 11.7 An example (in June 1944) of the brief and compact type of price “Congestion” thatcan be classed as a Flag. The advance here started at 5 from a 13-month Symmetrical Triangle ofwhich only the last two months appear above. The measuring implication of this tiny Flag was notfulfilled until after prices had undergone a sort of Triangular Consolidation in July.
In general, it may be said these particular chart patterns are most common (and most dependable) inuptrends. The appearance, after a Major Decline, of price pictures that, at the start, assume thedowntrend Flag or Pennant form must be regarded with caution. Unless such developments holdstrictly to the limitations we have stated above under the heading of “reliability,” do not trade onthem.
Flag pictures on weekly and monthly charts
One of our requisites for a dependable Flag (or Pennant) was it should not take more than fourweeks to complete its pattern and break out in a new move. It stands to reason, therefore, that a true
Flag cannot show up at all on a monthly chart and barely appears on a weekly chart. You will findprice areas on long-range charts, patterns that have taken 8 or 10 weeks to as many months,sometimes a year or two, in their construction, which assume the shape of a Flag, but do not expectthem to function as Flags. Examined in detail on a daily chart, these same long areas almost alwayswill be found to contain price formations having entirely different significance. Frequently, what isreally a Major Reversal Area following a long, rapid advance will look something like a Flag whenit is condensed on a monthly chart. So, do not trust such pictures on long-range charts; do not takeit for granted that they represent Consolidation for a new rise; find out what the detailed dailyplotting for the same period says.
The July-August Flag ran for five weeks—too long to be trusted without additional technicalevidence (see point 3 under “Reliability of Flags and Pennants”). The danger in
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Figure 11.8 Another example of the series of Flag-type Consolidations that may form in a rapid,third-phase Bull Market Advance. Mullins went from 15 to above 39 in six months in 1936,dropped back to 31, and then rose again in March 1, 1937, to its previous high, making a MajorDouble Top. (Note that “MNS” was split 2-for-1 in 1937.)
such prolonged formations is either when the breakout finally appears it will fail to follow through,or prices will keep drifting right on down. For the moment—on August 25—it looked as thoughthis Flag had “gone stale,” but when prices rose above the previous high on August 27, with a smartpickup in volume, purchases were obviously safe.
Rectangular Consolidations: an early phase phenomenon
In contrast with Flags and Pennants, which are typically last-stage Bull Market Concomitants,Consolidations of the Rectangle class are found more often in the earlier phases of Bull Trendevolution. In Major Bear Moves, Rectangles may develop in the first stage just before a PanicDecline, or in the last stage preceding a strictly limited final sell-off. The latter manifestationpresumably betokens premature accumulation by interests who feel that prices have already gonelow enough to suit their purposes. (They come out all right, if they are able to hold on through theremainder of the Bear Swing and long enough for the next Bull Market to put prices back up againto profitable levels.)
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Figure 11.9 The vertical lines marked “M” show how the measuring formula is applied to a FlagPattern. Note the first measurement is taken from the level at which the mast leaves the previous“Congestion” up to the peak of the Flag. This same distance is then measured up from the Flagbreakout. In “WYO,” the formula worked out exactly. Trading commitments should normally have
been cashed in above 36 on this move. They might then have been reinstated when it becameapparent by April 2 that a Rounding Bottom was completed (note volume) for a new advance.
Head-and-Shoulders Consolidations
All our references to the Head-and-Shoulders Formations up to this point (see Chapters 6 and 7)have considered that pattern as typifying a Reversal of Trend, and, in its normal and commonmanifestation, that is most definitely the Head-and-Shoulders function. But, occasionally, priceswill go through a series of fluctuations that construct a sort of inverted Head-and-Shoulders picture,which in turn leads to continuation of the previous trend.
There is no danger of confusing such Continuation or Consolidation Formations with regular Head-and-Shoulders Reversals because, as stated, they are inverted or abnormal with respect to thedirection of the price trend before their appearance. In other words, one of the patterns thatdevelops in a rising market will take the form of a Head-and-Shoulders Bottom. Those that appearin decline assume the appearance of a Head-and-Shoulders Top. By the time these price formationsare completed (left shoulder, head, and right shoulder evident), there is no question as to theirimplications. But at the head stage, before the right shoulder is constructed, there may be—usuallyis—considerable doubt as to what really is going on.
AMERICAN WOOLEN
WY
1946
44 **
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JANUARY-FEBRUARY MARCH APRIL MAY JUNE
5 12:1926 2' 9 16 23 2 9 16 23 30 6 13 20 27 4 11 18 25 1 : 8 15 22 29-
Figure 11.10 A 1946 chart that delighted technicians contains a perfect “Half-Mast” Pattern inJanuary, with measuring gaps (G, G) above and below it; a downside Flag in early February (checkmeasurement); a fine Ascending Triangle at the bottom of this reaction with a Throwback in April,giving an ideal “buy spot.”
The volume patter


:1926 2' 9 16 23 2 9 16 23 30 6 13 20 27 4 11 18 25 1 : 8 15 22 29-
Figure 11.10 A 1946 chart that delighted technicians contains a perfect “Half-Mast” Pattern inJanuary, with measuring gaps (G, G) above and below it; a downside Flag in early February (checkmeasurement); a fine Ascending Triangle at the bottom of this reaction with a Throwback in April,giving an ideal “buy spot.”
The volume pattern in Consolidations of this type does not follow the rule for Reversal Head andShoulders. In a downtrend, for example, the Consolidation Formation resembled in its price contoura Head-and-Shoulders Top, but the attendant volume will diminish instead of increase on the leftshoulder and head as well as on the right shoulder. The same holds true for the “Bottom” Patternsthat develop as Consolidation in an advance market; however, Breakouts resemble, in all respects,those arising from Reversal Formations.
Head-and-Shoulders Consolidations of the Complex or Multiple type seldom appear on the charts.Theoretically, they might and should be as easy for the chart technician to handle as the simpleforms.
The formula for determining the probable minimum price move (beyond the neckline) from aHead-and-Shoulders Reversal Formation was discussed in Chapter 6. To anyone familiar with theverities of stock market trends and the endless variety of pictures that the charts can present, it isamazing how accurately that formula works out and how often the first consequential move awayfrom a Head-and-Shoulders Top or Bottom will carry through to the point (or a little beyond)implied by the measurement of the formation. But, the same formula applied to ConsolidationPatterns of the Head-and-Shoulders form does not work out as well. Such patterns are usually quite“flat,” and the ensuing move generally
MO(D)
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Figure 11.11 MO. Talk about your technician's delights. Altria Group throws off some pretty gooddelights here: a breakaway gap and run days to the downside, a down flagpole with flag, andpattern gaps. But they are good pattern gaps and really interesting. Then a triangle complete with abreakaway and an up flagpole with flag. The non-technician probably is suffering from nausea atthis point. It is a roller coaster that bodes ill for everyone. Additionally note a completely tradablesituation for the alert short-term technician.
extends well beyond the measurement implied thereby, although, in some cases, it may not go quiteas far. Consequently, the Head-and-Shoulders formula cannot be applied to Consolidation Areaswith the assurance that it sets up a definite and dependable objective; one has to look, in thesecases, to a variety of other chart indications to appraise the probable proportions of the move tofollow.
Scallops: repeated Saucers
Our next chart picture differs from the Consolidation Formations previously discussed, in that itdoes not constitute a more or less definite area of Congestion or fluctuation to which one or morecritical boundary lines can be affixed. We could, perhaps, take it up as well in a subsequent chapterunder the general heading of normal trend action. Yet it is a pattern so characteristic of certain typesof stocks and certain types of markets, and so nearly related to the principle of Consolidation forfurther advance, that it may be better treated here.
When a stock for which there is a large number of shares outstanding, and for which there is, at alltimes, a fairly active and “close” market emerges from a long-time Bottom (as exemplified by thepast history of Radio Corporation and Socony-Vacuum), which will often make a long MajorAdvance in a series of “Saucers.” These successive patterns, each of which resembles, in both priceand volume action, the Reversal Formation described in Chapter 7 as a Rounding Bottom, areslightly uptilted, that is, the rising end always carries the price a little higher than the preceding Topat the beginning of the Saucer. The net gain accomplished by each Saucering movement will varyfrom stock to stock, but there seems
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Figure 11.12 A Flag (end of November) that seemed for several weeks to have failed completely.Prices, however, rose quickly to 36 1/4 from their December 23 low, thus finally carrying throughaccording to formula. Note the Flat-Topped Broadening Formation that started the move.
to be a strong tendency for it to amount to about 10%-15% of the price of the issue. The totalreaction from the left-hand lip of each Saucer to its Bottom level is usually a little greater, from20% to 30%, and the length (duration) of the Saucers is normally five to seven weeks, rarely lessthan three. Thus, the overall advance is slow but steady, in much the same sense as the progress ofthe man who eventually got out of the deep well by climbing three steps for each two that heslipped back.
The charts of stocks that take this sort of course show a picture of strikingly similar andsymmetrical Rising Scallops, one succeeding another with little or no pause between. Tradingactivity runs


han three. Thus, the overall advance is slow but steady, in much the same sense as the progress ofthe man who eventually got out of the deep well by climbing three steps for each two that heslipped back.
The charts of stocks that take this sort of course show a picture of strikingly similar andsymmetrical Rising Scallops, one succeeding another with little or no pause between. Tradingactivity runs up to a peak at the latter stage of each Scallop, as the previous high is approached andexceeded, then diminishes into dullness as prices curve down and flatten out at the Bottom of thenext Saucer, picking up again as prices curve up into their next rise.
The trading opportunities afforded by stocks of the Saucering habit hardly require extendedcomment (although we shall set down some detailed specifications in Section II of this book). TheBottom level of each Scallop is usually easy to detect by watching price trend and volume, and so isthe topping out at the end. Yet it is curiously a fact that most “tape watchers” handle such stocks inthe wrong way, becoming interested in them and buying when they show activity (“make a newhigh on volume”) and neglecting them entirely when they are in the dull, rounding-out stage oftheir trends.
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ANACONDA COPPER
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7 14 21 28 5 12 19 26
Figure 11.13 Typical of the form that Head-and-Shoulders Consolidation Patterns may take, bothas to price pattern and volume, was this development in Anaconda. Measuring formula for the smallFlag in October should be applied from the point of breakout through the Head-and-Shouldersneckline.
Figure 11.14 A 1945 Head-and-Shoulders Consolidation in which both of the shoulders and thehead took a “Saucer” form. Compare price and volume trends. Prices advanced to 31 1/2 in July,came back again to 25 1/2 in August, and then shot up to 40 in November.
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Figure 11.15 Part of a genuine “Scallop” uptrend, typical except for the short duration andrelatively small decline in the October Saucer. The next Scallop, which started in December,dropped prices back to 12 1/2 in January, and then carried them to 18 1/2 in February. A four-monthSaucer, from February 1945 to June, preceded this chart. Note the position traders found themselvesin if they bought at 9 on the “new high volume” in June.
COMMONWEALTH EDISON CWE
1945
28 Sales 100's
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7 14 21 28 4 11 18 25 1 8 15 22 29 6 13 20 27 3 10 17 24 1 8 15 22 29
Figure 11.16 Although the Scalloping habit characteristically appears in low-priced issues, it issometimes found in widely held, semi-investment stocks of medium price, such as “CWE.”
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INTERNATIONAL TEL. & TEL. IT
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APRIL
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Figure 11.17 This chart shows the last five months of a broad, 13-month Saucer-like Consolidationin “IT,” which followed its rapid run up from 3 to 16 in late 1943 and early 1944. “IT” is an erraticactor, and its volume is apt to be particularly deceptive in day-to-day movements. Major PricePatterns in it, however, are dependable. This final phase of its long Consolidation (distribution andre-accumulation) first took the form of a Rectangle (with a premature breakout) and then anAscending Triangle. Its 1945-1946 Bull Market Top was a massive Head-and-Shoulders.
Many boardroom tape watchers scorn charts with unfortunate consequences to their capital in thelong run. Genuinely expert tape readers—those who are able to show fairly consistent profits intheir trades—are really extremely rare. (EN: For “tape readers” substitute “day traders,” 99% ofwhom are unsuccessful.) When you do meet such an individual, you will find that he either, ineffect, “carries charts in his head” or else takes a careful look at the record before he buys on aticker showing activity.
As a stock with the Scalloping habit finally works up in price to 15 or so, its pattern tends tobecome less regular; it begins to depart from the smooth, narrow Saucer-like curve of the lowerlevels. Above 20, it is apt to break away entirely from the Scallop sequence and produce, from thereon, more rapid straight-line advances, interspersed with sharp reactions and standard types ofConsolidation Formations, which are characteristic at all times of medium- and high-priced issues.(There are exceptions: some high-priced preferred stocks for which there is always a market, butwhose trends depend almost entirely on the gradual changes in prevailing interest rates and supplyof funds for investment, have a persistent Scallop habit in their Primary Upswings.)
We have named rather specific price levels (15 and 20) in the preceding paragraph, but price is notthe sole factor determining the departure of a stock from a Scallop Trend. The only safe assumptionis that, once such a habit is detectable, it will be continued until the chart shows a definitedivergence from it, and such divergence usually takes first the form
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Figure 11.18 There are times when a Consolidation Pattern gives the only good technical signalthat a Reversal in an issue's Primary Trend has actually taken place. Although cases of a MajorTurn, particularly a Bottom, without some sort of recognizable Reversal Formation on the chart arequite rare, they do occur. This weekly chart of Flintkote illustrates such a phenomenon. A BearMarket low, from which it rose to 47 in 1946, was made at 8 5/8 in December 1941. Withoutdeveloping any important technical foundation on either a daily or weekly chart, its


place. Although cases of a MajorTurn, particularly a Bottom, without some sort of recognizable Reversal Formation on the chart arequite rare, they do occur. This weekly chart of Flintkote illustrates such a phenomenon. A BearMarket low, from which it rose to 47 in 1946, was made at 8 5/8 in December 1941. Withoutdeveloping any important technical foundation on either a daily or weekly chart, its first upswingtook it to 11 7/8 the following April. From that point, it went into a six-month Symmetrical Triangleand then broke out topside at the three-quarters stage on increased volume. This action, plus the factit immediately thereafter burst up through an old and highly significant Resistance Level at 12, wassufficient to mark it as being in at least a strong Intermediate if not a full Primary Uptrend. Thecombination of technical developments illustrated in this chart—a large Consolidation Patternforming just under a Major Resistance and then a breakout upside from both—is something towatch for when it appears a Reversal from a Bear to Bull Trend is due. Resistance Levels will bediscussed in Chapter 13.
of a greater-than-wanted advance arising at the end of one of the Saucers. Consequently, if youhave previously taken a position in it at a favorable point (near the Bottom of a Scallop), you willunlikely be hurt when the stock finally alters its action.
Very low-priced issues may persist in a Scalloping Trend right up to their Major Bull Tops, andeven attempt another Saucer Movement following what turns out to have been the final high, whichattempt then fails to carry out the previous successively higher and higher pattern. Such failures arenot difficult to detect; the change from the previous pattern appears before any appreciable damageis done to a properly assumed commitment.
Modern versus old-style markets
We have mentioned in our discussion of Reversal Formations that some of them have appeared lessfrequently in the charts of the 1960s than they did in prior years, and others more frequently. Thesame is true of Consolidation Formations. Patterns of the compact, strictly defined sort such asRectangles and Right-Angle Triangles are less common now. Symmetrical Triangles are apt to besomewhat looser than they were in the 1920s and 1930s—not as clean-cut and conspicuous on thecharts. Typical profit-taking patterns such as Flags and Pennants seem to be as common as ever,whereas “normal” trend pictures, including those formations associated with normal trenddevelopment (such as Head-and-Shoulders, Rounding Turns, and so on), are more common.
The reasons for these changes are fairly apparent; Securities and Exchange Commission (SEC)regulations, higher margin requirements, greater public sophistication, and a more conservative—we might better say more pessimistic—approach to the problems of investment and stock tradinggenerally have all played a part in this evolution. SEC and Stock Exchange vigilance have doneaway with the flagrant pool manipulations designed to take advantage of the “lambs” of formeryears. Nowadays, there is even very little of the more “legitimate” sort of syndicate operationplanned to facilitate large-scale accumulation or distribution.
It is still possible for “insiders” to hold back for a limited time, or to prematurely releaseannouncements of good or bad portent with regard to the affairs of a particular corporation to servetheir personal strategic purposes. But the stock purchase and sales of officers, directors, andprincipal owners are now too closely watched to allow a great deal of “skullduggery.”(Nevertheless, the average investor had better still be a trifle skeptical as to the probability of anygreat advance in the market following publication of a good report.) Collusion between investmentadvisory services and trading pools has been effectively outlawed. (It is safe to say it never did existas flagrantly, even in the 1920s, as many amateur traders seem to think.) The SEC (with thethorough cooperation of the Stock Exchange) polices the investment counsel profession thoroughly,constantly, and most effectively. No well-established investment counsel can afford to indulge indeceptive or collusive practices even if the desire were there. Most professionals go far beyond themost reasonable needs to safeguard themselves against any contacts that, however innocent oruseful, might be viewed with suspicion.
The old-time “plunger” has not disappeared entirely, but high margins and regulations preventing“Bear Raiding” have made present-day stock markets relatively difficult and unprofitable for him.The out-and-out boardroom gamblers (EN: day traders rushing to and fro probably exacerbatesdaily volatility) still come in, although high margins have cramped them too. In recent years, theyhave appeared in numbers only in the final stages of Bull Markets. (EN: Note the day-trading crazethat infected the markets in the late 1990s.) Their operations never did affect the charts muchexcept to augment activity.
On the other hand, higher taxes and greater regulation have most certainly not provided safer,closer, or more stable markets for the small investor. Higher margins have not prevented Panic
Collapses. If anything, markets have been “thinner” on the downside, more vulnerable to rapid anddrastic decline than they were before modern regulation. We still have the very same sort of Bulland Bear Markets, and much the same sort of market trend development as 50 years ago. Thesurprising thing is not that a few types of chart patterns that were, on occasion, produced byunregulated trading are now less common, but rather that the great majority of technical phenomenahave been practically unaffected. The chart student of 1907 would be quite at home with the chartsof 1966. (EN: And with those
Chapter eleven: Consolidation Formations 169 of 2000. That is why so little change has beennecessary to bring Edwards' classic account current to the third millennium. EN9: A note to a note.Pools and


ow less common, but rather that the great majority of technical phenomenahave been practically unaffected. The chart student of 1907 would be quite at home with the chartsof 1966. (EN: And with those
Chapter eleven: Consolidation Formations 169 of 2000. That is why so little change has beennecessary to bring Edwards' classic account current to the third millennium. EN9: A note to a note.Pools and manipulators disappear and are replaced by some new pernicious form of skullduggery.Specialists and market makers are hauled before the bar of justice for cheating. In the twenty-firstcentury, hedge funds proliferate like rabbits in Australia. For any exacerbation of volatility theycause, they probably make up for in additional market liquidity. The same patterns keep appearingbecause, computers to the contrary notwithstanding, humans are eventually responsible for pullingthe trigger. It does seem that frequently patterns are not so neat as they were “in the old days.”Trendlines, especially horizontal lines, seem to be more “zones” than hard and fast lines and morejudgment might be necessary in interpretation. But everything that Edwards says here might havebeen written in 2005 instead of in the mid-twentieth century.)
Taylor & Francis
Taylor & Francis Group
http://taylorandfrancis.com
chapter twelve
Gaps
A gap, in the language of the chart technician, represents a price range at which (at the time itoccurred) no shares changed hands. This is a useful concept to keep in mind because it helps toexplain some of their technical consequences, which are illustrated in Figures 12.1 through 12.13.
Gaps on daily charts are produced when the lowest price at which a certain stock is traded on anyone day is higher than the highest price at which it was traded on the preceding day. When theranges of any two such days are plotted, they will not overlap or touch the same horizontal level onthe chart; there will be a price gap between them. For a gap to develop on a weekly chart, it isnecessary for the lowest price recorded at any time in one week be higher than the highest recordedduring any day of the preceding week. This can and does happen, of course, but for obvious reasonsnot as often as daily gaps. Monthly chart gaps are rare in actively traded issues; their occurrence is
confined almost entirely to those few instances in which a Panic Decline commences just before theend of a month and continues through the first part of the succeeding month.
Which gaps are significant?
From the earliest days of stock charting, gaps attracted attention. These “holes” in theprice trend graph were conspicuous. It was only natural that observers should attachimportance to them and should try to assign some special significance to theiroccurrence. But the result was unfortunate, for there soon accumulated a welter of“rules” for their interpretation, some of which have acquired an almost religious forceand are cited by the superficial chart reader with little understanding as to why theywork when they work (and, as is always the case with any superstition, an utterdisregard of those instances where they do not work). We refer to this situation asunfortunate not so much because the gap “rules” are wrong, but rather because theirblind acceptance has barred the way to a real understanding of a gap's implications andthe establishment of a more logical basis for its uses in trading.
The most common superstition is that “a gap must be closed.” Sometimes it is statedmore cautiously in such words as follows: “If a gap is not closed in three days, it willbe closed in three weeks, and if it is not closed in three weeks, it will be closed in threemonths, etc.” There are numerous variations, but they all add up to the belief that a gapmust be closed and the trend is not to be trusted until the gap has been covered. It is thelatter inference that leads to error.
Closing the gap
But first, what is meant by “closing” or “covering” a gap? Suppose a stock in anAdvancing Trend moves up day after day, from 20 to 21, 22, 23, 24, and closes onenight at the top of its range for that day, at 25. The next morning it opens at 26 andkeeps right on moving up from there. This action leaves a 1-point gap, between 25 and26, on the chart. Then suppose the rise continues to 28, halts there and is followed by areaction in the course of which prices
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Figure 12.1 The April-June Rectangle on this 1945 chart of "AW" contained a numberof insignificant Pattern Gaps. The two larger gaps marked “G” are of the Continuationor Runaway class. Note that prices closed at or near the top on each day that made agap; neither of these was closed for two years.
slip to 28, and then halts there and is followed by a reaction in the course of whichprices slip back to 27, 26, and finally to 25. The return move has carried prices backthrough the gap area (25-26); the gap has thereby been covered or closed. In brief, agap is closed when a subsequent price trend comes back and retraces the range of thegap.
Must a gap be closed before prices move very far away from it? Certainly not. Will itbe closed eventually? Probably, yes. If it is not closed by the next Minor Reaction,there is a chance it will be covered by the next Intermediate Retracement, and if notthen, pretty surely by the next great Major Swing in the opposite trend. But that maybe years later—hardly a matter of interest to the ordinary trader. The investor whobought Chesapeake and Ohio shares at 260 on October 21, 1929, counting on theclosing of the gap which that issue had made on the preceding Friday, 2 points downfrom 266 to 264, had to wait nearly seven years to get out even. Not until it neared theTop of the next Major Bull Market did CO attain an equivalent market value (65, sinceit was split 4-for-1 in 1930). In the meantime, he saw his investment shrink in 1932 toless than a sixth of his purchase price. As a matter of fact, there were hundreds of gaps
made in the charts of the 1929-1930 market


nts downfrom 266 to 264, had to wait nearly seven years to get out even. Not until it neared theTop of the next Major Bull Market did CO attain an equivalent market value (65, sinceit was split 4-for-1 in 1930). In the meantime, he saw his investment shrink in 1932 toless than a sixth of his purchase price. As a matter of fact, there were hundreds of gaps
made in the charts of the 1929-1930 markets that never have been covered since then,and many of them, it is safe to say, never will be closed.
If you will think the matter over for a moment, you will see that the probabilities wehave stated above for a gap's being closed apply just as well to a stock's returning toany price range at which it has once been traded, gap or no gap.
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Figure 12.2 The large up-gap made on July 5 in this chart was a typical BreakawayGap, occurring as prices broke out of the complex base for the July-August SecondaryRecovery. (Compare this chart with Figure 7.14.) Another type of Breakaway Gap—through a trendline—occurred on August 26. That of September 7 was primarily due to
the “ex-dividend,” whereas that of September 18 was still another type of breakaway—through a Support Level. The first gap marked, on April 26, must be classified as aRunaway; it made a sort of an “Island” of the whole April-June complex base.
Another point: there are thousands of price gaps made in trading—some of them quitewide—that do not appear at all on the standard daily range charts because they aremade during a single day and not between one day's closing and the next day'sopening. Such intraday gaps are ordinarily overlooked entirely; the gap theorists areoblivious of them, although their significance is often greater than that of manyinterday gaps. Practically every emphatic breakout move from a strictly definedRectangle or Right-Angle Triangle is attended by a gap, but only those few show up onthe charts that occur at the day's opening gong.
If we seem to have “protested too much” in the foregoing, it is only because we wantour readers to study this topic with an open mind, free from preconceived notions as toany mystic qualities that gaps may possess. Turning to the other side of the picture,some gaps have technical import. Some gaps are useful to the chart analyst inappraising trend possibilities. Let us see what we can make of them.
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ZENITH RADIO
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Figure 12.3 A potent Breakaway Gap that showed on Zenith's weekly chart when itbroke out of a Head-and-Shoulders Bottom in early 1942. Note high volume developedbeyond the gap, suggesting it would not be quickly closed. The April reaction stoppedshort of it. In fact, this gap still had not been closed in 1956, more than 14 years later.
Ex-dividend gaps
First, however, we must eliminate from consideration the gaps that do not meananything. An eighth-point gap obviously has no technical significance as it representsonly the minimum permitted change in price. By the same token, a gap of a quarter ofa point or even a half point in a high-priced stock, such as Norfolk & Western (beforethe split), represents only a normal, in fact tight, spread between successive bids. Inbrief, to carry interest for the chart technician, a gap must be wider than the usualchanges in price that occur under normal or prevailing trading conditions. A secondclass of gaps that have no forecasting implications are those formed consistently andhabitually by “thin” issues in
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Figure 12.4 As a matter of interest, this monthly chart of Zenith Radio is reproducedfor comparison with Figure 12.3. The Head-and-Shoulders Bottom is easily seen.
the medium- and high-price brackets. You can spot them easily; if your chart of acertain issue shows numerous gaps as a regular thing, then no one of them is apt tomean anything special.
Finally, gaps that appear on the charts when a stock goes ex-dividend (whether thedividend be in cash, stock, rights, or warrants) possess no trend implications. They areoccasioned not by a change in the Supply-Demand relation that governs the trend, butrather by a sudden and irreversible alteration in the actual book value of the issue.
Also of interest in this chart is the Descending Triangle, which started to form inMarch, but it was never completed—a deceptive and discouraging picture until theApril 7 gap was made.
The Flag of mid-April “measured” the move from 9 1/2 to 14. The gaps measured thetwo halves of it, on either side of the Flag.
Eliminating the technically meaningless types named above, we are left with the gapsthat occur infrequently (and that are not occasioned by an ex-dividend change in value)
in issues that are so closely and actively traded as ordinarily to produce “solid” charts.A 1-point gap, for example, in the chart of New York Central would be an unusualevent; it would demand attention and presumably have some forecasting significance.
Such gaps, for the purposes of our study, may be divided into four classes: Common orArea Gaps, Breakout Gaps, Continuation or Runaway Gaps, and Exhaustion Gaps.
The common or area gap
This type of gap gets its name from its tendency to occur within a trading area or PriceCongestion Pattern. All of the Congestion Formations we have studied in the precedingchapters—both Reversal and Consolidation types—are attended by a diminution intrading turnover. The more strictly defined sorts—the Triangles and Rectangles—show
BLAW - KNOX
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Figure 12.5 The early 1946 daily chart of Blaw-Knox contained a number ofinteresting technical features. Its spurt from 19 to 25 in December


tended by a diminution intrading turnover. The more strictly defined sorts—the Triangles and Rectangles—show
BLAW - KNOX
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F EBRUARY .......M ARCH .......APR
’ 9 16 23 2 9 16 23 30 6 13 2C
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13 20
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Figure 12.5 The early 1946 daily chart of Blaw-Knox contained a number ofinteresting technical features. Its spurt from 19 to 25 in December 1945 was followedby a nine-week Rectangle Consolidation, the end of which appears in the chart above.Prices erupted from this Rectangle on February 11 with a typical Breakaway Gap. Fourdays later, another gap appeared on even greater volume, and prices closed at the top ofthe day's range. This looked like a Runaway Gap, in which case continuation to 32 wasimplied according to the “rule” stated above. (Note the Rectangle “measurement”called for only 31.) On the following day, however, a One-Day Reversal, from 31 backto 30, appeared and the next session closed the February 15 gap, which now had to berelabeled, tentatively, as an Exhaustion Gap. Prices subsequently dropped back to thesupport of the nine-week Rectangle, rallied grudgingly along an establishedIntermediate Up Trendline, and broke that on April 24 to return again to the 25 support.In May, another advance took “BK” up once more to 30, where it bumped against thepreviously broken trendline. That was its last effort; in late July, the “valley” level at25 was penetrated and a Major Double Top had been completed. To return to theFebruary 15 gap, this is fairly typical of many cases in which it is impossible to saywhether Continuation or Exhaustion is being signaled until two or three days after theday the gap is made.
this characteristic most conspicuously. Moreover, activity in these patterns tends to beconcentrated pretty much at or near the top and bottom edges, their Supply andDemand Lines, while the area in between is a sort of “no-man's land.” It is easy to see,therefore, why gaps develop frequently within such areas. You will find numbers ofgood examples of Pattern Gaps in the charts illustrated in Chapters 8 and 9.
Such Pattern Gaps are usually closed within a few days, and for obvious reasons,before the Congestion Formation in which they have appeared is completed and pricesbreak away from it, but not always. Sometimes a gap will develop in the last traverseof prices across the pattern area just before a breakout, and in such cases, it is notclosed for a long time, nor is there any reason why it should be.
The forecasting significance of Common or Pattern Gaps is practically nil. They havesome use to the technician simply because they help him recognize an Area Pattern—that is, their appearance implies a Congestion Formation is in the process ofconstruction. If, for example, a stock moves up from 10 to 20, drops back to 17, and
then returns to 20, making a gap in the course of that rally, it is a fair assumption thatfurther pattern development will take place between approximately 17 and 20. This is aconvenient thing to know and may, on occasion, be turned to profit in short-termtrading policy.
Pattern Gaps are more apt to develop in Consolidation than in Reversal Formations.Thus, the appearance of many gaps within an evolving Rectangle or SymmetricalTriangle
BALTIMORE & OHIO
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Figure 12.6 This is a good example of a Runaway Gap that performed according torule. After reacting from 26 1/4 in late 1936, “BO” formed a Head-and-ShouldersBottom (the left shoulder was a Triangle) and broke out of it on February 6, 1937. Asmall Flag formed immediately thereafter, calling for 28. At that level, another Flagdeveloped which signaled 30 1/4 or better. As prices reached this latter goal, however,a gap was made, on March 3, on extraordinary volume. The next two days confirmed
this to be a Runaway or Continuation Gap. As such, it implied further advance(measuring from the Head-and-Shoulders neckline) to 37 plus. “BO” made its BullMarket high at 40 1/4 on March 17. The measuring-gap rule should be used forpurposes of “getting out” rather than “getting in.” It does not guarantee a move willcontinue to the implied limit, but it does give assurance the move is near an end whenthe rule has been fulfilled.
reinforces the normal expectation that the pattern in question will turn out to be aConsolidation rather than a Reversal Area.
Breakaway gaps
The Breakaway type of gap also appears in connection with a Price CongestionFormation, but it develops at the completion of the formation in the breakaway move.Any breakout through a horizontal pattern boundary, such as the Top of an AscendingTriangle, is likely to be attended by a gap. In fact, it is safe to say that most of themare. And, if we consider what goes on in the market to create a Flat-Topped PriceFormation, it is easy to see why Breakaway Gaps should be expected. An AscendingTriangle, for example, is produced by persistent demand for a stock meeting a largesupply of it for sale at a fixed price. Suppose that supply is being distributed at 40.Other holders of the stock, who may have intended originally to liquidate at 40.5 or 41,see quotations come up to 40 time after time, stop there, and turn back. They tend, inconsequence, either to join the crowd selling at 40,
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Figure 12.7 Panic Declines often produce large Runaway Gaps. The September 7 gapin this chart, judged by its size, volume, subsequent action, and the fact that it wasmade in “new low ground,” marked it as being of the measuring type. The implied goalwas 26 or below. All other gaps in this chart were obviously of the “common” variety.
or else to figure that once through 40, prices will go much higher; they may eitherlower or raise th


duce large Runaway Gaps. The September 7 gapin this chart, judged by its size, volume, subsequent action, and the fact that it wasmade in “new low ground,” marked it as being of the measuring type. The implied goalwas 26 or below. All other gaps in this chart were obviously of the “common” variety.
or else to figure that once through 40, prices will go much higher; they may eitherlower or raise their selling price. The result is a “vacuum” on the books, a dearth of
offerings in the price range immediately above the pattern. Hence, when the supply at40 in our Ascending Triangle example is finally all absorbed, the next buyer of thestock finds none offered at 40.125 or 40.25 and he has to bid up a point or more to gethis shares, thus creating a Breakaway Gap.
As we remarked earlier in this chapter, gaps of this type actually occur on almost everydecisive breakout from a Horizontal Congestion, although many of them do not showon the charts because they occur during a day and not between one day's close and thefollowing day's opening. Breakaway Gaps also develop at times when prices move outof other types of Reversal or Consolidation Formations; they are not uncommon inconnection
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WILLYS - OVERLAND
WO
JULY
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8 15 22 29 6 13 20 27' 3 10 17 24 1 8 15 22 29 5 12 19 26 2 9 16 23 30!
Figure 12.8 The "skyrocket" run-up of Willys-Overland in June 1944 was marked by anumber of small gaps. The first two were too small to have much technicalsignificance. The larger gap made June 16 was marked by the "stickiness" of prices onthat day as Exhaustion. A small Flag Consolidation ensued. The June 27 gap also actedlike an Exhaustion Gap insofar as price action was concerned, but volume had declinedinstead of climbing to a new peak. On June 28, prices jumped away again, so the June27 gap was marked as another Runaway with an implied objective of 18 1/4 plus,which had already been reached. Note the Head-and-Shoulders Reversal that formedand the subsequent Intermediate Reaction.
with Head-and-Shoulders Patterns, for instance, and they even occur on the penetrationof trendlines, which we shall discuss in a subsequent chapter.
What forecasting value can we ascribe to them? First, they serve to call attention to,and emphasize the fact of, a breakout. There can be little doubt that a genuine breakouthas eventuated when prices jump out of a pattern with a conspicuous gap. False movesare seldom attended by gaps. Second, they carry the suggestion that the buying demand(or selling pressure, as the case may be) that produced the gap is stronger than wouldbe indicated by a gapless breakout. Hence, it may be inferred the ensuing move willcarry
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Figure 12.9 “SMC” is a thin stock whose daily chart is usually “full of holes,” but thislarge gap that appeared on its weekly chart in September 1946 evidently possessedtechnical significance. Treated as a Runaway measuring from the eight-weekCongestion at 68, it called for a downside objective of 44 or below, which was dulyfulfilled.
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38 Sales 100's
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Figure 12.10 A small Island in the right shoulder of the Head-and-Shoulders Top thatmarked this issue's Major Reversal. The Island served only to emphasize the chart'sBearish implications.
Figure 12.11 Island “shakeouts” are not uncommon in “thin” stocks. Why they shoulddevelop as they do is hard to explain, but their forecasting implications are obvious.
prices farther or faster, or both. It does not do to make too much of this point; it is alogical inference and one that has been borne out in the majority of cases, but it has itsexceptions and may prove most disappointing on occasion. Nevertheless, other thingsbeing equal, of two stocks that emerged from Ascending Triangles at the same time,we should choose to buy the one that gapped out over the one that pushed its way outby small fractional steps.
Except for the presumption of somewhat greater “steam” behind the move, theBreakaway Gap carries no particular measuring implication, nor any other forecastingsignificance. The next question is this: should we expect a Breakaway Gap to be closedwithin a relatively short time? Or, to put the question in more practical and pragmaticterms: should we defer buying in the expectation that it will be closed before anyworthwhile move develops?
To give a fair answer to that question, it is necessary to scrutinize the volume oftransactions before and after the gap. If a great many sales were recorded at the takeofflevel from which prices jumped the gap, but relatively few as prices moved away fromthe far side of the gap, then there is a chance—perhaps about 50-50—that the nextMinor Reaction will carry prices back to the edge of the pattern of origin, thus fillingthe gap. On the other hand, if high volume developed at the far side of the gap, and a
great many transactions took place there as prices moved on away from the gap, thenthe chances are remote that any near-term Throwback will close the gap. In such cases,a Throwback reaction is almost always stopped at the outside of the gap.
(One is constantly tempted in a work of this sort to employ the words always or neverwithout qualification. Unfortunately, the authors have never bee


p, and a
great many transactions took place there as prices moved on away from the gap, thenthe chances are remote that any near-term Throwback will close the gap. In such cases,a Throwback reaction is almost always stopped at the outside of the gap.
(One is constantly tempted in a work of this sort to employ the words always or neverwithout qualification. Unfortunately, the authors have never been able to discover arule of techniques to which the market did not, on rare occasion, produce an exception.It is always necessary to be on guard against such exceptional developments. Many ofthem are caused by general market conditions that counteract the technical trend inindividual issues. Keep an eye on the charts of the “Averages,” as well as the particularissues in which you are interested.)
Where Breakaway Gaps develop intraday, the daily chart cannot, of course, indicatehow the day's volume was distributed. In that event, it may be necessary to examinethe
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Figure 12.12 This Island Reversal Pattern at Bethlehem Steel's Major Top in 1937 is a“classic,” yet it was followed by a curious and disturbing abnormality in the strongrally that developed on March 30. Those who sold out on the Island's signal around 95on March 19 or 20 were startled, and, if they had also sold short, justifiably alarmedwhen prices jumped up a week later, not only through the second gap level but wellabove it. But eventually, as can be seen, everything worked out according to theoriginal forecast. This incident will illustrate a general principle: when a clear-cuttechnical pattern of unquestionable significance has been completed on your charts, donot let some apparently contrary development that occurs shortly thereafter lead you toforget or neglect the previous plain signal. Give such situations time to work out.Figure 12.2 shows the sequel to the above chart and, incidentally, another Island.Compare the volume.
ticker tape or ask your broker to refer to the published record of individual transactionsto which most brokerage firms subscribe. (EN: This data may now be easily obtained.See Appendix D, Resources. EN9: Candlestick charts, now much in use, will allow theanalyst to see the intraday breakaway gap.) Lacking any clear-cut volume clue, it issafest to figure that a Breakaway Gap will not be filled until long after the full moveimplied by the pattern of origin (usually a move of Intermediate Extent in the Dowsense) has been carried out.
Continuation or runaway gaps and the measuring rule
Less frequent in their appearance than either of the two forms we have discussedabove, gaps of the Continuation or Runaway type are of far greater technicalsignificance because
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1936
GE
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JULY AUGUST SEPTEMBER- OCTOBER NOVEMBERDECEMBER
■4 11 18 25' 1 8 15 22 29 5 12 19 26 3 '10 17 24 31 7 14 21 28 5 12 19 26
Figure 12.13 This looked like an Island in “PA,” but the second gap was actuallyattributable to a $0.50 dividend which went ex on November 20 and, therefore, had tobe discounted technically. Due to this dividend, it was necessary to lower the SupportLine at 40 (see Chapter 13) by half a point. That Support, therefore, was not violated inDecember and prices subsequently advanced to above 50 the following March.
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Figure 12.14 TLT shown here in computer notation produces gaps in profusion. As thereader can see, if one just traded in the direction of the gap many short-term scalpswould be garnered. This chart also lends perspective to the hand drawn charts. A gap isa gap is a gap.
they afford a rough indication of the probable extent of the move in which they occur.For that reason they have sometimes been called “Measuring” Gaps.
Both the Common or Pattern Gap and the Breakout Gap develop in association withPrice Formations of the Area or Congestion type, the former within the formation andthe latter as prices move out of it. The Runaway Gap, on the other hand, as well as theExhaustion Gap, which we will take up later, is not associated with Area Patterns, butoccurs in the course of rapid, straight-line advances or declines.
When a dynamic move starts from an area of accumulation, the upward trend of priceswill seem often to gather “steam,” to accelerate for a few days, perhaps a week ormore, and then begin to lose momentum as supply increases when the very extent ofthe advance invites more and more profit-taking. Trading volume jumps to a peak on
the initial breakout, tapers off somewhat in the middle of the advance, and then leapsup again to a terrific turnover as the move is finally halted. In such moves—and inrapid declines of corresponding character—a wide gap is quite likely to appear at thetime when the Runaway is at its height, when quotations are moving most rapidly andeasily with relation to the volume of transactions. That period comes normally at justabout the halfway point between the breakout that inaugurated the move and theReversal Day or Congestion Pattern that calls an end to it. Hence, a Continuation orRunaway Gap affords an approximate measurement of the move in which it develops.Its inference is that prices will go as much farther beyond the gap as they already havegone between the beginning of the move and the gap, as measured directly (andvertically) on the chart.
Since there is a tendency for advances to run, in terms of points, beyond the pricelevels arithmetically implied by this rule, and for declines to be more strictly limited,the gap-measuring rule works out particularly well when applied directly onsemilogarithmic scale charts. On arithmetic charts, look for a trifle more on the upsideand a trifle


as measured directly (andvertically) on the chart.
Since there is a tendency for advances to run, in terms of points, beyond the pricelevels arithmetically implied by this rule, and for declines to be more strictly limited,the gap-measuring rule works out particularly well when applied directly onsemilogarithmic scale charts. On arithmetic charts, look for a trifle more on the upsideand a trifle less on the downside. (In any event, you will be wise to “bank” onsomething short of the theoretical goal.)
Runaway Gaps are easy to find and identify in retrospect, but our task is to recognizethem as such at the time they appear; there is no danger of confusing them with Patternor Breakout Gaps. With those aside, any gap that shows up in a fast advance or declineafter prices have moved well away from an Area Formation (or the penetration of animportant trendline or break through a potent Support or Resistance Level, which weshall discuss later) may be a Runaway Gap. What then becomes necessary is todistinguish it from our next type, the Exhaustion Gap. Usually, the price and volumeaction on the day following the gap furnishes the evidence required for a safediagnosis.
Two or more runaway gaps
It will be much easier to bring out the characteristics distinguishing Runaway andExhaustion Gaps when we take up the latter in detail. Before doing so, we mustmention those cases in which two and, rarely, even three gaps intervene in a fast moveand are evidently all classifiable as of the Continuation or Runaway breed. It does nothappen often and is particularly unlikely to appear in the chart of a fairly large andactive issue, but one of the thinner stocks in the midst of a “skyrocket” move may goskipping along for three or four days, making gaps between each successive pair. Theonly question of practical importance that arises in such cases is this: where should thehalfway measuring point be located? No quick and easy rule can be laid down, butstudious inspection of the chart, especially of the volume trend, will usually afford ananswer. Remember that halfway in these fast moves tends to come at the stage at
which prices are moving most easily and rapidly with respect to the number oftransactions recorded (hence the tendency to gap). If there are two gaps, the halfwaystage may very likely have been reached somewhere between them. Inspect your chartcarefully and try to “average” the picture mentally; look for what appears to be thecenter of “thinness” and use that for your measuring level. But remember also thateach successive gap brings the move inevitably nearer to Exhaustion, so let yourjudgment lean to the conservative side; do not expect too much of the second or thirdgap.
Exhaustion gaps
The Breakout Gap signals the start of a move; the Runaway Gap marks its rapidcontinuation at or near its halfway point, and the Exhaustion Gap comes at the end.The first two of these are easily distinguished as to type by their location with respectto the preceding price pattern, but the last is not always immediately distinguishablefrom the second.
Exhaustion Gaps, like Runaway Gaps, are associated with rapid, extensive advances ordeclines. We have described the Runaway type as the sort that occurs in the midst of amove that accelerates to high velocity and then slows down again and finally stops asincreasing Resistance overcomes its momentum. Sometimes, however, “skyrocket”trends evidence no such gradual increase of Resistance as they proceed, showing notendency to lose momentum, but rather continue to speed up until, suddenly, they hit astone wall of supply (or, in cases of a decline, demand) and are brought to an abruptend by a day of terrific trading volume. In such moves, a wide gap may appear at thevery end, that is, between the next to the last and the last day of the move. This gets thename of Exhaustion Gap because the trend seems thereby to have exhausted itself inone final leaping spurt.
The best test of whether a gap formed in a rapid, straight-line advance or decline is ofthe Continuation or Exhaustion type comes on the day after the gap (more precisely,the day that makes the gap), although there are frequently other clues in the precedingchart picture. If trading activity mounts to an extraordinary height during the sessionfollowing the gap, and particularly if the previous trend in prices does not appear to becarried along at a pace commensurate with that day's activity, the gap is probably ofthe Exhaustion class. This interpretation is reinforced, in fact, made a virtual certainty,if the day after, the gap develops into a Reversal Day (as described in Chapter 10) withthe closing price registered back near the edge of the gap.
Evidence that may be derived from the chart anteceding the gap may be enumerated asfollows: If the trend has already carried out the full implications of the price formationor Congestion Area from which it emerged, Exhaustion is more likely than
Continuation. By the same token, if the reasonable measuring implications of thepattern of origin are still far short of attainment, the gap is probably of theContinuation type. An Exhaustion Gap is seldom the first gap in a runaway move; it isusually preceded by at least one Continuation Gap. Thus, you may ordinarily assume(unless the contrary appears from other and weightier indications) the first gap in arapid advance or decline is a Continuation Gap, but each succeeding gap must beregarded with more and more suspicion, especially if it is wider than its predecessor.
We have referred to Exhaustion Gaps as wide gaps. Width is, of necessity, relative inthis study; it is impossible to lay down any exact rules to define wide or narrow. Do notlet this bother you too much. Recognition of what constitutes an unusually wide gapfor the particular stock you have under observation soon comes with a little chartingexperience.
Runaway Gaps are usually not covered for a considerable length of time, as a rule, notuntil the market stages a swing o


relative inthis study; it is impossible to lay down any exact rules to define wide or narrow. Do notlet this bother you too much. Recognition of what constitutes an unusually wide gapfor the particular stock you have under observation soon comes with a little chartingexperience.
Runaway Gaps are usually not covered for a considerable length of time, as a rule, notuntil the market stages a swing of Major or full Intermediate proportions in theopposite direction. But Exhaustion Gaps are quickly closed, most often within two tofive days, a fact that furnishes a final clue to distinguish Exhaustion fromContinuation, if it should still be needed at that stage. This, incidentally, upsets thecommon superstition that all gaps must be closed before the trend can be trusted tocontinue very far. In the case of the Runaway Gap, it is not closed, but the trend movesright along, nevertheless, and often for a surprising distance. In the case of theExhaustion Gap, the closing of it actually contributes to the signal the trend has runout.
An Exhaustion Gap, taken by itself, should not be read as a sign of Reversal, or even,necessarily, of Reversal at all. It calls “stop,” but the halt is ordinarily followed bysome sort of area pattern development that may, in turn, lead to either Reversal orContinuation of the move before the gap. In practically every case, however, enough ofa Minor Reaction or delay ensues from the formation of an Exhaustion Gap before anew trend is established to warrant closing out commitments at once. (One can alwaysreenter if it subsequently appears that the previous trend is to be resumed.)
The Island Reversal
We mentioned (at the end of Chapter 10) a Reversal Pattern, the Island, which was tobe taken up under the general study of gaps. The Island Pattern is not common and it isnot, in itself, of major significance in the sense of denoting a long-term Top or Bottom,but it does, as a rule, send prices back for a complete retracement of the Minor Movethat preceded it.
An Island Reversal might be described as a compact trading range separated from themove that led to it (and that was usually fast) by an Exhaustion Gap and from the move
in the opposite direction that follows it (and that is also equally fast, as a rule) by aBreakaway Gap. The trading range may consist of only a single day, in which event itnormally develops as a One-Day Reversal, or it may be made up of from several daysto a week or so of Minor Fluctuations within a compact price zone. It is characterized,as might be expected, by relatively high volume. The gaps at either end occur atapproximately the same level (they should overlap to some extent) so that the wholearea stands out as an Island on the chart, isolated by the gaps from the rest of the pricepath.
We have said an Island does not, of itself, appear as a Major Reversal Formation, butIslands frequently develop within the larger patterns at turning points of Primary orimportant Intermediate consequence, as, for example, in the head of a dynamic Head-and-Shoulders Top. By the same token, they appear occasionally at the extremes of theMinor Swings that compose a Triangle or a Rectangle (in which event, the gaps that setthem off are really better classified as Common or Pattern Gaps).
The reasons why Islands can and do develop—in other words, why gaps can and dorepeat at the same price level—will be more apparent when we take up the generalsubject of Support and Resistance in a later chapter. Suffice it to repeat at this pointthat prices can move most rapidly and easily, either up or down, through a range wherelittle or no stock changed hands in the past, where, in other words, previous ownershave no “vested interest.”
Sometimes the second gap—the Breakaway that completes the Island—is closed a fewdays later by a quick Pullback or reaction. More often it is not. Rarely, the first gap—the Exhaustion Gap that starts the Island—is covered in a few days before the secondgap appears, in which event the Island Congestion takes on a sort of V-Shape (if it is aTop), and there is no clear “open water” across the chart horizontally between theIsland and the trends preceding and following it. Yet, in any of these variations, theinterpretation remains the same: the preceding Minor Move should be practicallyretraced.
An Island Pattern is not easy to trade on unless it be for a short-term “scalp,” as,obviously, a good share of the retracement already may have been accomplished by thetime the Island is charted and an order to buy or sell on its indications can be executed.If the entering gap is recognized as an Exhaustion Gap, the trader who is interested inthe stock presumably will take action before the second gap forms and before theIsland is in evidence. Perhaps the greatest utility that Islands have for the chart analystis that of calling attention to a situation of putting him on the alert as to itspotentialities.
Gaps in the Averages
Gaps appear also in nearly all Averages but, for obvious reasons, with rather lessfrequency than in the charts of individual issues. Although it is not necessary for all ofthe stocks composing an average to make a gap simultaneously to produce a gap in theAverage figures, a majority of them must. As might therefore be expected, Common orPattern Gaps are particularly rare in Average charts, but Breakaway and Runawaytypes are not uncommon, although they are small as compared with the size of suchgaps in single stocks. Exhaustion Gaps, and, in consequence, Islands, again are rare.The conditions that create an Exhaustion Gap seldom develop in a sufficient number ofindividual issues at any one time to produce a counterpart in the Averages.
The technical interpretation of gaps in Averages is, in the main, the same as in singlestocks. The authors have not found that an Average gap possesses any peculiar potencyor significance over and above that attributable to a gap in the chart of any actively andclosely traded single issue.
The broader, and henc