hs!) Remember,
the problem with Dow Theory (and trend following) is you give up the first
third of the move and the last third of the move and sometimes there is not a
middle third, as conventional market wisdom has it.
What essentially occurs when using Variant 2 of the procedure is as follows:
when blow-off or runaway conditions occur, the procedure changes from
selling weakness to selling strength. I believe very strongly in the variation
of tactics, generally. Also, I am intimately familiar with the pitfalls of
varying tactics, but I like the procedure in general and also think knowing
when to use it and when not to use it can require a great deal of experience
and emotional coolness in potentially high-stress conditions. If the entire
(Variant 2) procedure is executed and also combined with a scale-in/scale-
out plan, the user may succeed in shooting the moon.
The phlegmatic Marc Antony (who sleeps well of night and is sleek and
well fed) follows the conservative wave-low method (Variant 1) and
probably wins in the long run. The Variant 1 procedure is simpler and
naturally expands to accommodate the high-volatility market that ejects the
trader attempting to escape the inevitable collapse before going on to new
completely unexpected heights.
As it goes, damned if you do, damned if you don't, unless you are charmed
or kissed by the market fairy—or lucky.
The complete Basing Points procedure
1. A wave high is made, recognized by no higher prices coming for the
moment. If this high is 3% (Magee's number, but could be a parameter)
higher than the previous wave high (or the recent high in a run or blow
off), the Basing Point is raised to the low of the new high day.
Obviously, this comes into effect for the next trading day.
2. Prices recede and a low is made. This low is found by watching each
day after the previous high until no lower prices are made (a potential
wave low or Basing Points candidate). As prices begin to rise again,
we note each day on which prices are completely out of the range of
(away from) our low-day candidate, or a “day away.”
3. When three such days are observed (the three-days-away rule)
before a new low is made, we mark the candidate day as a Basing
Point and raise our stop to 6% (or x% as this is a parameter) under the
low of the Basing Point day. Obviously, the new stop is established the
day after the three days away have occurred.
4. If a new high is made without an intervening wave low Basing
Point, the process starts over from the new high.
5. If the new high is 3% (or x%) higher than the previous high
(whether made from a wave low or wave high), or from surging prices
continually making new highs, a new Basing Point is found at the low
of the new high day. Thus, a price move that went from 10 to 10.3 to
10.61 to 10.93 would create new Basing Points at the low of each new
high day.
11
14
13.5
13
12.5
12
11.5
Figure 28.3 Basing Points candlestick version. This chart is a
candlestick version of Figure 28.2. It illustrates the complete
procedure, showing establishment of Basing Points made by wave
lows and by higher highs. This is a blow up of the period in the chart
during which higher high conditions exist. As might be obvious, the
higher high rules begin to come into play late in the life of a trend, in
the runaway and blow-off stages.
10.5
10
Figure 28.4 Apple Variant 2 of the Basing Points Procedure. This chart
shows the trend from beginning to end as in Figure 28.2, with the
addition of dotted lines to show where stops fell when computed from
higher highs. The previous candlestick chart is used for the close-up
analysis. This chart puts into broad perspective the relative level of
stops using the Variant 2 method. As can be seen, setting stops from
new higher highs results in stops closer to the market prices. This can
be good or bad, depending on what the market does to you.
Two charts giving a long-view perspective on
the complete (Variant 2) procedure
There is another method Magee advocated for surging and blow-off
markets. He called this alternative method “progressive stops,” which is
explained in the ninth edition. Strictly speaking, although there is a
variation in tactics involved in using new highs for stop calculation, this
method is a twist on selling on strength. Variant 2 is still lagging stops
behind prices. A pure strength selling method would attempt to time exit on
a blow-off day, or a key reversal day or a one-day reversal, or even on a
strong long running day up. This is perhaps a little easier to visualize on the
downside. A panic selling day (which tends to finish at the lows) would
provoke an exit on the close.
The representative case fully analyzed using wave lows and new
highs
The case will not be unfamiliar to readers, and its use will fully highlight
the differences found in the procedure. The same materials will be used,
and the differences will be boldfaced in the text.
1. A rounding bottom, or perhaps a scallop.
2. Resistance or breakout line.
3. Wake-up call on volume.
4. Run day, big volume; breakout through line 2; sure entry signal.
5. First Basing Point (BP). Notice prior volume fall-off in
consolidation, and surge on run day.
6. BP.
7. A weak BP (because of shallow retracement).
8. BP.
9. Test of BP at 8.
10. A trendline drawn after point 9.
11. BP.
12. BP candidate that fails the three-day-away rule.
13. BP.
14. A potential BP but not a very good one because new high has not
been made from 13.
15. A Support-Resistance line.
16. BP.
16A. New High: 10.35.
17. BP.
17A. New Higher High 10.81; Low BP 9.89 (+3% 11.13); Stop 9.30.
17B. New Higher High 11.16; Low BP 10.58 (+3% 11.49); Stop 10.49.
17C. New Higher High 11.62; Low BP 11.22 (+3% 11.96); Stop 10.55.
18. A Resistance-Support line.
19. Flag that becomes BP. High 11.62.
19A. New Higher High 12.55; Low BP 11.91 (+3% 12.93); Stop 11.19.
20. Trendline, but too steep to last.
21. Trendline.
22. BP.
23. Trendline.
24. BP.
24A. New Higher High 12.93; Low BP 12.43 (+3% 13.


17B. New Higher High 11.16; Low BP 10.58 (+3% 11.49); Stop 10.49.
17C. New Higher High 11.62; Low BP 11.22 (+3% 11.96); Stop 10.55.
18. A Resistance-Support line.
19. Flag that becomes BP. High 11.62.
19A. New Higher High 12.55; Low BP 11.91 (+3% 12.93); Stop 11.19.
20. Trendline, but too steep to last.
21. Trendline.
22. BP.
23. Trendline.
24. BP.
24A. New Higher High 12.93; Low BP 12.43 (+3% 13.34); Stop 11.68.
24B. New Higher High 13.41; Low BP 13.07 (+3% 13.81); Stop 12.29.
25. BP.
25A. New Higher High 13.82; Low BP 13.36 (+3% 14.23); Stop 12.56.
25B. Stopped out at 12.56.
26. Horizontal trendline.
27. BP at 25 (stop 11.80); Stopped out at 11.80.
A narrative of the events in the chart
1-3. Had we been asleep, the event at number 3 should have awakened us; a
volume day like this (Cf. chart 28.2) should catch the attention. We begin
paying attention to the stock and note the pattern that has been developing
—the rounding bottom, or scallop.
4. At number 4 we see a run day on heavy volume. A good signal for
entry with the breaking of the horizontal line at 2. When we enter, we
set our stop 6% under the recent low. After entering on strength, there
is every possibility that some profittaking will occur as well as probing
by locals to chase out arrivistes.
5. We watch with interest for the first reaction. Each day we observe as
a candidate for a possible Basing Point. This occurs at 5 and we now
begin to count “days away” from the Basing Point, that is, days whose
range is entirely outside the range of the candidate day, and that occur
before a lower low is made. When the Basing Point at 5 is confirmed,
we raise our stop to 6% under 5.
6. A higher high is made after 5 with a subsequent reaction to 6, which
proves to be another Basing Point, so we raise our stop to 6% under 6.
7. Prices continue to climb and another Basing Point is made at 7. The
procedure is becoming clear: find a Basing Point and establish a stop a
prudent distance under it. If a new Basing Point is made, raise the stop.
Watch with interest the reactions against the trend. Either they allow
you to establish a new higher Basing Point, or they end your trade.
8-10. We find a new Basing Point at 8, raise our stop, and draw the
trendline at 10. At 9 we have a lower low than 8, but our “filter,” our 6%
padding, keeps our position intact. We do not lower our stops using 9 as a
new Basing Point. One of the inviolable rules is that stops are never
lowered. The filter is important, because traders try to take out nearby lows
and exacerbate volatility. It is called the running of the lambs.
11. At 11 we find a new, if tenuous, Basing Point. An advance with a
thin higher high.
12. At 12 we have a candidate for a Basing Point that fails the three-
day-away rule.
13. At 13 we find the Basing Point that is good and raise our stop.
14. At 14 we are confronted with a marginal situation. It is potential
Basing Point, but a marginal one because a higher high was not made
after 13.
15. At 15 we are able to draw a line defining resistance—a line that
will become a support line.
16. At 16 we get a Basing Point.
16A. New High: 10.35 (a benchmark).
17. At 17 we find a new Basing Point and at 18 we can identify a
resistance line. The spurt across this line is both gratifying and a
warning because it becomes a flagpole from which the flag at 19 flies.
Flags and flagpoles are messages that the market has heated up and
now wants close watching. A flag can serve as a Basing Point, so we
move our stop again, fully aware the end may be approaching. The
trendline at 20 is further confirmation of this environment due to its
steepness. However, we see two good trendline anchor points in 16
and 17 and draw trendline 21—a better line to defend.
17A. New Higher High 10.81; Low BP 9.89 (+3% 11.13).
17B. New Higher High 11.16; Low BP 10.58 (+3% 11.49).
17C. New Higher High 11.62; Low BP 11.22 (+3% 11.96).
18. Support-resistance line.
19. Flag that becomes BP. High 11.62.
19A. New Higher High 12.55; Low BP 11.91 (+3% 12.93); Stop 11.19.
22-24. A good reaction finally occurs at 22 giving a strong Basing Point and
good rationale for raising the stop. Notice the interesting fact that points 22
and 24 have come back to rest on the trendline we drew at 10. As the tempo
has increased, and the volatility, 24 furnishes us another valid Basing Point.
24A. New Higher High 12.93; Low BP 12.43 (+3% 13.34); Stop 11.68.
24B. New Higher High 13.41; Low BP 13.07 (+3% 13.81); Stop 12.29.
25. Even 25 is a valid point and we can now see the clear support line
at 26.
25A. New Higher High 13.82; Low BP 13.36 (+3% 14.23); Stop 12.56.
25B. Stopped out at 12.56.
26. Support-resistance line.
27. When this line is pierced at 27 upon extraordinary volume, and in
the process takes out our Basing Point stop from 25, it is clearly time
to exit the train.
chapter twenty-nine
Trendlines in action
From what has already been said in Section I of this book, you will be
familiar with the characteristic single-line trends of stocks and the
numerous exceptions and deviations that come into the picture from time to
time. We know stocks often move in parallel trends, sometimes for months,
occasionally even for years. We also know they may, and do, break out of
trend or change the direction of their trends without notice.
Most of the pattern formations we have studied can be considered as
manifestations of trend action, or Continuations or Reversals of a trend.
Thus, a Symmetrical Triangle is simply the meeting of two trends. During
the formation of the Triangle, the stock is following both trends in a
narrowing pattern until, finally, the dominant trend asserts itself. An
Ascending Triangle is following an upward trend but has encountered a
Resistance Level at the Top. A Head-and-Shoulders Formation shows the
end of an upward trend and the beginning of a downward trend. A
Rectangle is a Parallel Trend Channel running in a horizontal direction, and
so on.
We can project a Parallel Trend and, in the

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


owing pattern until, finally, the dominant trend asserts itself. An
Ascending Triangle is following an upward trend but has encountered a
Resistance Level at the Top. A Head-and-Shoulders Formation shows the
end of an upward trend and the beginning of a downward trend. A
Rectangle is a Parallel Trend Channel running in a horizontal direction, and
so on.
We can project a Parallel Trend and, in the case of stocks continuing to
move in that trend, we can buy and sell at almost the precise points of
contact with the trendline. Unfortunately, long and perfect straight-line
trends of this sort are the exception rather than the rule. For actual trading
purposes, we will project our trends more or less continuously on the basis
of the most recently established data.
From the standpoint of tactics, let us consider the trends as they are
indicated by the successive Minor Tops and Minor Bottoms. For illustration
of this, and as a guide to what we are leading up to, we will consider
simplified, ideal situations (see the examples in Diagrams 29.1 through
29.6).
To avoid confusion, mark the top trendline in blue pencil and the bottom
trendline in red pencil. We will refer to the upper trendline as the Blue
Trend, and the lower trendline as the Red Trend. From time to time, we will
also want to draw a line parallel to a Blue Trend across the Bottom of the
trend so as to include a segment of the Trend Channel between two Tops
within parallel lines. This we will call the Blue Parallel, and we will mark it
with a dotted or broken blue line. Conversely, we may wish to draw a
parallel to the Red Trend so as to include the segment of the Trend Channel
between two Bottoms, and this dotted red line we will call the Red Parallel.
Ordinarily, a Top (wave high) will be formed after a Bottom (wave low) and
a Bottom after a Top; thus, we will expect to draw, alternately, a Blue
Trendline and a Red Trendline with these lines being drawn as soon as the
new Top or Bottom is established. (In some cases, a light pencil line may be
drawn to indicate suspected Tops or Bottoms, until developments confirm
their validity.)
We have already taken up the important and rather difficult question of
determining the Minor Tops and Bottoms. Very often, these points will be
clear and obvious. Sometimes they will be obscure, and you will be able to
draw trendlines with confidence, in such cases, only after considerable
experience covering many types of actions. The most difficult times to
determine Minor Trends are during Reversals, especially in cases in which
these are of
Diagram 29.1 Here is a rising trend showing the Basic Trendline across two
Bottoms, which we call the Red Trendline, and its parallel (indicated by a
broken line) through the Top of the intervening peak. The parallel suggests
the approximate objective of the next move if the stock continues in trend.
Diagram 29.2 The same rising trend with the Return Line, which we call
the Blue Trendline, drawn through two Tops. The broken line represents its
parallel through the intervening Bottom. This Blue Parallel is useful in
determining a buying point, especially in trends of rapidly changing form
when the stock may not react to its Basic Trendline.
Diagram 29.3 This is a declining trend showing the Basic Trendline across
two Tops, which we call the Blue Trendline, and its parallel (indicated by a
broken line) through the Bottom of the intervening decline. The parallel
suggests the approximate objective of the next move if the stock continues
in trend.
the rounded and irregular types. In these cases (of Reversal), however, we
will not depend much on the trendlines to determine buying and selling
points.
As long as a stock persists in a Parallel Trend Channel, it is perfectly clear
to buy near the Bottom of the channel and sell near the Top. From the
geometry of the situation (see examples), you will see at a glance it is not
likely to be profitable to sell short in an

Diagram 29.4 The same declining trend with the Return Line, which we
call the Red Trendline, drawn through two Bottoms. The broken line
represents its parallel through the intervening Top. This Red Parallel is
useful in determining a point at which to make short sales, especially in
trends of rapidly changing form when the stock may not rally to its Basic
Trendline.
Diagram 29.5 Simplified diagram of a stock chart showing trend action.
Basic Trendlines are marked with heavy lines; Return Lines are marked
lightly.
upward-moving trend (because the reactions are necessarily smaller than
the advances), or to buy stock in a downward-moving trend.
Therefore, a trend must show it is presumably an uptrend before you are
justified in buying stock. Plus, you must have what is presumably a
downtrend to justify a short sale.
You will notice from the simplified examples shown here that pattern
formations indicate trends. The breaking of a Rectangle on the upside
results in an upward slope of the Blue Trend. The move up out of an
Ascending Triangle confirms the rising Red Trend and creates a rising Blue
Trend. The downside breaking of a Head-and-Shoulders neckline confirms
a descending Blue Trend and sets up a descending Red Trend, and so on.
From studies of these patterns and various trend actions, we arrive at a
compact set of trading rules based on these Red and Blue trendlines. These
rules are summarized below.
Buying stock, “going long”
• Preparatory buying signals (indicating a buying opportunity may be in
the making). Penetration of Blue Trend to a new high closing (in most
cases). The simple breaking of a descending Blue Trendline, in cases in
which no other pattern or indication is present, is not sufficiently conclusive
evidence of Reversal to justify commitments.
b

g
h
Diagram 29.6 Preparatory buying signals shown by trend action.
a. Penetration of an ascending Blue Trendline.
b. Penetration of a horizontal Blue Trendline.
c. The penetration of a descending Blue Trendline without other
technical indications is n


endline, in cases in
which no other pattern or indication is present, is not sufficiently conclusive
evidence of Reversal to justify commitments.
b

g
h
Diagram 29.6 Preparatory buying signals shown by trend action.
a. Penetration of an ascending Blue Trendline.
b. Penetration of a horizontal Blue Trendline.
c. The penetration of a descending Blue Trendline without other
technical indications is not conclusive evidence of a change in trend
and does not justify long commitments.
d. Contact with the Blue Trendline of an Ascending Parallel Trend
Pattern.
e. Contact with the Blue Trendline of an Ascending Divergent Trend
Pattern.
f. In this case, contact with the Blue Trendline does not suggest a buy
on the next reaction, because the trend appears to be converging; a
possible Wedge in the making, with Bearish implications.
g. Contact with the Blue Trendline of a Rectangle at its fifth point of
Reversal.
h. Contact with the Blue Trendline of an Ascending Triangle.
i. Penetration on volume of descending Blue Trendline when Red
Trendline is ascending (Symmetrical Triangle).
• Contact with the ascending Blue Trend if the Red Trend is also ascending,
provided the trends do not converge (Parallel or Divergent Trend Channel).
• Contact with the horizontal Blue Trend if the Red Trend is also horizontal
or ascending (Rectangle, Ascending Triangle).
• Penetration of the descending Blue Trend on volume if the Red Trend is
ascending (Symmetrical Triangle).
• Execution of buys (after preparatory buying signal).
• In case the previous Blue Trend has been ascending, draw the Blue
Parallel and buy at or near this line.

Diagram 29.6 (Continued) Preparatory signals for short sales shown by
trend action.
j. Penetration of a descending Red Trendline.
k. Penetration of a horizontal Red Trendline.
l. The penetration of an ascending Red Trendline without other
technical indications is not conclusive evidence of a change in trend
and does not justify short commitments.
m. Line of a Descending Parallel Trend Channel.
n. Contact with the Red Trendline of a Descending Divergent Trend
Pattern.
o. In this case, contact with the Red Trendline does not suggest a short
sale on the next rally, because the trend appears to be converging; a
possible Wedge in the making, with Bullish implications.
p. Contact with the Red Trendline of a Rectangle at its fifth point of
Reversal.
q. Contact with the Red Trendline of a Descending Triangle.
r. Penetration of ascending Red Trendline (with or without volume)
when Blue Trendline is descending (Symmetrical Triangle).
In descending trends, the Red Trendline is a return Line, and short sales will
be made on rallies to a line parallel to the new Red Trendline established at
the Bottom of the signal move and drawn through the intervening peak.
Note in the case of decisive breakouts from patterns such as Rectangles and
Triangles, a short sale might also be made on the basis of a computed
40%-50% correction of the breakout move, or on a return to Resistance.
• In case the previous Blue Trend has been horizontal or descending (that is
to say, emerging from Rectangles, Triangles, and various Reversal
Patterns), buy on a reaction of 40%-45% of the distance from the last
previous Minor Bottom to the extreme Top of the most recent move.
Liquidating, or selling a long position
Immediately on execution of the buy order, determine the stop level (see
Chapter 27, Stop Orders) and place your protective stop. Penetration of this
stop level will automatically close out your transaction. The stop level may
be moved up according to the “three-days-away” rule but may never be
moved down (except to adjust for ex-dividend or ex-rights). If the stock
closes below a previous Minor Bottom (thus setting up a descending Red
Trend), sell on tight (EN: or hair-trigger) progressive stops.
At the start, the stock declines in a Parallel Trend Channel. The Blue
Trendline is basic here. A short sale on a rally to the Red Parallel at point A
will find its objective on the Blue Parallel at B. Another short sale on the
Red Parallel at C would be followed by failure to reach the objective.
Chances are good, however, that increased volume would develop at the
Double Bottom and give warning to get out of short commitments. The
upside penetration of the basic Blue Trendline at E, alone, is not sufficient
reason to reverse position and go long. Trendlines set up during formation
of the Rectangle would be marked in the regular way, but they are indicated
here by broken lines to emphasize the pattern. Another short sale, if tried on
the sixth point of contact with the Rectangle at F, would be stopped out on
the breakout.
The trend is now rising, although we cannot yet draw a Basic (Red)
Trendline. The first buy would be made on a 40%-50% correction of the
breakout move from the Rectangle, or on a return to the Top (Support) level
at H.
A trendline would be drawn to the first Bottom established in the Triangle.
This is not shown, as it would ultimately be replaced by the line shown
through the outermost point in the Triangle. We have indicated by broken
lines the trendlines set up during the formation of the pattern.
The objective of the breakout move from the Triangle would be the Red
Parallel to our now rising Basic Trendline; this objective is reached at J. A
Return Line (Blue) would be drawn from the first Reversal Top of the
Triangle at G through the Top of the breakout move at J, and the parallel to
this through point I would indicate about where to make the next purchase.
As a matter of fact, the stock does not actually get back to that point; in
practice, the purchase would probably be made at K on the basis of a
40%-50% correction, or on a reaction to the Support Level G.
The subsequent upward move would not carry through to the Red Parallel
marked W; however, the alarm would probably be sounded clearly by a day
of heavy volume, a One-Day Reversal, or a gap. Since the trend is now
obviously convergent, no further purchas


o that point; in
practice, the purchase would probably be made at K on the basis of a
40%-50% correction, or on a reaction to the Support Level G.
The subsequent upward move would not carry through to the Red Parallel
marked W; however, the alarm would probably be sounded clearly by a day
of heavy volume, a One-Day Reversal, or a gap. Since the trend is now
obviously convergent, no further purchases would be considered. The next
move fails to make such headway and falls far short of the objective set by
the Red Parallel marked Y. Soon after, the Wedge breaks out downside.
If the stock advances on moderate volume and then develops unusually high
volume on any day during the advance before either the Blue Trend is
broken (with a close above that trendline) or before the stock has made a
new high closing over the last Minor Top, close out the transaction on tight
progressive stops.
If the stock develops high volume on the day on which it either tops and
closes above the Blue Trend or makes a new high closing over the previous
Minor Top, hold it. If heavy volume again occurs on the following day or
any subsequent day, however, sell on tight progressive stops.
In rising trends, the Blue Trendline is a Return Line, and purchases will be
made on reactions to a line parallel to the new Blue Trendline established at
the Top of the signal move and drawn through the intervening Bottom. Note
in the case of decisive breakouts from patterns such as Rectangles and
Triangles, a purchase may also be made on the basis of a computed
40%-50% correction of the breakout move, or on a return to Support.
You will find in many cases the heavy volume signal will develop
(sometimes with also a One-Day Reversal or an Exhaustion Gap) on or near
the Red Parallel; watch especially for this volume indication as a sign of a
good profit-taking point. If the volume signal does not show up, your
selling objective is this Red Parallel, at a limit or on tight progressive stops.
In case there is no such volume signal at the top of the move and the move
does not reach the Blue Trend or make a new high, you are very likely
running into a Triangle situation. In that case, you will have to wait for a
breakout one way or another. Meanwhile, maintain your stop protection
underneath.
Selling stock short
• Preparatory selling signals (indicating an opportunity for short sales may
be in the making).
• Penetration of Red Trend to a new low closing (in most cases). The simple
breaking of an ascending Red Trendline where no other pattern or
indication is present is not sufficiently conclusive evidence of Reversal to
justify commitments.
• Contact with descending Red Trend if Blue Trend is also descending,
provided the trends do not converge (Parallel or Divergent Trend Channel).
• Contact with horizontal Red Trend if Blue Trend is also horizontal or
descending (Rectangle, Descending Triangle).
• Penetration of ascending Red Trend (with or without volume increase) if
Blue Trend is descending (Symmetrical Triangle).
• Execution of short sales (after preparatory selling signal).
• In case the previous Red Trend has been descending, draw the Red
Parallel and sell at or near this line.
• In case the previous Red Trend has been horizontal or ascending (that is to
say, emerging from Rectangles, Triangles, and various Reversal Patterns),
sell on a rally of 40%-45% of the distance from the last previous Minor Top
to the extreme Bottom of the most recent move.
Covering short sales
Immediately on execution of the short sale, determine the stop level (see
Chapter 27, Stop Orders) and place your protective stop. Penetration of this
stop level will automatically close out your transaction. The stop level may
be moved down according to the three-days-away rule, but it may never be
moved up.
If the stock closes above a previous Minor Top (thus setting up an
ascending Blue Trend), buy to cover on tight progressive stops.
If the stock declines on moderate volume and then develops unusually high
volume on any day during the decline before either the Red Trend is broken
(with a close below that trendline), or before the stock has made a new low
closing under the last Minor Bottom, close out the transaction on tight
progressive stops.
If the stock develops high volume on the day on which it either breaks and
closes below the Red Trend or makes a new low closing under the previous
Minor Bottom, hold it short. If heavy volume again occurs on the following
day or any subsequent day, however, buy to cover on tight progressive
stops.
You will find in many cases the heavy volume signal will develop
(sometimes with also a One-Day Reversal or an Exhaustion Gap) on or near
the Blue Parallel; watch especially for this volume indication as a sign of a
good profit-taking point. If the volume signal does not show up, your
buying objective is the Blue Parallel, at a limit or on tight progressive stops.
In case there is no such volume signal at the bottom of the move and the
move does not reach the Red Trend or make a new low, you are very likely
running into a Triangle situation. In that case, you will have to wait for a
breakout one way or another, meanwhile maintaining your stop protection
overhead.
Additional suggestions
When a level is reached that appears to be either a Minor Bottom on a
reaction or a Minor Top on a rally, and when the stock continues to stall and
remain at this point, moving in a very narrow range for three weeks or more
without giving any signal either by way of price change or volume action as
to its next move, it is wise to assume this congestion is definitely a key area
and should be considered a Minor Top or Bottom; protective stops should
be adjusted to it as a Basing Point, instead of the previously established Top
or Bottom, as against the possibility that the move out of this area, when it
comes, may be in the wrong direction.
After a series of moves in a trend, with each move in the Primary Direction
marked by heavier volume than the retre


nitely a key area
and should be considered a Minor Top or Bottom; protective stops should
be adjusted to it as a Basing Point, instead of the previously established Top
or Bottom, as against the possibility that the move out of this area, when it
comes, may be in the wrong direction.
After a series of moves in a trend, with each move in the Primary Direction
marked by heavier volume than the retreats or Corrective Moves against the
trend, you are likely to have a move in the Primary Direction, which is
marked by extraordinary volume (much larger volume than the normal
increase for a Primary Move). On such a move, after taking your profits on
previous commitments, you would ordinarily begin to plan the next
commitment on the Correction. In this particular case, noting the extreme
volume, you would cancel any immediate plans for further commitments in
the Primary Direction.
The reason for this is such climactic volume normally indicates the final
“blow-off” of the Intermediate Trend, to be followed either by a Reversal,
or at least by a period of stagnation, or by formation of Consolidation
Patterns, or by Intermediate Correction. In such a case, it is not safe to make
any further commitments on this trend pending further developments and
the positive reassertion of the trend.
If you examine daily charts of various stocks, covering long and important
trends, you will find the series of Minor Moves making up the Intermediate
Trend is likely to culminate in a Minor Move marked by tremendous
volume. This is truer of Tops than Bottoms, although at the end of the Panic
Phase of a Bear Market, we very often see climactic volume. The climax
indicates, on the other hand, the sale of large amounts of stock by strong
investors to weak traders, near the top; on the other hand, the liquidation of
holdings by weak traders occurs near the bottom, into the hands of strong
investors who will hold them for the next Major Move.
One of the most common errors, and easiest to fall into, is to mistake a
Climactic Top or Bottom for a normal confirmation or preparatory signal
for a new commitment in line with the preceding trend.
It is similar in nature to the error often made by novices in the market of
buying on the Minor Tops (becoming dazzled with the rapid price advance
and the great volume of activity). However, in the case of these final “blow-
off” moves, the volume is greater and the adverse portent far more serious.
General outline of policy for trading in the Major Trend
A. Always trade in the direction of the Major or Primary Dow Trend
(EN: see the editor's comments in Chapter 3) as it is indicated at the
time.
B. If the two component Averages of the Dow Theory (Industrials and
Rails; EN9: Transportations) are not in agreement, trade in the
direction of the last established Primary Trend but only in the
component that is still following that trend.
C. Examine charts of group Averages covering groups of businesses in
the same or related lines; trade in the Primary Direction when the trend
of the group corresponds.
D. Trade in any particular stock when its own individual chart
indicates a trend in the same direction as the Primary Trend, and when
the technical picture has indicated a probable move in that direction.
Make all new commitments on the reactions or rallies following the
signaling move in the Primary direction, except in the case of Primary
Reversals from Bull Market to Bear Market, when short sales may be made
at the market immediately following the Reversal.
Exception: after an extended move or a series of moves in the Primary
Direction, when signs of exhaustion and Reversal appear in individual
charts, commitments in the opposite direction may be made with objectives
limited to a correction of the preceding Intermediate Move in the Primary
Direction.
(EN9: Now the reader's head is spinning and the color blind are completely
confused. As this book is unfortunately printed in black and white, the
reader without colored pencils will be at sea. This is what I recommend:
take out your colored pencils and color the lines yourself. The principles
articulated here by Magee are of great value to a trader and are worth
studying.)
Taylor & Francis
Taylor & Francis Group
http://taylorandfrancis.com
chapter thirty
Use of Support and Resistance
We know that after many breakouts from well-defined Reversal and Consolidation Patterns, we get ashort countermove back to the edge of the pattern and the checking of this move at that point is anexample of Support or Resistance, as the case may be. Also, we should be familiar by now with thetendency of stocks to move up or down in a series of zigzag steps (EN10: i.e., waves and wavelets). If themove is upward, the reaction after each advance tends to stop at the level of the preceding peak. If themove is downward, the rally after each decline tends to stop at the level of the preceding bottom. This isagain a matter of Support and Resistance and provides the basis for buying on reactions or selling onrallies. It has also been pointed out Intermediate Secondary Moves will frequently stop at or close to theprevious Intermediate Top or Bottom.
It is necessary to evaluate the importance of these phenomena of Support and Resistance and apply themin market practice, for they are among the most important tools we have. Unfortunately, it is not easy toreduce this particular subject to a neat formula or body of rules. (EN9: And the effort will be made. Seeendnote of this chapter for an interesting effort to do just that.) Here you will depend very largely onexperience and observation. You will have to be alert in spotting the levels at which Resistance or Supportis likely to be encountered, and some judgment is needed in balancing the various factors that will affectthe situation.
For example, there is a stock that has broken up out of a well-defined Rectangle of considerable duration.Should the heavy volume of the breakout move give way to a dull reaction, you will look


tion. You will have to be alert in spotting the levels at which Resistance or Supportis likely to be encountered, and some judgment is needed in balancing the various factors that will affectthe situation.
For example, there is a stock that has broken up out of a well-defined Rectangle of considerable duration.Should the heavy volume of the breakout move give way to a dull reaction, you will look for anopportunity to buy this stock at a point a little above the top level of the Rectangle. It will probably notpenetrate very far below that level and, indeed, will often fail to react all the way to the Support. If thestock should then advance to a new high, and once more decline on low volume, you may look foranother buying point at about the level of the peak reached on the original breakout. Another advancemay be followed by reaction to the second peak, and this process may be repeated a number of times,each reaction carrying back to the level of the preceding high.
Now we all know this sort of thing does not continue indefinitely. When the stock first breaks out,moving from, say, 15 to 19, we may buy rather confidently on the reaction to 17, if that is the SupportLevel. If we did not buy on this move, we may buy with considerable assurance on the reaction toSupport after the next advance. This advance might have carried the price to 21 and our buying pointwould be at the previous peak of 19. As the stock moves up to 25, 30, 40, it must be clear we areapproaching a real Top; although we cannot say where that Top will be reached, we can be sure it isbecoming increasingly tempting to long-time holders of this stock to sell and take their substantial gains.The series of steps is bound to come to an end. To be sure, the Major course of the stock and of themarket may continue up for months or years, but after a series of sharp rises, we may reasonably expect aReversal and a rather substantial Intermediate Decline before the upward move is continued.
Therefore, we must regard each successive step of advance with increasing suspicion; after a stock hasmade three such moves in the Primary Direction, it is time to look for an Intermediate Correction or atleast for an important period of Consolidation. Thus, we have the rough shape of a rule. Buy on thereaction to Support after the first breakout; buy on the reaction to the first Minor Peak after the nextmove, but do not buy on the reaction to the second Minor Peak.
Let us say, then, we have been successful in two short-term moves, buying on the reaction to Support andselling on the climax after a new Top has been made. Nevertheless, we have decided not to attempt a thirdsuch trade. What, then, may we expect next? We may see a period of Consolidation, we may see thebeginning of an Intermediate Decline, or we may see the stock actually go right on moving up. No matter—we will wait for the Intermediate Reaction. We will wait until the stock makes a very substantial
decline, and this may take many weeks. Then, if the Major Trend has not reversed itself, we will againlook for a buying opportunity at (or somewhat above) the Intermediate Support, which will usually be thetop level of the advance preceding the one just completed, for this is the level from which the nextPrimary Advance is likely to proceed and is a good buying point.
We find the same situation in Bear Markets. A breakout is likely to be followed by one, two, three, ormore steps of decline, with intervening rallies to Minor Resistance. Sooner or later (and we would counton no more than three such steps in a series), we will get a turn and an Intermediate Recovery. We willthen wait for this rally, which may itself be made up of several Minor steps, to reach or approach closelythe preceding Intermediate Bottom, at which point we may look for substantial Resistance. Here is theplace again to put out shorts.
Questions will come to your mind. One of them, and one of the most important: how do we decide whenan expected Support or Resistance has failed us, and at what point do we then abandon our position?
It will be clear this question can be a very painful one. Let us suppose you have seen a stock rise to 25and have placed an order to buy it at 23 1/2 on the basis of expected Support at 23, the level of a previousMinor Peak. The order is executed during a dull reaction. The next day, the stock slips down to 22 1/2, onperhaps only two or three sales. The next day, it continues down to 21 1/2, still on low volume. Plus,during the next week, it goes down steadily, without much volume, nearly every sale being at a lowerprice, as though no new bids were being received, and as though no substantial number of bids werestanding on the book at any point. A decline of this sort can eventually assume the magnitude of anIntermediate Reaction. The move may carry down to 15 before it turns. Obviously, this was not what youexpected, and you should be out of the stock.
The painful part of these drifting moves is you do not want to sell your stock (which you bought at 231/2) on just a slight move down, say to 22 3/4, because the probability is strong it will shoot up at anymoment to new high levels. Yet, at some point during a continued decline, you must decide, “This hasgone through the Support; I should sell and take a small loss now, rather than risk a more serious loss.”The most painful part of all is, sometimes, the moment you have sold and taken your loss, the stock willcome to life and complete what would have been an extremely profitable move.
You might just as well prepare yourself for this sort of disappointment, for it will happen to you. To avoidnights of pacing the floor and days of worry, you should decide, at the time you make the originalcommitment, just how much leeway you are prepared to give the stock. Then you will not be tempted toput off a decision from day to day if things are not going the way you hoped.
In the case of purchases or short sales made against Minor Peaks or Bottoms, as the


ent, for it will happen to you. To avoidnights of pacing the floor and days of worry, you should decide, at the time you make the originalcommitment, just how much leeway you are prepared to give the stock. Then you will not be tempted toput off a decision from day to day if things are not going the way you hoped.
In the case of purchases or short sales made against Minor Peaks or Bottoms, as the case may be, youmight set up the following rule. Measuring from the extreme high of the previous (Supporting) MinorTop, or the extreme low of the previous (resisting) Minor Bottom, set a stop using the method we haveoutlined in Chapter 27. (EN9: See also Chapter 28 and consider the risk limitation procedures in Chapter42.) This often would be the intraday high or low, not necessarily the closing price. Penetration to thatextent should be presumptive evidence that your expected Support or Resistance is not going to function.
Where you are buying against Major or Intermediate Support, or selling short against Major orIntermediate Resistance, you can allow a little more leeway for penetration. In such cases, examine theSupport or Resistance Area, and estimate visually its core or axis; in other words, try to gauge the “centerof gravity” of this area, the point is most nearly the mean price of sales occurring there, taking intoaccount the volume, because the important thing is to determine the approximate price level at which agreat many shares changed hands. Having determined this point, set your stop beyond it, according to themethods specified in Chapter 27.
Up to this point we have concerned ourselves (reversing the usual order) with how to get out of situationsthat have gone bad. We have said nothing about where, precisely, to get in, nor where, precisely, to takeprofits.
In the matter of getting in, that is, making the original commitment, you might feel there is a conflictbetween acting on Support or Resistance and acting on either trendline action or a computed reaction of40% to 50% after a previous move. At times, these conflicts might arise and it is not possible to state anyexact rule that will reconcile these three different trading indications. In a great number of cases,however, you will be delighted to observe a reaction of about 45% will bring your stock to the trendlineand will also bring it near to the Support or Resistance Level. After a move to a new Minor Top, a stockmay be expected to react (1) about 40% to 50% of that move, (2) to the Basic Trendline, and (3) to theprevious supporting Minor Top. Your purchase, then, will be based on a consideration of all three factors.If you have bought “early,” on the basis of one factor alone, you may expect the stock to react a bitfurther without spoiling the triple indications to the extent of catching your stop. It would be best to makeyour purchases on the basis of whichever factor indicates the smallest reaction and to place your stopbeyond the greatest reaction indicated by any of the three. Ordinarily, there will not be too muchdifference between these three factors. As usual, the method applies in reverse to short sales.
In cases in which you are buying after an Intermediate Decline or selling after an Intermediate Rally, youwill lean somewhat more heavily on Support and Resistance than on either a computed percentage for theSecondary Move or a trendline. You will examine the history of the stock, preferably on weekly ormonthly charts first, to see its Major Trend, to locate important Support or Resistance Areas, and toestimate roughly the extent of the Corrective Move, the termination of which you are trying to gauge. Youwill then check these data in the more detailed picture you can get from your daily charts. As theIntermediate Corrective Move approaches within 4% or 5% of the Support or Resistance Level, you maycome to a day of extremely heavy volume, and this day may also be a One-Day Reversal. If so, yourcommitment should be made at once and protected by a stop. Otherwise, you may make yourcommitment whenever the chart begins to hesitate or flatten out, or, lacking other indications, when it hascome to within 3% of the Support or Resistance.
In this case, your problem in taking profits is a bit more difficult than in the case of Minor Moves. Youare expecting a Reversal of the Intermediate Corrective Move and the establishment of a newIntermediate Trend in the Primary Direction. You are at a point at which the course of the market isuncertain. You must realize prices may stay at the Support (or Resistance) Level, forming a Line orRectangle, and finally penetrate that level, establishing Reversal of the Major Trend. However, they maybe stopped and turned at the Support or Resistance Level, only to make a small move away and thenreturn for another, and possibly successful, attempt at penetration. Then again (and this is what you hope),a continuation of the Major Trend may develop with a sharp move on increased volume in the favorabledirection, to be followed by a Minor Corrective Move and another thrust in the Primary direction—perhaps a new series of Minor Moves carrying the entire Primary Trend into new ground.
Taking these cases one by one, if the stock remains at the Support or Resistance Level for many days orseveral weeks and then penetrates that level, closing at a price that is clearly through it, get out at once. Ifthe stock makes a small move in the right direction and returns to the Support or Resistance, prepare toget out if there is a definite penetration. If, however, the move is in the right direction, watch for volumeindications, and prepare to set tight stops to take your profits as soon as heavy volume appears (except ona day of breakout). Once such a signal has appeared, you are then justified in continuing to make newcommitments on the following Minor Correction, and the one following that, for you are again moving inthe Major Trend.
One other situation should be mentioned; up to this point, we have assumed al


cations, and prepare to set tight stops to take your profits as soon as heavy volume appears (except ona day of breakout). Once such a signal has appeared, you are then justified in continuing to make newcommitments on the following Minor Correction, and the one following that, for you are again moving inthe Major Trend.
One other situation should be mentioned; up to this point, we have assumed all of your commitmentshave been made to take advantage of a move in the direction of the Major Trend. Let us suppose a move
that has carried a stock up to new high levels in a series of Minor steps proceeds to form and then breaksout of a Reversal Pattern. We must now look for a Secondary Move of Intermediate extent. We may sellshort on the rally to the Minor Resistance, and, if the move continues down, we may make a second andeven (more cautiously) a third commitment against successive Minor Bottoms. In this case, we will belooking for the decline to end somewhere in the vicinity of the last previous Intermediate Top, which isnow a Support Level. Similarly, following a recognized Reversal Pattern and upward breakout on volumeduring a Bear Market, we may expect an Intermediate Rally that can be used for trading up to theprevious Intermediate Bottom where strong Resistance is likely to show up. A skillful trader can turnthese Secondary Moves into profits during periods when it is not possible to trade along the indicatedPrimary Trend; however, it should be remembered, ordinarily, such moves cannot be expected to go as faras will those in the Primary Direction.
We might close this chapter by reminding you again that, although Support and Resistance action in theMinor Trend is shown clearly in daily charts, the Intermediate and Major Supports and Resistances aremost easily recognized on weekly or monthly charts.
(EN9: It seems to this editor that Magee's discussion here of the use of Support and Resistance is reallymost pertinent to position building and pyramiding. Alternatively, the method applies to an issue that hasjust caught the analyst's attention, and he has missed the breakout, which is usually obvious (at least inhindsight). I feel strongly that the serious trader should not miss the original breakout. Chasing movingtrains is never a healthy activity. Does this appear an impossible occupation, to watch thousands ofstocks? Impossible for your average analyst, but not for your average computer. For example, thecomputer may be programmed to alert you when a stock is gapping on volume or trading at volumes thatare suspiciously large. And given the plethora of services and user groups, the trader stands a goodchance of spotting an issue to put on his watch list before it takes off.
Investors should, in theory, never miss a breakout, because they should be watching a much more limitedgroup of issues. In my opinion, these are primarily indexes and iShares. An investor's portfolio mightinclude a few well-chosen individual issues, but these would be of obvious visibility to the individual, forexample, biotechs for an investor with some knowledge of the area, or Internets for an engineer, and soon.
The unending effort to remove ambiguity from market interpretation extends to identifying areas ofSupport and Resistance. Metastock (http://www.metastock.com), an excellent software package, has anumber of value-added packages. One of the more interesting of these, Powerstrike™ by John Slauson ofAdaptick, Inc. (http://www.adaptick.com) attempts to mathematically define Support and Resistancezones. Slauson's package is interesting, and the reasoning and observation behind it are interesting aswell. Market analysis is rooted in one thing: the intelligent observation of the operation of the market.Dow watched the markets for years and came to the understanding of waves that led to Dow Theory.Schabacker and Edwards, equipped with these observations and comments, collated and observed moredata and recognized the persistent patterns that occurred over and over in the markets, and added Mageefor his practical engineer's approach to solving the tactical and strategic questions. In the 1980s, one ofmy friends, a Chicago market maker in the options pit, noticed that there was a 90-second delay on datacoming out of the futures pits to the options pit. He set up a “human ticker” with a direct phoneconnection to his pit and enjoyed a 90-second advantage over other market makers until the glitch wasnoticed and corrected.
Slauson (among others) noticed that important trading and Support and Resistance in optionable stockstended to cluster around important option strike price levels. In fact, these levels influence stock pricesand may be said to determine where “important” buying and selling occur. Obviously, Support andResistance Levels are set by concentrated face-offs between buyers and sellers. A battleground metaphoris appropriate: since the time of the Greeks, battles have occurred time and again in the same physical
locations. The reason is obvious. You need physical space to deploy an army. So commanders will beattracted to the plain or open ground for face-offs and to the high ground for defensive purposes. Optionstrike prices have the same attractiveness for traders that a good battleground has for a militarycommander. A good place to test the enemy.
Powerstrike™ analyzes the instrument price and volume around the nearby option strike prices anddetermines whether Support or Resistance is stronger. All in all, this is a clever application of number-driven analysis to the Support and Resistance question. The chart analyst may supplement his analysiswith a routine like this.)
Taylor & Francis
Taylor & Francis Group
http://taylorandfrancis.com
chapter thirty-one
Not all in one basket
(EN: As diversification for the general investor is nowadays infinitely easier, an important endnotefollows Magee's text.)
Diversification is important because technical patterns do not always carry out their original promise. Ifall yo


t may supplement his analysiswith a routine like this.)
Taylor & Francis
Taylor & Francis Group
http://taylorandfrancis.com
chapter thirty-one
Not all in one basket
(EN: As diversification for the general investor is nowadays infinitely easier, an important endnotefollows Magee's text.)
Diversification is important because technical patterns do not always carry out their original promise. Ifall your capital is tied up in one stock, or in a few stocks of the same group or line of business, you maybe hurt by a false move affecting only your holdings, even though the rest of the market may continue tohold firm or even to move farther along the Primary Trend. By diversifying, you are protected by the lawof averages against all of your holdings going the wrong way, except in the case of some Reversalaffecting the entire market or a large segment of it.
Intelligent diversification calls for study of the costs of buying and selling stocks, especially in smallquantities. You might wish to have a portfolio of stocks representing the entire Dow-Jones Averages, or aselection that includes at least one stock of every major group. However, if your capital is limited, thismight mean buying only a half-dozen shares of each stock, and the minimum commission charges wouldmake this an expensive operation, entirely too costly for short-term trading. The short-term trader mustalways think of these costs. They are more important to him than to the long-term investor who mayintend to hold the same stock for many months or years. To you as a trader, a quarter point or a half pointmay amount to serious proportions when it is multiplied through a number of transactions.
Your broker can give you a schedule showing commission and tax costs, and in case there are anyimportant changes in the rates, which you should study to see what effect they will have on your costs oftrading in stocks at various prices. (EN: You may also evaluate these charges at http://www.gomez.comand by checking websites of http://www.scottrade.com, http:// www.etrade.com, and
http://www.tdameritrade.com. Google is, as ever, an important price-checking resource, and Barron'spublishes a yearly edition evaluating brokerage houses. In general, this editor believes the investor whodoes it the “old-fashioned way,” that is, by phone and human broker, operates at a disadvantage unlessthe broker's value added can be quantified and proven.)
You will find your round-trip costs are a higher percentage of the capital invested in low-priced stocksthan in high-priced stocks. Also, the percentage costs will be higher on a smaller number of shares thanon a round lot and increasing as the number of shares decreases. Additionally, the percentage costs rise asthe total amount of capital used is less.
If your capital is, say $1,000 or $2,000, you might do well to divide it into units of about $500 each andconfine your trading to odd lots of stocks selling at 40 or higher. With larger capital, you could use largertrading units and extend the range of trading into somewhat lower priced stock. In any case, it isimportant to diversify your holdings. By dividing your capital and using it in such a way as to avoidunnecessary penalties in high costs, you will have greater protection against freak moves and suddenchanges that might affect a single stock very seriously.
On the other hand, if you have sufficient capital to secure plenty of diversification (8 or 10 stocks shouldbe a maximum for an active trading account), you can increase the size of the trading units. The wholequestion here is as to the minimum amounts to be invested in a single commitment and, if these amountswere doubled or tripled, it would not increase costs, but would, in many cases, reduce them.
EN: diversification and costs
In this original chapter, Magee discussed the necessity for considering costs while striving fordiversification. In present-day markets, diversification may be achieved through the use of Standard &Poor's Depository Receipts (SPDRs; SPY) and DIAMONDS™ (DIA) and similar instruments (ETFs) atcomparatively reasonable costs. Index funds and mutual funds also represent diversification and costcontrol for the general investor. Mutual funds will not control costs and expenses as efficiently as theIndex Shares and ETFs. This is because mutual funds create costs that the Index Shares do not:management fees and expenses, slippage, the spread, turnover, and taxes resulting from realized gains.These costs may be avoided by the careful independent investor.
An internationally prominent trader has told me, on more than one occasion, his considerable tradingfortune amounts to what brokers and specialists would have made off of him if he had been a member ofthe general public instead of a member of the Exchanges. The most important weapons in his quiver wereseats in Chicago, New York, and San Francisco.
The message is extremely clear. The general investor must control his costs. The more frequently hetrades, the greater his chances of having his capital ground to hamburger meat by brokers, specialists,floor traders, market makers, tax authorities, Exchanges, etc., etc., because there is undoubtedly anotherparty out there taking a chunk as the capital changes hands. The phone company maybe.
Trading costs are the last item brokerage firms want to focus on (see the book Where Are the Customers'Yachts?). For years, the Street firms and Exchanges controlled commission costs, keeping them high, butentering the Internet age a different ethos rules—cutthroat (and cut fees) competition, reluctantly broughtto the old-line exchanges and brokers by upstart competitors, and not suppressed by the Securities andExchange Commission (SEC) and the Commodities Futures Trading Commission.
It would be misleading to attempt to analyze costs in this book because of the mercurial nature of costfigures as firms compete in the Internet age.
The SEC runs a mutual fund calculator for computing costs of mutual funds. Mutual


old-line exchanges and brokers by upstart competitors, and not suppressed by the Securities andExchange Commission (SEC) and the Commodities Futures Trading Commission.
It would be misleading to attempt to analyze costs in this book because of the mercurial nature of costfigures as firms compete in the Internet age.
The SEC runs a mutual fund calculator for computing costs of mutual funds. Mutual funds are amongthose that manage somehow to not be overly punctilious in estimating (read, disclosing) their costs toinvestors. Another good resource for researching mutual funds is http://www.morningstar. com.
But let me emphasize once again that iShares and ETFs have really made mutual funds obsolete if theinvestor uses the simple procedures outlined in this book.
chapter thirty-two
Measuring implications in technical chart patterns
If you show one of your charts to a friend and tell him it looks Bullish, he will reply immediately, “Howfar do you think it will go?” This is an automatic response; you can count on it.
The question is a good one. How far is this expected move likely to go? You do not know, nor doesanyone. Very often you can say, with a fair degree of assurance, “This stock, which has just made such-and-such an advance, is likely to react to around such-and-such a price.” That you can estimate fairlyclosely 7 or 8 times out of 10, by referring to the Basic Trendline, the parallel projection of the toptrendline, or the Support Level.
These rules work out fairly well as applied to reactions in the Bull Trend, and similarly, we can estimaterallies in a Bear Trend. Not so with the move in the direction of the trend itself. A Bullish Move may, andoften does, overrun the upper trendline by running up as far again as the move to the trendline. A BearishMove may exceed the downtrend, dropping apparently without limit. (That is one reason we haveprotective stops—to prevent disaster in case the trend suddenly reverses itself.) Additionally, it is why weprefer the use of nearby progressive stops as a method of taking profits, rather than using limit ordersplaced at a trendline, Resistance Level, or at some other definite point. Very often, to be sure, a stock willcheck its advance at one of these indicated points, but the cases in which a move carries beyond itsobjectives are fairly common, and in such cases, no one can make even a reasonable guess as to whatlimit the stock will reach on the move.
This follows because the move itself is an unreasonable one. It is an example of public participation, thesurge of uncontrolled speculation (and, very often, it is the final surge of that particular trend).
In exactly the same way, and often more violently, the uncontrolled falling out of trend in a downwardmove is an example of Panic, and being completely beyond reason, it follows no rule and knows nopredetermined limits.
There are, however, certain patterns and certain situations in which we can make some estimate of theprobable extent of a move in the Primary Direction—usually an estimate of its minimum extent. In thesecases, we have a guide to help us in making the decision as to whether the situation offers enoughpotential gain to be worth the risks involved. Also, the indicated measurement gives us at least a hint ofabout where we might reasonably begin to look for the volume that will indicate the Top.
For example, a decisive breakout from a Symmetrical Triangle is likely to carry at least as far as theheight of the Triangle measured along its first reaction. This is a conservative measurement. The movemay go much farther. In fact, the trend implications of the Triangle would suggest a continuation equal tothe move preceding the Triangle and leading into it, for if the trend continues valid, the move should runup to the upper limit of the channel. In the case of a Reversal, we would also use the height of the firstreaction as a minimum measure. With Right-Angle Triangles, we also can take the long side (formed bythe first reaction) as a rough measure of the minimum expected move.
What is more, with Rectangles the minimum we may reasonably expect after a breakout is a distanceequal to the height of the Rectangle. The Head-and-Shoulders Pattern carries a good measuring stick. Theheight of the formation from the extreme Top of the head down to the point directly beneath where theneckline crosses represents the minimum probable move from the neckline down. Again, this is a matterof Trend Channels, and most emphatically, this is only a minimum move. Some Head-and-ShouldersPatterns, representing an implied move of no more than 3 or 4 points, have marked the start of a declineeventually running to hundreds of points.
The rather unusual breakout that takes the form of an almost vertical “mast” running up (or down) manypoints before arriving at a stopping point, where some Consolidation Pattern is made, carries with it amost explicit measuring rule, and one that works out with amazing accuracy. The Flag or PennantConsolidation will occur at the halfway point—“the Flag flies at half-mast.” The speculation moveleading up to the Flag very likely will be duplicated by another rise, at least equal to the first, in the nearfuture. Following this rise, there may be another Consolidation and other rises, or there may not. Aftertwo surges of this sort, it is best to stand back and let someone else carry the ball. If you keep enoughcharts, and for a long enough time, you will see many perfect examples of this beautiful formation. Youwill also see some imperfect examples and some failures. And because the move is so spectacularlyprofitable when it works out, you will be tempted to buy on every Consolidation Pattern formed after asharp rise. It would be best to wait until the example is clear—a nearly vertical, almost unbelievable rise,followed by several days of congestion with practically no volume. If the congestion continues or sags offfor more than about three weeks, sell the stock; it is probably not the


pectacularlyprofitable when it works out, you will be tempted to buy on every Consolidation Pattern formed after asharp rise. It would be best to wait until the example is clear—a nearly vertical, almost unbelievable rise,followed by several days of congestion with practically no volume. If the congestion continues or sags offfor more than about three weeks, sell the stock; it is probably not the real thing.
Needless to say, this same pattern appears in reverse in downtrends and can be traded on accordingly.
The questions relating to the measuring attributes of gaps have been reviewed in detail in Chapter 12. Theonly type of gap that carries substantial implications as to the extent of the move to follow is theRunaway or Continuation Gap. The appearance of such a gap during a rapid price move is likely to markapproximately the halfway point; two or more such gaps can be weighed, in connection with volume andtotal extent of the move, to estimate the probable midpoint of the move and thus to predict a probableultimate objective.
Measuring properties have been ascribed to other patterns and occasionally work out according to plan. Ingeneral, the best measuring devices are your trendlines, Support-and-Resistance Levels, and the all-important signals of increased volume.
Other tools exist for measuring moves. Arthur Sklarew (see Bibliography) describes the-rule-of-seven,which I have often found effective. In addition, Wyckoff used PnF charts to measure moves and I haveseen some impressive analyses produced by Professor Hank Pruden using PnF charts.
(EN9: I have always been extremely chary of measuring moves. If the measurement does not lead thetrader to indulge in expectations that distract him from the crucial nature of the moment at hand, it mightbe quite all right. So, as an off-hand casual tool, it might serve some use. Always better to observe closelywhat the situation is when the price arrives at the measured point. Decisions should always be made inthe here and now, and not in the “I measured it then.”)
chapter thirty-three
Tactical review of chart action
The Dow Theory
(EN: In this chapter, multiple references are made to the tight stop - 1/8 point which decimalizes to .125.Readers should read this as decimal.13 to.25, depending on the habits of the issue. Issues greater than adollar are quoted at two decimal places. Penny stocks can go to 4 decimal places.)
The record shows an investor who had bought a representative group of stocks on every Major BullMarket signal according to the Dow Theory, as outlined in Chapters 3 through 5, and sold all his stockson every Major Bear Market signal, since the start of the Dow Averages, would have come out very wellindeed over the years. (EN: see tables in Chapter 4.) Although this tabulation does not take short salesinto account (EN9: now taken into account in the ninth edition), it would be perfectly consistent to add arepresentative group of stocks might be sold short on every Major Bear Market signal and covered at thenext Bull Market signal. Additionally, if the figures for such short sales, based on the level of theIndustrial Average, were included, the total profits on these theoretical transactions, both long and short,would be enormous. (EN9: Buy and Hold to 2018: $55,411.83. Dow Theory, long only: $795,592.01.Dow Theory, long and short: $5,757,390.17.) (For illustrations in this chapter, see Figures 33.1 through33.16.)
We believe this record carries some weighty implications that have a bearing on the operations of everytrader and investor. We will comment on these shortly, but before doing so, it should be pointed out thatfew, if any, investors have actually followed the long-time Dow signals, buying or selling 100% on everyMajor signal.
In the first place, to do so would require a long market lifetime and would presuppose the investor hadaccepted the Dow Theory in its classic form in toto from the start and he had never wavered, never alteredthe definitions nor his method of trading, and never withdrew any of his capital during the entire period.
In the second place, we would have to assume our ideal investor had an extraordinary degree of courageto stand firm in periods during which the Major Trend appeared to be making dangerous threats againsthis position and an extraordinary degree of patience to wait out the many months of stagnation when thetrend seemed to be getting nowhere at all.
Finally, we would have to make the assumption the group of stocks actually bought or sold reallyrepresented a fair cross-section of the Averages in that they would make about the same moves as theAverage itself. As a matter of fact, if the group were well diversified, the chances are good its movesmight approximate those of the Averages.
However, it is taking a lot for granted to suppose an investor could meet all of these conditions over aperiod of years, which he would have to do to operate strictly as a “Dow Theory” trader. It is not seriouslysuggested anyone try to follow any such plan literally. (EN: Well, in retrospect, why not? Given, in theInternet age, the availability of trading instruments and markets [DIAMOND™—DIA, Standard &Poor's Depositary Receipts—SPY] it might not
Figure 33.1 Head-and-Shoulders Top. The Bull Market that carried Southern Pacific from 8 to 70 in theyears 1941 through 1946 culminated in June 1946 with this formation. Notice the heavy volume on theleft shoulder, lower volume on the head, and small volume on the right shoulder. The breakout signal,which was decisive on July 15, served notice on holders of long commitments to sell at the market thenext day (at about 63) instead of waiting for the protective stop, which would have been set at 61, to becaught. Volume eventually developed at the Bottom of the breakout move at about 58 1/2, which move,incidentally, carried out the minimum measure of the Head-and-Shoulders prediction.
From this point, however, a weak rally on low volume started and continued up for four weeks. T


at the market thenext day (at about 63) instead of waiting for the protective stop, which would have been set at 61, to becaught. Volume eventually developed at the Bottom of the breakout move at about 58 1/2, which move,incidentally, carried out the minimum measure of the Head-and-Shoulders prediction.
From this point, however, a weak rally on low volume started and continued up for four weeks. Theweakness of this picture would justify a short sale on a rally of 40% to 50% of the move from the leftshoulder to the bottom or on a return to the neckline, say, at 63. The rally actually extended to theneckline at 64, broke away on a gap with volume, and continued down in a move that led, in the nextthree months, to prices below 40, and later even lower.
An extraordinary feature of Head-and-Shoulders Tops is the frequency with which a comparatively smallformation, such as the one shown here, will herald a Major Move, changing the course of the stock formonths or even years to come. Not all patterns of this type will lead to such big moves as this, but noHead-and-Shoulders should be regarded lightly, ever.
be such a bad idea. The implementation of such a plan in Magee's time would have been extremelycumbersome and expensive, but it is eminently practicable in modern markets.)
The important implications of which we spoke are these: if the record of the Averages shows on theseMajor Signals it is possible to take substantial theoretical profits over the long term, and if the Averagesare composed of the prices of individual stocks, then the probabilities favor buying or selling a majorityof stocks in line with the Major Trend of the Averages. The evidence shows Major Trends normallycontinue for months or years. The line of “most probable gain,” therefore, is the line of the Major Trend.
On this basis, we would be on safe ground to say when a trend of sufficient importance gives a MajorSignal, the Averages are under way and there will be a greater likelihood of finding profitable situationsamong individual stocks moving in that trend than among those moving in the reverse trend.
Figure 33.2 Head-and-Shoulders (or Kilroy) Bottom in Braniff Airways, 1945. Strictly speaking, aContinuation Head-and-Shoulders after a Secondary Correction in the Bull Market. A Major Bottom,reversing a long Bear Market, would normally take much longer to form.
Here we see heavy volume on the left shoulder, somewhat less on the head, and very little on the rightshoulder, with a sharp increase, as required, on the breakout move of September 21. The breakout wasfollowed by a Throwback to the neckline on diminishing volume, providing a good opportunity forpurchases at 23. The upward move was resumed, and again there was a reaction to the neckline Support.A second reaction of this sort is not unusual. The closing at 22 3/4 on October 19, below the previousMinor Bottom, and on increased volume, was mildly disturbing. But in view of the strength of the patternand breakout, we would not have sold the stock, and the protective stop at 21 7/8 was not eventhreatened. On October 25, the advance was resumed with a Breakaway Gap and continued up to 29 1/2,where the move was signed off with a One-Day Reversal and Exhaustion Gap.
Notice on reaching 29 1/2, “BNF” went into a Consolidation Pattern for more than three weeks, makingan Ascending Triangle, before leaping to 37 1/2. Notice also (we might as well get all we can out of theseexamples) the Ascending Triangle takes shape at approximately the halfway point of the whole advance.We are already familiar with this tendency of stocks in fast moves to form “halfway” patterns.
It is suggested you read this preceding paragraph again, carefully. It means we do not try to sell stocks “atthe Top” in a Bull Market. We do not try to “pick up bargains at the Bottom” in a Bear Market. We do notdeliberately buck the kind of trend that history shows is likely to continue for an undetermined andpossibly long time.
What we have said here is stated with a little different emphasis than in previous editions of this book.You will notice we have not said you will never sell a stock short during a Major Bull Market or buy astock in a Bear Market. There will be, and often are, cases of stocks moving against the Major Trend and,on the basis of their individual technical behavior, may justify a commitment against the trend of theAverages.
ASSOCIATED DRY GOODS DG
•••••••••••
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JANUARY FEBRUARY MARCH APRIL
5 12 19 26 2 9 16 23 2 9 16'23 30'6 13 20 :
13'20 27 4
MAY
11 18 25 1
8 15 22
Figure 33.3 Associated Dry Goods winds up its Bull Market Trend with a Rounding Top. This is a dailychart for the first six months of 1946.
The advance in “DG” from 4 to above 72 in just 3 1/2 years, when seen on monthly charts, is a smooth,accelerating curve that emerged from a long Bottom Formation that had lasted five years from 1938through 1942.
As we enter the final six months leading up to the ultimate peak, note first the action during January andFebruary. “DG” had just completed a fast run-up in the last quarter of 1945 and was about due for aConsolidation or a Secondary Correction. On reaching 48, it turned back to 45, advanced to 50 1/2, to 51,and finally to 52, and then reacted to 44 at the end of February. Had the move on January 22 gone a littlelower and closed below the January 3 low, followed by an even lower closing on February 26, we wouldhave had to consider this January-February pattern a completed Broadening Top, a definite Reversalsignal. However, the pattern was not perfect, and, therefore, not valid, but the erratic price action showsincipient weakness.
It is not unusual in these last stages, when public participation is running high, for the climactic advancesto be spectacular and fast; that is what we see here. A five-point Breakaway Gap occurred on March 25,followed by an advance that petered off at 63 1/2 reacted, and then ran up to more than 68.
From here on the move advanced sl


ot valid, but the erratic price action showsincipient weakness.
It is not unusual in these last stages, when public participation is running high, for the climactic advancesto be spectacular and fast; that is what we see here. A five-point Breakaway Gap occurred on March 25,followed by an advance that petered off at 63 1/2 reacted, and then ran up to more than 68.
From here on the move advanced slowly with suggestions of a Convergent Trend and a succession of“heads” and “shoulders,” and volume dropped off as the Top was reached. The drop on June 4 to belowthe May 7 Minor Bottom on increased volume would complete the Rounding Top and call for immediatesale if we were still long; and the penetration of the “neckline” on June 18 was a conclusive break.
We feel such trades should be made cautiously and with a full realization the majority of stocks aremoving in a contrary manner. Such trades might be made, for example, in particular cases as indicated bythe charts of the stocks involved, as partial hedges to reduce overall risk. For example, if a Bull Markethad persisted for several years and was still presumably in effect, but certain stocks had broken badly andshowed individual weakness, a trader might continue to hold three-quarters of his capital in good longpositions but might make a limited number of short sales in the weaker stocks. If, then, the
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Figure 33.4 Greyhound: a Rounding Bottom in 1945. A Continuation Pattern after the May run-up tomore than 29 and reaction to Support at 24, the 1944 high.
In July, volume ran fairly high on downside days, drying up as we entered August. August 10 showed aspurt of volume on the upside, and then more dullness.
The various small moves through August and September would not give us any basis for tradingoperations. The move to a new high in the pattern on August 31 suggested an upturn, and again onSeptember 19-20, we see another little push up to the 26 level—still not conclusive, however.
The move that got under way in the week ending October 13 is more definite. This decisive move withgood volume carries right out of the “Bowl” in an almost vertical ascent; not a big move, but a clearindication of the probable trend. We would look for a point to buy “G” on a correction of 40-50% of theentire move up from the Bottom, or on a return to near the Support Level around 26. The purchase wouldprobably be made around 26 1/2. Notice the drying up of volume on this reaction.
The advance from here to 30, marking an entirely new Bull Market high, came almost immediately. OnNovember 3, with very heavy volume for a Saturday, “G” closed at 30; since this volume was not on theday of breakout, we would have closed out the transaction on a tight stop at 29 7/8 on Monday (unless wehad elected to wait out the next Minor Reaction for a further advance).
Two weeks later, on the basis of the reaction to good Support, we would have bought “G” again at about29 (you cannot figure on getting the extreme low price on any reaction). The following advance carriedup to 34 1/4 in two days. At that point, profits could have been taken or the stock held for the longer term.“G,” it might be noted, continued up eventually to 54.
Bull Market continued, he might eventually have to close out the shorts for losses, which could beregarded as the reasonable cost of “insurance.” On the other hand, if the general weakness became greaterand eventually reversed the Major Trend, then the short sales would cushion the depreciation of the longsup to the time of the Reversal signal. (EN9: An extremely wise observation the present editor hasdeveloped at greater length in the theory of “natural hedging.” Given the complexity of modern markets,profits may be made on both sides of the hedge, and this should be the objective.)
By using an Evaluative Index (see Chapter 38) instead of, or in addition to, the Averages, it is possible tosay, “The market appears to be about 60% Bullish,” or “55% Bullish,” instead of merely Bullish orBearish. This takes account of the fact that some markets are more
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Figure 33.5 Symmetrical Triangle in Allied Stores, a Consolidation in the 1946 decline. Notice heavyvolume as “LS” crashed to the first Reversal point of the pattern on September 10, and the drying up ofvolume during the successive swings of the Triangle. In Point-and-Figure charts, this type of pattern isknown as a Pendulum Swing because it does seem to come to rest like a pendulum. Often, volume willpick up somewhat at each Reversal point, but a valid Triangle must show some overall decrease ofvolume.
If, by some unhappy chance, you were then long “LS,” you should have had your protective stop at 331/8, 8% below the Bottom reached at 36. However, the move down out of the Triangle on Friday andSaturday, October 4 and 5, although on slight volume, was a true breakout (remember that downsidebreakouts do not require volume confirmation), and you would have been justified in selling your longcommitment at the market on Monday. You would have received about 38 1/2. To justify a short sale,however, the breakout would have had to close at least 3% outside the Triangle. The return to the borderof the pattern at 40 was interesting, and you will notice volume increased characteristically as the declinereally got under way on October 9 and 10.
No question about the validity of this breakout. Short sales were in order on a return to the border of theTriangle, or a 40-50% Correction of the breakout move, say, at 38 1/2 to 39. The rally carried to the apexof the Triangle and then broke away fast for the decline to 33, where, on October 30, a Selling Climaxand One-Day Reversal occurred—a signal to take profits.
Notice the small Head-and-Shoulders in August. This was a Continuation Pattern marking the top of therally before the September-November crack-up.
Bullish or more Bearish than others, and it enables the investor to


e rally carried to the apexof the Triangle and then broke away fast for the decline to 33, where, on October 30, a Selling Climaxand One-Day Reversal occurred—a signal to take profits.
Notice the small Head-and-Shoulders in August. This was a Continuation Pattern marking the top of therally before the September-November crack-up.
Bullish or more Bearish than others, and it enables the investor to “roll with the punch” instead of havingto take an all-out position one way or the other. (EN9: I have called this “Rhythmic Trading.”)
It should be noted, however, while he may take such a partial position against the (presumed) MajorTrend, he will continue to use the bulk of his capital in situations that accord with the main trend. He willnever risk the larger part of his assets in opposition to the trend, and he will make any countermoves witha clear understanding they are of the nature of insurance and serve this purpose even though theyultimately may be closed out as small losses.
Summarizing all these implications of the Dow Theory: do not make a majority of your commitmentsagainst the Major Trend. During periods of potential Reversal, gradually reduce your long holdings, andmake short sales to a limited amount in weak stocks; but do not attempt to anticipate either a Major Topor Major Bottom in the Averages by making an all-out commitment counter to the main trend.
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Figure 33.6 An Ascending Triangle. “CMR,” after emerging from the doldrums in 1943, forged up toabout 12 early in 1945. The first eight months of the year on a monthly chart showed an AscendingTriangle with Top at 12 1/4. On daily charts, however, we see the more detailed aspects of this largepattern. For instance, the final reaction of the whole (monthly) formation in August became here aSymmetrical Triangle. The breakout from this pattern carried out the minimum measuring requirements,bringing the price again to the 12 1/4 Top, from which point there was a reaction that was stopped cold at11, the apex of the Triangle. A purchase on the reaction after the powerful breakout from the Triangle, sayaround 11 1/2, would have been closed out on progressive stops, starting September 28 when “CMR”reached 14, the sale being consummated October 2 at 14 1/2, a highly profitable move.
Profit-taking of this sort would largely explain the stopping of the rise and the formation of aConsolidation Pattern that turned out to be the Ascending Triangle with Top at 16 1/4, lasting eightweeks. Notice the November 7 volume when price went through the 16 1/4 level, but failed to closeoutside the pattern, and the volume on November 30 when a clean, decisive breakout move closed at 17.This move ran to 20, and purchases would have been made at 18 or less on the reaction. The next wavetook “CMR” to its ultimate Bull Market Top at 24 in January. On the ratio scale, the Top of the AscendingTriangle was exactly halfway between the September Bottom at 11, and the extreme high of 24. This typeof halfway consolidation is typical of Flags and Pennants, and this is a very similar case.
Head-and-Shoulders Top
A. If you are long a stock, should a breakout down through the neckline occur, with a closing at least 3%below the neckline, next morning place a stop 1/8 point below the last close. Continue to place such“tight stops” if not caught the first day, 1/8 point under each day's close until one is caught.
B. Short sales may be made after a breakout, on a recovery of 40% of the distance from the top of theright shoulder to the bottom of the breakout move, or on a recovery to a line drawn down across the topof the head and right shoulder, or on a Pullback to
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Figure 33.7 A Broadening Top. This somewhat rare but beautiful and highly dependable formationdeveloped as CertainTeed made its Bull Market Peak in 1946. A quick glance at the volume scale in thisdaily chart shows the high volume on the final stages of the advance, the dullness during the developmentof the Top Pattern, and the increased volume after the breakout.
As we all know by now (or go back to Chapter 10 and review the specifications), a Broadening Top is aFive-Point Reversal, differing from the Head-and-Shoulders, Triangles, Rectangles, and so on, in thateach Reversal must be at a new high or low for the pattern. It is, if you wish, a sort of reversed Trianglewith its apex to the left, the swings becoming continually wider.
In the second week of May, “CT” (the symbol has since been changed to “CRT”) made a new BullMarket high at 25 1/4 (marked “1”). The reaction carried back to Support at the previous Minor Peak(point “2”) and the following week, “CT” advanced to another new high at 3, closing 1/8 point above theprevious Top.
Another week had brought “CT” down to point “4” with a closing at 22 1/2, three-quarters of a pointbelow point “2.” This, in itself, is not sufficient reason for making short commitments. Three weeks later,“CT” closed at 25 5/8, another new high, at point “5.” Finally, the stock dropped to 21 1/2 on July 23, andat this point (marked “B”), the pattern was completed. Notice the tendency of volume to rise at eachReversal point of the pattern.
Long holdings would be sold at the market the day after the breakout, but short sellers should wait for acorrection of 40-50% of the move from point "5" to point "B." If shorts were put out at 23, we would notworry if the stock advanced for a time, as it did, without making a new high. The downside move in "CT"went quickly to 15 1/2, and within 12 months to 11 1/2.
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Figure 33.8 Rectangles in Remington Rand. This is part of a long Bull Market rise that carried “RR”from under 10 to above 50 in the period from 1942 to 1946. The last three years of this advance werealmost continuous, as seen on monthly charts, without any extensive reactions. When we put the chart ona daily basis, such as this section covering the end of 1944 and the early months of 1945, right in themiddle of the advance, we s


ton Rand. This is part of a long Bull Market rise that carried “RR”from under 10 to above 50 in the period from 1942 to 1946. The last three years of this advance werealmost continuous, as seen on monthly charts, without any extensive reactions. When we put the chart ona daily basis, such as this section covering the end of 1944 and the early months of 1945, right in themiddle of the advance, we see that the rise was not actually continuous but rather was built up of steps inan ascending “staircase” of Accumulation Patterns. Each sharp advance on increased volume is followedby a period of dullness and slight recession.
A picture of this type suggests the methodical campaign of buyers who intended to purchase large blocksof the stock for large long-term advances without creating a “skyrocket” market by their own buyingoperations. Presumably, each advance was checked by the temporary distribution of part of the stock heldby such buyers, and accumulation restarted on reactions.
In October and November, there is a well-marked Rectangle between 20 3/4 and 22. A purchase couldhave been made at or near the bottom limit, say at 21, on the fifth Reversal on November 14. The moveout of pattern in the week of December 2 did not carry 3% out of pattern, but about two weeks later, amove got under way that qualified as a valid breakout, with volume confirmation as required on upsidemoves. Notice the volume increase and One-Day Reversal on December 20 as this move neared its Top.Purchases would have been made at about 22 1/2 on the basis of a normal correction, and you would have
expected Support at the 22 level. This Support was respected, but the move did not advance beyond 233/4 (made this same Top three times in a period of two weeks) and returned again to 22 1/4.
There was no question about the breakout on January 25. Extent and volume were decisive. Notice thegap and One-Day Reversal on the following day as this Minor Move reached its end.
In mid-March, as you will see, “RR” plunged down from its high of 27, but the decline was stopped in itstracks at the top level of the January Rectangle, a good Support shelf. Never again during the Bull Marketdid “RR” even threaten this level because it moved up in April and continued its long march to the 1946Top.
the neckline, whichever point is reached first. If the breakout move continues down another day, or forseveral days, the 40% recovery would be based on the entire move from the top of the right shoulder tothe lowest point reached.
Head-and-Shoulders Bottom
(EN: The editor, long distressed by the paradox of the term “Head-and-Shoulders Bottom,” proposes thisformation be renamed in technician's nomenclature to “the Kilroy Bottom” [see Figure 7.4.])
A. If you are short a stock, should a breakout on increased volume occur, penetrating the neckline andclosing at least 3% above it, place a stop next morning to cover at 1/8 point higher than the close. If sucha stop is not caught, continue each day to place a stop 1/8 point higher than the previous day's close untilone is caught.
B. New purchases may be made after a breakout, on a reaction of 40% of the distance from the bottom ofthe right shoulder to the top of the breakout move (which reaction must be on decreasing volume), or on areaction to a line drawn across the bottom of the head and the right shoulder, or on a Throwback to theneckline, whichever is reached first. As in the case of the Top Formation, this 40% reaction is figured onthe entire distance of the breakout move if it should continue up for several days.
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Figure 33.9 A Double Bottom in Paramount Pictures. Double Tops and Double Bottoms are not ascommon as many traders like to think. They require considerable time to develop and must conform tospecifications as to price range and time, and also (on upside breakouts from Double Bottoms) as tovolume. They are easier to spot on weekly charts than on dailies.
This is a weekly chart of “PX” from September 1941 through March 1943. A Bottom was made onclimactic volume at 11 3/4 during the “Pearl Harbor Panic” Move. Then came a rise lasting eight weeksthat brought “PX” back to 15 5/8—a rise, incidentally, on feeble volume, strongly suggesting thepossibility of another crack-up to even lower levels. This rise, you will notice, was a considerable one,amounting to 35% of the price at the December low.
The downward move, however, which lasted to mid-April, was on low volume and ended precisely at theDecember low of 11 3/4. (Note: it is not necessary moves of this sort end at exactly the same level; thesecond Bottom could have been a bit higher or lower without spoiling the pattern.)
The second week in July shows the first sign of a possible Reversal when the price advanced on increasedvolume, but it did not close above 15 5/8 and, therefore, was not a breakout. Two weeks later, on heavyvolume, “PX” had moved up to 16 1/2, closing the week at 16. This is a true breakout and purchaseswould have been in order on reactions from this point on.
The move continued up for three years to an ultimate Top at 85.
Figure 33.10 A Right-Angled Broadening Formation in Associated Dry Goods. A beautiful example of abreakout through Multiple Tops, followed by an important move. This is, however, a pattern that is morefun to observe in retrospect than to follow as an active trader. The stock had moved up from an importantBottom around 4, established in 1938, 1940, and 1942. At the time of this chart in 1945, “DG” wasstarting the accelerating climb that eventually ended with the 1946 Rounding Top at more than 70 (seeFigure 33.3).
If you had been holding the stock, you would have been watching for a substantial corrective move afterthe advance from 12 to 20. In late February and the first week of March, “DG” went into a new BullMarket high-ground, reacted to Support around 19 to 19 1/2, and then advanced again in the week ofMarch 17, failing in this move to make a new h