science of artificial
intelligence, aided by yet unimaginable computer hardware, makes new
breakthroughs.
If it is definitive, why offer a new edition?
Unlike Nostradamus and Jules Verne (and many current investment
advisors), the authors did not have a crystal ball or a time machine. Magee
did not foresee the electronic calculator and made do with a slide rule. And
while he knew of the computer, he did not anticipate that every housewife
and investor would have 1,000 times the power of a Whirlwind or Univac I
on his (her) desk (cf., “About Gender”). In short, the March of Time. The
Progress of Science. The Inexorable Advance of Technology.
Amazingly, the great majority of this book needed no update or
actualization. Who is to improve on the descriptions of chart formations and
their significance?
But insofar as updates are necessary to reflect the changes in technology
and in the character and composition of the markets, that is another story.
Human character may not change, but in the new millennium, there is
nothing but change in the character and composition of the markets. And
while regulatory forces might not be completely in agreement, the majority
of these changes have been positive for the investor and the commercial
user. Of course, Barings Bank and some others are less than ecstatic with
these developments.
The most important additions to this book to reflect changes in the times,
technology, and markets
Generally speaking, these additions, annotations, and updates are intended
to inform the general reader of conditions of which he must be aware for
investing success. In most cases, because of the enormous amount of
material, no attempt is made to be absolutely exhaustive in the treatment of
these developments. Rather, the effort is made to put changes and new
conditions in perspective and furnish the investor with the resources and
proper guide to pursue subjects at greater length if desired. In fact, an
appendix has been provided, entitled Resources (EN10: now Appendix B),
to which the reader may turn when he has mastered the material of the book
proper.
The stubborn individualist may realize investment success with the use of
this book alone (and paper, pencil, ruler, and chart paper [cf., Section on
TEKNIPLAT™ chart paper]).
Technology
In order to equip this book to serve as a handbook and guide for the markets
of the new millennium, certain material has been added to the text of the
fifth and seventh editions. Clearly, the astounding advances in technology
must be dealt with and put in the context of the analytical methods and
material of the original. To achieve success in the new, brave world, an
investor must be aware of and utilize electronic markets, the internet, the
microcomputer, wireless communications, and new exchanges offering
every kind of exotica imaginable.
The advanced investor should also be aware of and understand some of the
developments in finance and investment theory and technology—the Black-
Scholes Model, Modern Portfolio Theory, Quantitative Analysis.
Fortunately, all these will not be dealt with here because, in truth, one
intelligent investor with a piece of chart paper, a pencil, and a quote source
can deal with the markets, but that is another story we will explore later in
the book. Some of these germane subjects will be discussed sufficiently to
put them in perspective for the technical analyst, and then guides and
resources will be pointed out for continued study. My opinion is that the
mastery of all these subjects is not wholly necessary for effective investing
at the private level. What need does the general investor have for an
understanding of the Cox-Ross-Rubinstein (CRR) options analysis model to
recognize trends? The Edwards-Magee model knows things about the
market the CRR model does not.
Trading and investment instruments
The new universe of available trading and investment instruments must be
taken into account. The authors would have been in paradise at the
profusion of alternatives. In this future world, they could have traded the
Averages (one of the most important changes explored in this book); used
futures and options as investment and hedging mechanisms; practiced
arbitrage strategies beyond their wildest dreams; and contemplated a candy
store full of investment products. The value and utility of these products
would have been immeasurably enhanced by their mastery of the charting
world of technical analysis. As only one example, one world-prominent
professional trader I know has made significant profits selling calls on
stocks he correctly analyzed to be in down trends, and vice versa— an
obvious (or, as they say, no-brainer) to a technician, but not something you
should attempt at home without expert advice. Techniques like this
occasioned the loss of many millions of dollars in the Reagan Crash of
1987.
Changes and developments in technical analysis
Have any new chart patterns (that is to say, changes in human behavior and
character) emerged since the fifth edition? Not to my knowledge, although
there are those who take the same data and draw different pictures from
them. How else could you say that you had something new! different!
better!? There are other ways of looking at the data that are interesting,
sometimes valuable, and often profitable, which goes to prove that many
are the ways and gateless is the gate to the great Dow. Point and figure
charting have been used very effectively by traders I know, and candlestick
charting depicts data in interesting ways. Furthermore, since Magee's time,
aided by the computer, technicians have developed innumerable, what I
call, number-driven technical analysis tools: (the puzzlingly named)
stochastics, oscillators, exponential and other moving averages, etc., etc.,
etc. It is not the intent of this book to explore these tools in depth. That will
be done in a later volume. These concepts are briefly explored in an
appendix (Appendix C, 8th edition) supplied by Richard McDermo


cians have developed innumerable, what I
call, number-driven technical analysis tools: (the puzzlingly named)
stochastics, oscillators, exponential and other moving averages, etc., etc.,
etc. It is not the intent of this book to explore these tools in depth. That will
be done in a later volume. These concepts are briefly explored in an
appendix (Appendix C, 8th edition) supplied by Richard McDermott, editor
of the seventh edition.
I have also made additions to the book (see Chapter 18) to give a
perspective on longterm investing, since Magee specifically addressed the
second part of the book (on tactics) to the speculator. I have substantially
rewritten Chapters 24 and 42 to reflect current ideas on portfolio
management and risk management. I have expanded on the idea of
rhythmic trading—an idea which is implicit in the original. I have expanded
the treatment of runaway markets so the internet stocks of the 1990s might
be put in perspective (see Chapter 23).
And then, paradigms. Paradigms, as everyone should know by now, are the
last refuge of a fundamentalist when all other explanations fail.
Paradigm changes
Whenever the markets, as they did at the end of the 20th century, depart
from the commonly accepted algorithms for determining what their prices
ought to be, fundamentalists (those analysts and investors who believe they
can determine value from such fixed verities as earnings, cash flow, etc.)
are confronted with new paradigms. Are stock prices (values) to be
determined by dividing price by earnings to establish a reasonable
price/earnings (p/e) ratio? Or should sales be used, or cash flow, or the
phases of the moon, or—in the late 1990s—should losses be multiplied by
price to determine the value of the stock? Technicians are not obliged to
worry about this kind of financial legerdemain. The stock is worth what it
can be sold for today in the market.
The crystal ball
Investors will get smarter and smarter, starting with those who learn what
this book has to say. The professionals will stay one step ahead of them
because they are preternaturally cunning and spend all their time figuring
out how to keep ahead of the public, but the gap will narrow. Software and
hardware will continue to advance, but not get any smarter. Mechanical
systems will work well in some areas, yet not in others. Mechanical systems
are only as good as the engineer who designs them and the mechanic who
maintains them. Buying systems is buying trouble. Everyone should find
his own method (usually some variant of the Magee method, in my
opinion). All good things will end; all bad things will end. The bag of tricks
with which the insiders bilk the public will get smaller and smaller. New
and ingenious procedures will be developed by the insiders. The well of
human naivete is bottomless. For every one educated, a new one will be
born in a New York minute. It is deeply disturbing at the turn of the century
that the owners of the NASDAQ and the NYSE should be thinking of going
public. Could there be any more ominous sign that enormous changes are
about to occur?
Vigorous development of the systems, methods, procedures, and philosophy
outlined in this book is about the only protective shield I know of to guard
against inimical change.
W. H. C. Bassetti
San Geronimo, California January 1, 2001
About the editorial practices in this eighth edition
Needless to say, one approaches the revision of a classic work with some
trepidation. Every critic and reader has his or her (cf., “About Gender”)
opinion as to how revision should be done—whether the authors' original
text should be invisibly changed as though they had written the book in
2000 instead of 1948 and were omniscient, or whether errors and
anachronisms were to be lovingly preserved, or footnoted, or ... etc., etc. (I
have preserved Magee's favorite usage of “etc., etc., etc.” against the
protestation of generations of English composition teachers because I like
its evocation of an ever-expanding universe.)
Notwithstanding every reader having an opinion, I am certain all critics will
be delighted with the practices followed in this third millennium edition of
the most important book on technical analysis written in the second
millennium.
Integrity of the original text
By and large, the fifth edition has been the source of the authors' original
text. Amazingly, almost no stylistic or clarifying emendation has been
necessary to that edition. This is a tribute to the clarity, style, and content of
the original—one might almost say awesome if the word were not in such
currency on “Saturday Night Live” and the Comedy Central. Considering
its complex subject was written in the middle of the last century and the
markets were one-tenth of their present complexity, awesome may be the
appropriate word. No change or update has been necessary to the technical
observations and analysis. They are as definitive today as they were in
1950.
While I have preserved the authors' original intent and text, I have taken the
liberty of rearranging some of the chapters. Novices wishing to learn
manual charting will find the appropriate chapters moved to appendices at
the back of the book, along with the chapters on Composite Leverage and
Sensitivity Indexes.
About apparent anachronisms
Critics with limited understanding of long-term trading success may think
that discussions of “what happened in 1929” or “charts of ancient history
from 1946” have no relevance to the markets of the present millennium.
They will point out that AT&T no longer exists in that form, that the New
Haven has long since ceased to exist as a stock, that many charts are records
of long-buried skeletons. This neglects the value of the charts as metaphor.
It ignores their representations of human behavior in the markets which will
be replicated tomorrow in some stock named today.com or
willtheynevergetit.com. Even more important, it ignores the significance of
the past to trading in the present. I cite here material fro

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


sed to exist as a stock, that many charts are records
of long-buried skeletons. This neglects the value of the charts as metaphor.
It ignores their representations of human behavior in the markets which will
be replicated tomorrow in some stock named today.com or
willtheynevergetit.com. Even more important, it ignores the significance of
the past to trading in the present. I cite here material from Jack Schwager's
illuminating book, The New Wizards of Wall Street. Schwager, in
conversation with Al Weiss: “Precisely how far back did you go in your
chart studies?” Answer: “It varied with the individual market and the
available charts. In the case of the grain markets, I was able to go back as
far as the 1840s.” “Was it really necessary to go back that far?” Answer:
“Absolutely. One of the keys in long-term chart analysis is realizing that
markets behave differently in different economic cycles. Recognizing these
repeating and shifting long-term patterns requires lots of history. Identifying
where you are in an economic cycle—say, an inflationary phase versus a
deflationary phase—is critical to interpreting the chart patterns evolving at
that time.”
Identification of original manuscript and revisions
True believers (and skeptics) will find here virtually all of the original
material written by Edwards and Magee, including their charts and
observations on them. Changes and comments introduced by editors since
the fifth edition have been rearranged, and, when appropriate, have been
identified as a revision by that editor.
Maintaining this policy, where updates to the present technological context
and market reality were necessary, the present editor has clearly identified
them as his own work by beginning such annotations with “EN” for Editor's
Note. Figure insertions are identified as “x.1, x.2.”
Absolutely necessary revisions
Not too long ago my youngest son, Pancho, overheard a conversation in
which I referred to a slide rule. “What's a slide rule, Dad?” he asked. Well,
needless to say the world has, in general, moved on from the time of
Edwards and Magee when instead of calculators we had slide rules. Where
time has made the text useless, moot, or irrelevant, that problem has
unobtrusively been corrected.
Where the passage of time has made the text obsolete, I have either
footnoted the anachronism and/or provided a chapter-ending annotation,
which are marked in the text with “EN.” It is absolutely essential to read the
annotations; failure to do so will leave the reader stranded in the 20th
century.
In some cases, these annotations amount to new chapters—for example,
trading directly in the averages was difficult in Magee's time. Nowadays, if
there is not a proxy or option or index for some Index or Average or basket
of stocks, there will be one in less than a New York minute (which, as
everyone knows, has only 59 seconds). This new reality has resulted in
major additions to this new edition, which are detailed in the Foreword.
Major chapter additions necessary to deal with developments in technology
and finance theory have been clearly identified as this editor's work by
designating them as interpolations, viz., Chapter 18 (with the exception of
Chapter 23, which I have surreptitiously inserted).
Absolutely necessary revisions that arose in the 30 minutes since this
editorial note was written
In a number of instances, the book relayed information that, in those days of
fixed commissions and monopolistic control by the existing exchanges,
remained valid for long periods of time; for instance, brokerage
commissions and trading costs. It is no longer possible to maintain such
information in a printed book because of the rate of change in the financial
industry. It must now be filed and updated in real time on the internet.
Consequently, readers will be able to refer to the internet for this kind of
ephemeral data. The general importance of the ephemera to the subject is
always discussed.
About gender
I quote here from my foreword to the second edition of Magee's General
Semantics of Wall Street (charmingly renamed according to the current
fashions, Winning the Mental Game on Wall Street):
About Gender in Grammar
Ich bin ein feminist. How could any modern man, son of a beloved woman,
husband of an adored woman, and father of a joyful and delightful daughter
not be? I am also a traditionalist and purist in matters of usage, grammar,
and style. So where does that leave me and my cogenerationalists,
enlightened literary (sigh) men (and women), with regards to the use of the
masculine pronoun when used in the general sense to apply to the neuter
situation?
In Dictionary of Modern American Usage, Garner notes: “English has a
number of common-sex general words, such as person, anyone, everyone,
and no one, but it has no common-sex singular personal pronouns. Instead
we have he, she, and it. The traditional approach has been to use the
masculine pronouns he and him to cover all persons, male and female alike
... . The inadequacy of the English language in this respect becomes
apparent in many sentences in which the generic masculine pronoun sits
uneasily.”
Inadequate or not, it is preferable to s/he/it and other bastardizations of the
English language. (Is it not interesting that “bastard,” in common usage, is
never used of a woman, even when she is illegitimate?) As for the
legitimacy of the usage of the masculine (actually neuter) pronoun in the
generic, I prefer to lean on Fowler, who says, “There are three makeshifts:
first, as anybody can see for himself or herself; second, as anybody can see
for themselves; and third, as anybody can see for himself. No one who can
help it chooses the first; it is correct, and is sometimes necessary, but it is so
clumsy as to be ridiculous except when explicitness is urgent, and it usually
sounds like a bit of pedantic humor. The second is the popular solution; it
sets the literary man's (!) teeth on edge, and he exerts himself to give the
same meaning in some


selves; and third, as anybody can see for himself. No one who can
help it chooses the first; it is correct, and is sometimes necessary, but it is so
clumsy as to be ridiculous except when explicitness is urgent, and it usually
sounds like a bit of pedantic humor. The second is the popular solution; it
sets the literary man's (!) teeth on edge, and he exerts himself to give the
same meaning in some entirely different way if he is not prepared to risk the
third, which is here recommended. It involves the convention (statutory in
the interpretation of documents) that where the matter of sex is not
conspicuous or important the masculine form shall be allowed to represent a
person instead of a man, or say a man (homo) instead of a man (vir).”
Politically correct fanatics may rail, but so are my teeth set on edge; thus, I
have generally preserved the authors' usage of the masculine for the generic
case. This grammatical scourge will pass and be forgotten, and weak-willed
myn (by which I intend to indicate men and women) who pander to
grammatical terrorists will, in the future, be seen to be stuck with
malformed style and sentences no womyn will buy. What would Jane
Austen have done, after all?
About Gender in Investors
As long as we are on the subject of gender, we might as well discuss,
unscientifically, gender in investors. Within my wide experience as a
trading advisor, teacher, and counselor, it strikes me that the women
investors I have known have possessed certain innate advantages over the
men. I know there are women gamblers—I have seen some. But I have
never seen a woman plunger (shooter, pyramider, pie-eyed gambler) in the
markets, though I have known many men who fit this description. I have
also noted among my students and clients that, as a group, women seem to
have more patience than men. I refer specifically to the patience that a wise
investor must have to allow the markets to do what they are going to do.
These are wholly personal observations. I have made no study of the
question and can't speak to the entire class of women investors— and do not
personally know Barbra Streisand (who I understand is a formidable
investor, especially in IPOs). But just as I believe the world would be better
off if more women ran countries and were police officers, I expect the
world of finance will benefit from the steadily increasing number of women
investors and managers.
A crucial question: sensitivity indexes and betas
Long before the investment community had formalized the beta measure—
the coefficient measuring a stock's volatility relative to the market—Magee
and Edwards were computing a Sensitivity Index, which, for all practical
purposes, was the same thing. Readers interested in this aspect of their work
may find references in Resources (EN10: now Appendix B), which will
enable them to obtain betas to plug into the Composite Leverage formula
with which Magee intended to determine risk levels. The old appendix on
Sensitivity Indexes has been consigned to Appendix A (8th edition), along
with the chapter on Composite Leverage, both originals of which have been
emended to reflect current practices in finance theory and practice.
Betwixt and between, 1/8 of a dollar or 12.5 cents
As this edition went to press, the financial services industry was once again
threatening to implement decimals in stock prices. Pricing in eighths has
endured long past its time
because it was in the self-interest of the financial industry—it allowed
brokers and market makers to enforce larger bid-ask spreads and fatten their
profit margins. The importance for this book, and for traders, is what will
happen as full decimalization occurs. Often in these pages, Magee will
recommend placing a stop 1/8 off the low or high, or placing progressive
near stops in eighths. We do not yet know what the psychological interval
will be in the new era; it may be 12.5 cents, or more psychologically, 10
cents, or for gaming purposes, 9 or 11 cents. This remains to be seen. As all
the charts in this book are in the old notation, that usage has been preserved
in this edition.
The editorial “I”
Readers will quickly note the “editorial we” of Edwards and Magee has
been replaced by the first-person voice—or, the “editorial I” or perhaps the
“professorial I.” Well, there were two authors in Edwards and Magee, and
there is only one of me; my text is immediately noticeable as mine, and the
reader may discriminate quickly. As for the use of “I” as an expression of
ego, the reader is assured that after 40 years in the market, the editor has no
ego left to promote. Perhaps the best way to put the editor's sense of
importance in perspective is to quote Dr. Johnson's definition of
lexicographer from his dictionary. Some people might have thought
Johnson self-important in creating the first English dictionary; his definition
of his trade put that right: “Lexicographer: a writer of dictionaries. A
harmless drudge.” An editor is something like the same.
As this book goes to the printer, the publisher, recognizing the importance
of the work done on this edition, will credit the editor as co-author of the
eighth edition. John Magee would be pleased. We had a cordial master-
student relationship, and nothing pleases a Zen master more than to transfer
the dharma to a passionate student.
Acknowledgments
In General:
John Magee, for his ever-patient tutoring.
Blair Hull, for teaching me the mercurial nature of options.
Bill Dreiss, for teaching me the nature of trading systems.
Art von Waldburg, respected colleague and discoverer of the Fractal Wave
Algorithm. Fischer Black, who should have lived to get the Nobel Prize.
Bill Scott, friend and fellow trader.
For specific support and assistance in the preparation of this eighth edition:
Professor Henry Pruden, Golden Gate University, San Francisco, for
invaluable support and advice.
Martin Pring; Lawrence Macmillan; Mitch Ackles, Omega Research
Corporation; Carson Carlisle; Edward Dobson; David Robinson;


Fischer Black, who should have lived to get the Nobel Prize.
Bill Scott, friend and fellow trader.
For specific support and assistance in the preparation of this eighth edition:
Professor Henry Pruden, Golden Gate University, San Francisco, for
invaluable support and advice.
Martin Pring; Lawrence Macmillan; Mitch Ackles, Omega Research
Corporation; Carson Carlisle; Edward Dobson; David Robinson; Shereen
Ash; Steven W. Poser; Lester Loops, late of Hull Trading Company; Tom
Shanks, Turtle.
At St. Lucie Press, the dedication and support of the publisher, Drew
Gierman, and Production Associate, Pat Roberson, have been invaluable, as
has been the dedication of Gail Renard, the Production Editor.
And special acknowledgment to my Research Assistant, Don Carlos
Bassetti y Doyle.
Special appreciation goes to makers of software packages used in the
preparation of this and previous editions:
AIQ Systems P.O. Box 7530 Incline Village, NV 89452 702-831-2999
http://www.AIQsystems.com
Metastock Equis International, Inc. 3950 S. 700 East, Suite 100 Salt Lake
City, UT 84107 http://www.equis.com
Tradestation Omega Research 14257 SW 119th Avenue Miami, FL 33186
305-485-7599 http://www.tradestation.com
Taylor & Francis
Taylor & Francis Group
http://taylorandfrancis.com
In memoriam
This book is a memorial for John Magee, who died on June 17, 1987. John
Magee was considered a seminal pioneer in technical analysis, and his
research with co-author, Robert D. Edwards, clarified and expanded the
ideas of Charles Dow, who laid the foundation for technical analysis in
1884 by developing the “Averages,” and Richard Schabacker, former editor
of Forbes in the 1920s, who showed how the signals, which had been
considered important when they appeared in the averages, were applicable
to stocks themselves. The text, which summarized their findings in 1948,
was, of course, Technical Analysis of Stock Trends, now considered the
definitive work on pattern recognition analysis. Throughout his technical
work, John Magee emphasized three principles: stock prices tend to move
in trends; volume goes with the trend; and a trend, once established, tends
to continue in force.
A large portion of Technical Analysis of Stock Trends is devoted to the
patterns which tend to develop when a trend is being reversed: Head and
Shoulders, Tops and Bottoms, “W” patterns, Triangles, Rectangles, etc.—
common patterns to stock market technicians. Rounded Bottoms and
Drooping Necklines are some of the more esoteric ones.
John urged investors to go with the trend, rather than trying to pick a
bottom before it was completed, averaging down a declining market. Above
all, and at all times, he refused to get involved in the game of forecasting
where “the market” was headed, or where the Dow-Jones Industrial
Averages would be on December 31st of the coming year. Rather, he
preached care in individual stock selection regardless of which way the
market “appeared” to be headed.
To the random walker, who once confronted John with the statement that
there was no predictable behavior on Wall Street, John's reply was classic.
He said, “You fellows rely too heavily on your computers. The best
computer ever designed is still the human brain. Theoreticians try to
simulate stock market behavior, and, failing to do so with any degree of
predictability, declare that a journey through the stock market is a random
walk. Isn't it equally possible that the programs simply aren't sensitive
enough or the computers strong enough to successfully simulate the thought
process of the human brain?” Then John would walk over to his bin of
charts, pull out a favorite, and show it to the random walker. There it was—
spike up, heavy volume; consolidation, light volume; spike up again, heavy
volume. A third time. A fourth time. A beautifully symmetrical chart,
moving ahead in a well-defined trend channel, volume moving with price.
“Do you really believe that these patterns are random?” John would ask,
already knowing the answer.
We all have a favorite passage or quotation by our favorite author. My
favorite quotation of John's appears in the short booklet he wrote especially
for subscribers to his Technical Stock Advisory Service: “When you enter
the stock market, you are going into a competitive field in which your
evaluations and opinions will be matched against some of the sharpest and
toughest minds in the business. You are in a highly specialized industry in
which there are many different sectors, all of which are under intense study
by men whose economic survival depends upon their best judgment. You
will certainly be exposed to advice, suggestions, offers of help from all
sides. Unless you are able to develop some market philosophy of your own,
you will not be able to tell the good from the bad, the sound from the
unsound.”
I doubt if any man alive has helped more investors develop a sound
philosophy of investing on Wall Street than John Magee.
Richard McDermott President, John Magee, Inc.
September 1991
Preface to the seventh edition
More than 100 years ago, in Springfield, MA, there lived a man named
Charles H. Dow. He was one of the editors of a great newspaper, the
Springfield Republican. When he left Springfield, it was to establish another
great newspaper, the Wall Street Journal.
Charles Dow also laid the foundation for a new approach to stock market
problems.
In 1884, he made up an average of the daily closing prices of 11 important
stocks, nine of which were rails, and recorded the fluctuations of this
average.
He believed the judgment of the investing public, as reflected in the
movements of stock prices, represented an evaluation of the future
probabilities affecting the various industries. He saw in his average a tool
for predicting business conditions many months ahead. This was true
because those who bought and sold these stocks included people intimately
acquainted with the industrial situation from every angle. Dow reasoned the
price of a security, as determin


n the
movements of stock prices, represented an evaluation of the future
probabilities affecting the various industries. He saw in his average a tool
for predicting business conditions many months ahead. This was true
because those who bought and sold these stocks included people intimately
acquainted with the industrial situation from every angle. Dow reasoned the
price of a security, as determined by a free competitive market, represented
the composite knowledge and appraisal of everyone interested in that
security—financiers, officers of the company, investors, employees,
customers—everyone, in fact, who might be buying or selling stock.
Dow felt this market evaluation was probably the shrewdest appraisal of
conditions to come that could be contained, since it integrated all known
facts, estimates, surmises, and the hopes and fears of all interested parties.
It was William Peter Hamilton who really put these ideas to work. In his
book, The Stock Market Barometer, published in 1922, he laid the
groundwork for the much-used and much-abused Dow Theory.
Unfortunately, a great many superficial students of the market never
understood the original premise of the “barometer” and seized on the bare
bones of the theory as a sort of magic touchstone to fame and easy fortune.
Others, discovering the “barometer” was not perfect, set about devising
corrections. They tinkered with the rules of classic Dow Theory, trying to
find the wonderful formula that would avoid its periodic disappointments
and failures.
Of course, what they forgot was the Averages were only averages at best.
There is nothing very wrong with the Dow Theory. What is wrong is the
attempt to find a simple, universal formula—a set of measurements that will
make a suit to fit every man, fat, thin, tall, or short.
During the 1920s and 1930s, Richard W. Schabacker reopened the subject
of technical analysis in a somewhat new direction. Schabacker, who had
been financial editor of Forbes Magazine, set out to find some new answers.
He realized whatever significant action appeared in the average must derive
from similar action in some of the stocks making up the average.
In his books, Stock Market Theory and Practice, Technical Market Analysis,
and Stock Market Profits, Schabacker showed how the “signals” that had
been considered important by Dow theorists when they appeared in the
Averages were also significant and had the same meanings when they
turned up in the charts of individual stocks.
Others, too, had noted these technical patterns, but it was Schabacker who
collated, organized, and systematized the technical method. Not only that,
he also discovered new technical indications in the charts of stocks;
indications of a type that would ordinarily be absorbed or smothered in the
averages, and, hence, not visible or useful to Dow theorists.
In the final years of his life, Richard Schabacker was joined by his brother-
in-law, Robert D. Edwards, who completed Schabacker's last book and
carried forward the research of technical analysis.
Edwards, in turn, was joined in this work in 1942 by John Magee. Magee,
an alumnus of the Massachusetts Institute of Technology, was well oriented
to the scientific and technical approach.
Edwards and Magee retraced the entire road, reexamining the Dow Theory
and restudying the technical discoveries of Schabacker.
Basically, the original findings were still good; however, with additional
history and experience, it was possible to correct some details of earlier
studies. Also, a number of new applications and methods were brought to
light. The entire process of technical evaluation became more scientific.
It became possible to state more precisely the premises of technical
analysis: that the market represents a most democratic and representative
criterion of stock values; that the action of a stock in a free, competitive
market reflects all that is known, believed, surmised, hoped, or feared about
that stock; and, therefore, that it synthesizes the attitudes and opinions of
all. That the price of a stock is the result of buying and selling forces and
represents the “true value” at any given moment. That a Major Trend must
be presumed to continue in effect until clear evidence of Reversal is shown.
And, finally, that it is possible to form opinions having a reasonably high
probability of confirmation from the market action of a stock as shown in
daily, weekly, or monthly charts, or from other technical studies derived
from the market activity of the security.
It is important to point out that the ultimate value of a security to the
investor or trader is what he or she ultimately receives from it. That is to
say, the price the investor gets when it is sold, or the market price
obtainable for it at any particular time, adjusted for dividends or capital
distribution in either case. If, for example, he or she has bought a stock at
$25 a share, and it has paid $5 in dividends and is now bid at $35, he or she
has realized an accrued benefit of $5 plus $10, or $15 in all. It is the
combination of dividends and appreciation of capital that constitutes the
total gain.
It seems futile to try to correlate or compare the market value of a stock
with the “book value” or with the “value” figured on a basis of capitalized
earnings or dividends, projected growth, etc. There are too many other
factors that may also affect the value, and some of these cannot easily be
expressed in simple ratios. For example, a struggle for control of a
corporation can as surely increase the value of its securities in the market as
a growth of earnings. Again, a company may lose money for years and pay
no dividends, yet still be an excellent investment on the basis of its
development of potential resources as perceived by those who are buying
and selling its stock. The market is not evaluating last year's
accomplishments as such; it is weighing the prospects for the year to come.
Then, too, in a time of inflation, a majority of stocks may adva


s. Again, a company may lose money for years and pay
no dividends, yet still be an excellent investment on the basis of its
development of potential resources as perceived by those who are buying
and selling its stock. The market is not evaluating last year's
accomplishments as such; it is weighing the prospects for the year to come.
Then, too, in a time of inflation, a majority of stocks may advance sharply
in price. This may reflect a depreciation in the purchasing power of dollars
more than improvement in business conditions—but it is important,
nonetheless, in such a case to be “out of dollars” and “into” equities.
As a result of their research from 1942 to 1948, Edwards and Magee
developed new technical methods. They put these methods to practical use
in actual market operation. Eventually, in 1948, these findings were
published in their definitive book, Technical Analysis of Stock Trends.
This book, now in its seventh edition, has become the accepted authority in
this field. It has been used as a textbook by various schools and colleges
and is the basic tool of many investors and traders.
In 1951, Edwards retired from his work as a stock analyst and John Magee
continued the research, at first, independently, and then from January 1953
to March 1956 as Chief Technical Analyst with an investment counseling
firm.
Meanwhile, beginning in 1950, Magee started on a new road, which, as it
turned out, was destined to open up virgin fields of technical market
research.
Using the methods of Dow, Hamilton, Schabacker, and Edwards as a base,
he initiated a series of studies intended to discover new technical devices.
These investigations were long and laborious, and, often, they were
fruitless. One study required four months of work, involved hundreds of
sheets of tabulations, many thousands of computations, and proved nothing.
But from this type of work, eventually in late 1951, there began to emerge
some important new and useful concepts—new bricks to build into the
structure of the technical method.
The new devices are not revolutionary. They do not vitiate the basic
technical approach. Rather, they are evolutionary and add something to the
valuable kit of tools already at hand. The new studies often make it possible
to interpret and predict difficult situations sooner and more dependably than
any other method previously used.
Mr. Magee has designated these newest technical devices the Delta Studies.
They are basically an extension and refinement of the technical method.
There is no magic in the Delta Studies. They do not provide infallible
formulas for sure profits at all times in every transaction, but they have
proved eminently successful over a period of years in practical use in actual
market operations, as an auxiliary to the methods outlined in the book,
Technical Analysis of Stock Trends.
Through his technical work, John Magee emphasized these three principles:
1. Stock prices tend to move in trends.
2. Volume goes with the trends.
3. A trend, once established, tends to continue in force.
A large portion of the book, Technical Analysis of Stock Trends, is devoted
to the patterns that tend to develop when a trend is being reversed. Head
and Shoulders, Tops and Bottoms, “W” Patterns, Triangles, Rectangles, etc.,
are common patterns to stock market technicians. Rounded Bottoms and
Drooping Necklines are some of the more esoteric ones.
Magee urged investors to go with the trend, rather than trying to pick a
Bottom before it was completed or averaging down in a declining stock.
Above all, and at all times, he refused to get involved in the game of
forecasting where “the market” was headed, or where the Dow Jones
Industrial Average® would be on December 31st of the coming year.
Rather, he preached care in individual stock selection regardless of which
way the market “appeared” headed. Finally, his service recommended short
positions as regularly as it did long positions, based simply on what the
charts said.
Richard McDermott Editor and Reviser Technical Analysis of Stock
Trends, Seventh Edition January 1997
Taylor & Francis
Taylor & Francis Group
http://taylorandfrancis.com
Preface to the fifth edition
During the 16 printings of the fourth edition of Technical Analysis of Stock
Trends, very few changes have been made in the original text, mainly
because the lucid presentation of market action by the late Robert D.
Edwards covered so thoroughly the basic and typical market action of
common stocks. There has seemed no reason, for example, to discard a
chart picture illustrating some important technical phenomenon merely
because it occurred several or many years ago.
Instead, over the various printings of the book, pages have been added
showing similar examples, or in some cases entirely new types of market
action taken from recent history; but these demonstrate mainly that the
inherent nature of a competitive market does not change very much over the
years, and that “the same old patterns” of human behavior continue to
produce much the same types of market trends and fluctuations.
The principal change in this fifth edition, and it is a spectacular
improvement, is that practically all of the chart examples drawn to the
TEKNIPLAT™ scale have been redrawn and new plates of these have been
substituted. In the course of this work, several minor errors of scaling,
titling, etc., previously undiscovered, came to light and have been corrected.
The difficult work of revision was initiated in our charting room by two
ambitious teenagers, Anne E. Mahoney and Joseph J. Spezeski, who took
on the entire job of preparing the finished drawings and making necessary
corrections. This enormous project was undertaken and carried through by
these two young people spontaneously. In order to free them entirely from
other distractions, their regular charting work was taken over for a period of
months by the rest of the chartroom staff, so that a great deal of credit is due
to the fine efforts of the entire chartro


reparing the finished drawings and making necessary
corrections. This enormous project was undertaken and carried through by
these two young people spontaneously. In order to free them entirely from
other distractions, their regular charting work was taken over for a period of
months by the rest of the chartroom staff, so that a great deal of credit is due
to the fine efforts of the entire chartroom group.
John Magee December 3, 1966
xli
Taylor & Francis
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Preface to the fourth edition
In the several years since publication of the first edition of this work, “the
stock market goes right on repeating the same old movements in much the
same old routine.” Nearly all of the technical phenomena outlined in the
first edition have appeared many times since then, and we see no reason to
expect these habits of stocks will change materially in the years ahead,
barring revolutionary changes in the economy, such as the abolishment of
the free market entirely.
Since the basic nature of the market has not changed appreciably, it has
been unnecessary to make sweeping alterations in the text of “Part One:
Technical Theory.” The previous edition has been very carefully restudied,
and revisions have been made where they were called for to bring the
material up to date. In “Part Two: Trading Tactics,” more extensive changes
were needed, due to the more specific nature of the material and some
differences in the present margin requirements, trading rules, etc. Also,
there have been some improvements in the application of technical methods
at the tactical level, and these have been incorporated in this section.
Somewhat less emphasis has been put on the use of stop-loss orders, since
their need is not so great in the case of the experienced trader as it might be
with the novice. The principle of always following the Major Trend has
been modified to achieve better protection of capital through balance and
diversification. In line with avoiding “all-out” situations, with their
consequent dangers, the idea of using an Evaluative Index has been
introduced, and this concept has modified somewhat the tactics of following
the Major Trend. It also has a bearing on the Composite Leverage or
determination of total risk.
Type for the entire book has been reset in this edition. The illustrative charts
originally used have been, in the main, retained, since they demonstrate the
various points very well, but a new chapter includes a number of additional
charts taken from the market history of recent years, showing how the same
phenomena continue to appear again and again.
The appendix (Appendix C, 5th edition) on the Sensitivity Indexes has been
completely recomputed and extended to cover a broad list of the more
important issues. The arduous labor of determining these index figures was
undertaken by Frank J. Curto and Marcella P. Curto. Material help in
proofreading and revision for this edition was given by Beverly Magee and
Elinor T. Magee.
John Magee January 1, 1957
Taylor & Francis
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Preface to the second edition
It is, needless to say, gratifying to the authors of this treatise to report that
not only has a large first edition been exhausted (although it was originally
assumed it would suffice for many years), but also, the demand for copies
has been increasing at a rather astonishing pace during the past six months
without any “promotion” except word-of-mouth recommendation from one
investor to another.
In preparing this new edition, a careful perusal of everything that was
written in the previous printing, checked by the market events of the past 24
months and compared with all of the additional chart data accumulated
during that period, resulted in the not unexpected, but nevertheless mildly
surprising conclusion that nothing of real consequence needed to be
changed or amplified. Hence, only minor revisions of an editorial nature
have been made.
It would have been interesting to augment our already copious illustrations
with a number of charts from current months of market action, but costs of
engraving and printing have risen to such a distressingly high level that any
additions of that sort would, it was found, be prohibitively expensive. Aside
from their novelty, they would add nothing to the book; they would only be
substituted for other charts of precisely the same nature and significance,
and fully as pertinent to present-day conditions.
The stock market, as I wrote in the original Foreword, “goes right on
repeating the same old movements in much the same old routine. The
importance of a knowledge of these phenomena to the trader and investor
has been in no whit diminished.” We see the same forecasting patterns
developing on the charts today that we have seen over and over again for
the past 20 years. Neither the mechanics nor the “human element” of the
stock market has changed, and there is no reason to think they will.
Robert D. Edwards May 1, 1951
xlv
Taylor & Francis
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Foreword
This book has been written for the layman rather than for the Wall Street
professional. But, it assumes the reader is already possessed of at least an
elementary knowledge of the nature of stocks and bonds, and he has had
some dealings with a broker and some familiarity with the financial pages
of his newspapers. Hence, no attempt is made herein to define common
stock market terms and procedures. Every effort, however, has been exerted
to explain, in full, the theories and the terminology of our specific subject,
technical market analysis.
Part One is based, in large part, on the pioneer researches and writings of
the late Richard W. Schabacker. Students of his Technical Analysis and
Stock Market Profits (the latest revision of which is now out of print was
made in 1937 by the present writer and Albert L. Kimball) will find in the
pages of this section much that is familiar and, except


ur specific subject,
technical market analysis.
Part One is based, in large part, on the pioneer researches and writings of
the late Richard W. Schabacker. Students of his Technical Analysis and
Stock Market Profits (the latest revision of which is now out of print was
made in 1937 by the present writer and Albert L. Kimball) will find in the
pages of this section much that is familiar and, except for the illustrations,
only a little that is really novel. It has been a matter of surprise, in fact, to
the authors and other students of market technics that all the new controls
and regulations of the past several years, the new taxes which have placed a
heavy handicap on successful investors, the greatly augmented and
improved facilities for acquiring dependable information on securities, even
the quite radical changes in certain portions of our basic economy, have not
much altered the “pattern” of the stock market.
Certain of the evidences of pool manipulation that used to appear on the
charts are now seldom seen. A few of the price formations that formerly
were quite common, now appear rarely or may have lost much of their
practical utility for the trader; they have been omitted from this text. Others
have altered their habits slightly, or their consequences to a degree (but not
their fundamental nature), which has, of course, been noted herein. The
distressing thinness of the market at times—one of the undoubted effects of
regulation—has resulted in a few more “false moves,” more spells of
uninteresting (and unprofitable) inactivity. But, in the main, the market goes
right on repeating the same old movements in much the same old routine.
The importance of a knowledge of these phenomena to the trader and
investor has been in no whit diminished.
Part Two, which has to do with the practical application of these market
patterns and phenomena, with the tactics of trading, is all new. For more
than 15 years (his total market experience extends back nearly 30 years),
John Magee has invested and traded exclusively via the technical theory,
kept thousands of charts, made hundreds of actual trades, tested all sorts of
applications, audited and analyzed methods, tactics, and results from every
conceivable angle, depended on his profits for his living. His contribution is
that of one who has tried and knows.
It may well be added here—and will be often repeated in the following
pages—that the technical guides to trading in stocks are by no means
infallible. The more experience one gains in their use, the more alive one
becomes to their pitfalls and their failures. There is no such thing as a sure-
fire method of “beating the market”; the authors have no hesitancy in
saying that there never will be. Nevertheless, a knowledge and judicious
application of the
xlvii principles of technical analysis does pay dividends—is more profitable
(and far safer) for the average investor than any other of the presently
recognized and established approaches to the problems of buying and
selling securities.
Robert D. Edwards
July 1948
part one
Technical theory
Taylor & Francis
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chapter one
The technical approach to trading and investing
Few human activities have been so exhaustively studied during the past
century, from so many angles and by so many different sorts of people, as
the buying and selling of corporate securities. The rewards the stock market
holds out to those who read it right are enormous; the penalties it exacts
from careless, dozing, or “unlucky” investors are calamitous. No wonder it
has attracted some of the world's most astute accountants, analysts, and
researchers, along with a motley crew of eccentrics, mystics, “hunch
players,” and a multitude of just ordinary hopeful citizens.
Able brains have sought, and continue constantly to seek, for safe and sure
methods of appraising the state and trend of the market, as well as
discovering the right stock to buy and the right time to buy it. This intensive
research has not been fruitless—far from it. There are a great many
successful investors and speculators (using the word in its true sense, which
is without opprobrium) who, by one road or another, have acquired the
necessary insight into the forces with which they deal and the judgment, the
forethought, and the all-important self-discipline to deal with them
profitably.
In the course of years of stock market study, two quite distinct schools of
thought have arisen, providing two radically different methods of arriving at
the answers to the trader's problem of what and when. In the parlance of
“the Street,” one of these is commonly referred to as the fundamental or
statistical, and the other as the technical. (In recent years a third approach,
the cyclical, has made rapid progress, and although still beset by a “lunatic
fringe,” it promises to contribute a great deal to our understanding of
economic trends.)
The stock market fundamentalist depends on statistics. He examines the
auditors' reports, the profit-and-loss statements, the quarterly balance
sheets, the dividend records, and the policies of the companies whose shares
he has under observation. He analyzes sales data, managerial ability, plant
capacity, and the competition. He turns to bank and treasury reports,
production indexes, price statistics, and crop forecasts, to gauge the state of
business in general, and reads the daily news carefully to arrive at an
estimate of future business conditions. Taking all these into account, he
evaluates his stock; if it is selling currently below his appraisal, he regards
it as a buy. (EN9: And, no surprise, the buyer's name is Warren Buffet, and
he buys the company, not the stock, for although this is an excellent way to
buy companies, it is not a very good way to buy stocks.) EN: Read Robert
Prechter's summation of the fundamental methodology as an amusing
endnote at the end of this chapter.
As a matter of fact, aside from the greenest of newcomers when t


regards
it as a buy. (EN9: And, no surprise, the buyer's name is Warren Buffet, and
he buys the company, not the stock, for although this is an excellent way to
buy companies, it is not a very good way to buy stocks.) EN: Read Robert
Prechter's summation of the fundamental methodology as an amusing
endnote at the end of this chapter.
As a matter of fact, aside from the greenest of newcomers when they first
tackle the investment problem, and to whom, in their inexperience, any
other point of view is not only irrational but incomprehensible, your pure
fundamentalist is a rare bird. Even those market authorities who pretend to
scorn charts and “chartists” utterly are not oblivious to the “action”
chronicled by the ticker tape, and they do not conceal their respect for the
Dow Theory, which, whether they realize it or not, is, in its very essence,
purely technical.
Definition of technical analysis
The term “technical,” in its application to the stock market, has come to
have a special meaning, quite different from its ordinary dictionary
definition. It refers to the study of the action of the market itself as opposed
to the study of the goods in which the market deals. Technical Analysis is
the science of recording, usually in graphic form, the actual history of
trading (price changes, volume of transactions, etc.) in a certain stock or in
“the Averages” and then deducing from that pictured history the probable
future trend. EN: With the advent of the computer, many schools of
technical analysis have arisen. Number-driven technical analysis (e.g.,
moving average studies, oscillators, etc.) attempts to completely objectify
the analysis of the markets. The work of Edwards and Magee is the
embodiment and definition of “classical technical analysis.”
The technical student argues thus: it is futile to assign an intrinsic value to a
stock certificate. One share of U.S. Steel, for example, was worth $261 in
the early fall of 1929, but you could buy it for only $22 in June 1932. By
March 1937, it was selling for $126 and just one year later it was selling for
$38. In May 1946, it had climbed back up to $97, and 10 months later, in
1947, had dropped below $70, although the company's earnings on this last
date were reputed to be nearing an all-time high and interest rates in general
were still near an all-time low. The book value of this share of U.S. Steel,
according to the corporation's balance sheet, was about $204 in 1929 (end
of the year), $187 in 1932, $151 in 1937, $117 in 1938, and $142 in 1946.
This sort of wide divergence between presumed value and actual price is
not the exception—it is the rule. It is going on all the time. The fact is the
real value of a share of U.S. Steel common is determined at any given time
solely, definitely, and inexorably by supply and demand, which are
accurately reflected in the transactions consummated on the floor of the
New York Stock Exchange (see Figure 1.1).
Of course, the statistics fundamentalists study play a part in the supply-
demand equation—that is freely admitted. But many other factors are
affecting it as well. The market price reflects not only the differing value
opinions of many orthodox security appraisers, but also all the hopes and
fears and guesses and moods, rational and irrational, of hundreds of
potential buyers and sellers, as well as their needs and their resources—in
total, factors that defy analysis and for which no statistics are obtainable,
but that nevertheless are synthesized, weighed, and finally expressed in the
one precise figure at which a buyer and a seller get together and make a
deal (through their agents, their respective stock brokers). This is the only
figure that counts.
Moreover, the technician claims, with complete justification, that the bulk
of the statistics the fundamentalists study are past history, already out of
date and sterile because the market is not interested in the past or even in
the present. It is constantly looking ahead, attempting to discount future
developments, weighing and balancing all the estimates and guesses of
thousands of investors who look into the future from different points of
view and through glasses of many different hues. In brief, the going price,
as established by the market itself, comprehends all the fundamental
information the statistical analyst can hope to learn (plus some that is
perhaps secret from him or known only to a few insiders) and much else
besides of equal or even greater importance.
All of which, admitting its truth, would be of little significance were it not
for the fact, which no one of experience doubts, that prices move in trends
and trends tend to continue until something happens to change the supply-
demand balance. Such changes are usually detectable in the action of the
market. Certain patterns or formations, levels or areas, appear on the charts
that have a meaning and that can be interpreted in terms of probable future
Figure 1.1 Monthly price ranges of U.S. Steel common from January 1929
to December 1946. Compare the great swings in the market price for this
stock—from 1929 (extreme high, 261 3/4) to 1932 (extreme low, 21 1/4),
from 1932 to 1937, from 1937 to 1938, from 1942 to 1946—with its book
values for those years as cited on the previous page.
trend development. They are not infallible, it must be noted, but the odds
are definitely in their favor. Time after time, as experience has amply
proved, they are far more prescient than the best informed and most shrewd
of statisticians.
The technical analyst may go even further in his claims. He may offer to
interpret the chart of a stock whose name he does not know, so long as the
record of trading is accurate and covers a long enough term to enable him to
study its market background and habits. He may suggest he could trade with
profit in a stock knowing only its ticker symbol, completely ignorant of the
company, the industry, what it manufactures or sells, or how it is
capitalized. Needless to say, su


erpret the chart of a stock whose name he does not know, so long as the
record of trading is accurate and covers a long enough term to enable him to
study its market background and habits. He may suggest he could trade with
profit in a stock knowing only its ticker symbol, completely ignorant of the
company, the industry, what it manufactures or sells, or how it is
capitalized. Needless to say, such practice is not recommended, but if your
market technician is really experienced at his business, he could, in theory,
do exactly what he claims.
Should the reader, at this point, find the technical approach to trading or
investing, as explained in the foregoing, completely abhorrent, perhaps he
had better close the book now, for it is primarily the technical approach, the
science of technical analysis, with which the remainder of the book deals.
EN: The Elliott Wave Theory: perspective and comments from a Magee
investment letter of the 80s. This week, we had the pleasure of attending the
December meeting of the Market Technicians Association of New York
(MTANY).
Long-term subscribers will remember the MTANY as the organization that
honored John Magee with its Man of the Year award in 1978. The speaker
was Robert Prechter, publisher of “The Elliott Wave Theorist,” an
investment advisory that bases its forecasts on interpretations of R. N.
Elliott's work on the stock market.
Of primary interest to subscribers are Prechter's comments on technical
analysis itself. The Elliott Wave Theory, it must be remembered, is really no
more than a “catalog” of stock market price movements, laid one on top of
the other, so to speak, until a grand, underlying, and enduring pattern is
observed; in short, pure technical analysis. Among Prechter's definitions
and observations regarding fundamental analysis are the following:
1. First, let's define "technical" versus "fundamental" data ... technical
data is that which is generated by the action of the market under study.
2. The main problem with fundamental analysis is its indicators are
removed from the market itself. The analyst assumes causality between
external events and market movements, a concept which is almost
certainly false. But, just as important (and less recognized), is that
fundamental analysis almost always requires a forecast of the
fundamental data itself before conclusions about the market are drawn.
The analyst is then forced to take a second step in coming to a
conclusion about how those forecasted events will affect the markets!
Technicians only have one step to take, which gives them an edge right
off the bat. Their main advantage is they don't have to forecast their
indicators.
3. What's worse, even the fundamentalists' second step is probably a
process built on quicksand. ... The most common application of
fundamental analysis is estimating companies' earnings for both the
current year and next year and recommending stocks on that basis. .
And the record on that basis alone is very poor, as Barron's pointed out
in a June 4 article, which showed that earnings estimates averaged
18% error in the 30 Dow Jones Industrial Average (DJIA) stocks for
any year already completed and 54% error for the year ahead. The
weakest link, however, is the assumption that correct earnings
estimates are a basis for choosing stock market winners. According to
a table in the same Barron's article, a purchase of the 10 DJIA stocks
with the best earnings estimates would have produced a 10-year
cumulative gain of 40.5%, while choosing the 10 DJIA with the worst
earnings estimates would have produced a whopping 142.5% gain.
We enjoyed Prechter's polished exposition of a technical approach, which is
different from our own. As for his observations about fundamental analysis,
we simply couldn't agree more.
chapter two
Charts
Charts are the working tools of the technical analyst. They have been
developed in a multitude of forms and styles to represent graphically almost
anything that takes place in the market as well as to plot an “index” derived
therefrom. They may be monthly charts on which an entire month's trading
record is condensed into a single entry, or they may be weekly, daily,
hourly, transaction, “point-and-figure,” and candlestick charts. They may be
constructed on arithmetic, logarithmic, or square-root scale, or they may be
projected as “oscillators.” They may delineate moving averages, proportion
of trading volume to price movement, average price of most active issues,
odd-lot transactions, the short interest, and an infinitude of other relations,
ratios, and indexes—all technical in the sense that they are derived, directly
or indirectly, from what actually has been transacted on the exchanges.
Fortunately, we shall not need to concern ourselves with most of these
charts; they are of interest only to the full-time economic analyst. Many of
these charts have derived from a completely futile (so far, at least) endeavor
to discover a “mechanical” index or combination of indexes that will
always, automatically, without ever failing or going wrong, give warning of
a change in trend; in our experience, such charts are often confusing and
sometimes downright deceptive at a most critical juncture. This book,
however, is designed for the layman, the professional who cannot spend all
of his hours on his investing or trading operations, but to whom these
operations are, nevertheless, of sufficient importance or interest to warrant
his devoting at least a few minutes a day to their study and management.
(EN9: In retrospect, this is an underestimation of the importance of the
work. In the 21st century, the best professionals are acutely aware of the
importance of trend analysis and use this work as their textbook.) The
theories and methods outlined herein will require only the simplest form of
stock chart—a record of the price range (open, high/low and close) and
volume of shares traded each day. These daily graphs will be supplemented,
for certain purposes that wil


he
work. In the 21st century, the best professionals are acutely aware of the
importance of trend analysis and use this work as their textbook.) The
theories and methods outlined herein will require only the simplest form of
stock chart—a record of the price range (open, high/low and close) and
volume of shares traded each day. These daily graphs will be supplemented,
for certain purposes that will be discussed later in this text, by weekly or
monthly charts, which for most stocks can be easily generated by almost all
commercially available investment software and websites.
Nearly all the illustrations throughout the following chapters are examples
of such daily charts. They are easy to make and maintain manually,
requiring only a supply of graph or cross-section paper (almost any kind
can serve), a daily newspaper that gives full and accurate reports on stock
exchange dealings, a sharp pencil, and a few minutes of time. EN:
Alternatively, numerous data services are available for use with computer
software packages, not to mention internet sites (which are mentioned in
Appendix B, Resources). The use of this technology eliminates the burden of
manual chart keeping. If there is a drawback to this technology, it might be
in the loss of the “feel” the investor gets through manual charting.
It is customary in preparing ordinary daily stock charts to let the horizontal
axis represent time, with the vertical cross-lines (or as some prefer, the
spaces between them) from left to right, thus standing for successive days.
The vertical scale is used for prices, with each horizontal cross-line then
representing a specific price level. Space is usually provided at the bottom
of the sheet to plot volume, that is, the number of shares that change hands
each day. The newspapers publishing complete stock market reports give
the day's turnover or volume (exclusive of odd-lot transactions that for our
present purpose may be disregarded), the highest and lowest price at which
each stock sold during the day, the closing price (which is the price at which
the last sale effected during the day was made), and usually the opening or
first sale price. On our charts, the daily price range is plotted by drawing a
vertical line connecting the points representing the high and the low. Then a
short horizontal “tick” is added, either crossing the vertical range line or
extending out to the right from it, at the level of the closing price.
Sometimes all transactions in a stock during a day take place at one and the
same price; the high, low, and close are thus all on level and the only mark
on our chart will be the horizontal dash representing the closing figure.
Volume is depicted by drawing a vertical line up from the baseline of the
chart.
The opening price need not be recorded. (EN10: Candlestick charts require
this piece of data.) Experience has shown that it seldom, if ever, has any
significance in estimating future developments, which is all that ordinarily
should interest us. The closing price is important, however. It is, in fact, the
only price that many casual readers of the financial pages ever look at. It
represents the final evaluation of the stock made by the market during the
day. The closing price may be registered in the first hour of trading,
provided no other sales are subsequently affected, but, it nevertheless
becomes the figure upon which a majority of prospective traders base their
plans for the following day. Hence, its technical significance is evident and
will appear in various contexts in later chapters.
Different types of scales
Many specific suggestions as to the details of charting are deferred for
discussion in Section II of this book, but there is one chart feature that may
well be considered here. Until recent years, nearly all stock price charts
were kept on the common form of graph paper ruled to what is known as
plain or arithmetic scale. But more and more chartists have now come to
use what is known as semilogarithmic paper, or sometimes as ratio or
percentage paper. Our experience indicates that the semilogarithmic scale
has definite advantages in this work, and most of the charts reproduced in
this book employ this scale. The two types of scales may be distinguished at
a glance: on arithmetic paper, equal distances on the vertical scale (i.e.,
between horizontal lines) represent equal amounts in dollars, whereas on
the semilogarithmic paper, they represent equal percentage changes. Thus,
on arithmetic paper, the distance between 10 and 20 on the vertical scale is
exactly the same as that from 20 to 30 and from 30 to 40. On the
semilogarithmic scale the difference from 10 to 20, representing an increase
of 100%, is the same as that from 20 to 40 or from 40 to 80, in each case
representing another 100% increase.
Percentage relations, it goes without saying, are important in trading in
securities. The semilogarithmic scale permits direct comparison of high-
and low-priced stocks and makes it easier to choose the one offering the
greater (percentage) profit on the funds to be invested. It facilitates the
placing of stop-loss orders. Area patterns appear much the same on either
type of paper, but certain trendlines develop more advantageously on the
ratio scale. Almost anyone can quickly become accustomed to making
entries on semilogarithmic paper. (We recommend its use.) Its advantages,
however, are not so great as to require one to change—one who, because of
long familiarity and practice, prefers an arithmetic sheet. Such percentage
calculations, as may seem to be required, can be made on another sheet or
in the head, and the results then can be entered on the arithmetic chart, if a
record is desired.
Several firms specializing in the manufacture of graph paper and other
engineers' and architects' supplies now offer sheets specifically designed for
stock charting, on which heavier lines to define the business week mark
each sixth day on the time scale, and the price scale is subdivid


other sheet or
in the head, and the results then can be entered on the arithmetic chart, if a
record is desired.
Several firms specializing in the manufacture of graph paper and other
engineers' and architects' supplies now offer sheets specifically designed for
stock charting, on which heavier lines to define the business week mark
each sixth day on the time scale, and the price scale is subdivided into
eighths to represent the standard fractions of the dollar in which stocks are
traded on all U.S. exchanges. (EN9: Eighths went the way of the New
Haven and now decimals reign.) These sheets are available in various sizes
and with either arithmetic or logarithmic price and volume scales. EN: This
paper is only of interest to the manual chartist, as modern software, as
detailed in Appendix B, Resources, enables the computer chartist to easily
switch between price scales and methods of charting. References to such
paper are also found there.
On weekly charts, each vertical line represents a week's worth of trading.
The price range for the week is plotted thereon and usually the total
volume, but the closing price may be omitted. The range extends from the
highest price at which the stock sold on any day during the week to the
lowest price at which it sold on any day; these two extremes might, and
sometimes do, occur on the same day, but the weekly chart makes no
distinction as to day. Monthly charts are prepared in the same way but do
not, as a rule, record volume. These two charts—often referred to as long-
term or major charts—are used chiefly for determining important support
and resistance levels and for marking long-term trends. Weekly charts—if
the reader prefers to keep his own—can be posted easily from the Sunday
morning editions of those daily newspapers (e.g., the New York Times or
Barron's Business and Financial Weekly) that publish a summary of the
previous week's transactions.
In concluding this chapter on the construction of the charts that we shall
study in succeeding chapters, it can well be said that there is no special
virtue, certainly no magic, in the chart itself. It is simply a pictorial record
of the trading history of the stock or stocks in which we may be interested.
To the person possessed of a photographic memory, no chart work is
necessary; his mind records all the necessary data—he carries his charts in
his head. Many of the expert “tape-readers” who have no use for charts are
gifted with that rare memory talent that renders reference to graphic records
unnecessary. But most of us are not so blessed; to use the chart is necessary
and useful because it lends itself conveniently to the type of analysis that
indicates future probabilities.
There is a saying on Wall Street to the effect that “there is nothing wrong
with charts— the trouble is with the chartists,” which is simply another way
of expressing the truth that it is not the chart but its interpretation that is
important. Chart analysis is neither easy nor foolproof. Yet, it is not at all
uncommon for some casual investor who has no idea whatever of market
technics to pick up a chart by chance and see in it something he had not
hitherto suspected, something perhaps that saves him from making an
unfavorable commitment.
If you have never used stock charts, and have never paid much attention to
them, you may be surprised at some of the significant things you will detect
as soon as you begin to study them seriously.
EN9: Surprise and astonishment are the words used to describe the
reactions of even professionals when they are fully exposed to a coherent
presentation of the methods of Edwards and Magee. I have often
commented that no understanding of other (number driven statistical)
methods of technical analysis is possible without a firm grasp of the
concepts and principles of this book.
Some other comments are worth noting relevant to Edwards' discussion.
For manual charting, semilog remains the superior scale. Given the ease of
changing scale and time frames on internet sites (e.g., prophet.net,
thinkorswim.com, tdameritrade.com, and stockcharts.com) and in the
standalone software, one may switch from a close-up of a month to a long-
range perspective of years. In this process, it is important to maintain
perspective. Multiyear log charts of large ranges lose graphic importance
at the top as chart intervals shrink. This distortion must be countered by
breaking the time frame into smaller increments. Thus, instead of five years
of a chart that spans a range of 10-200, we look at five charts of one year
each as well as the five-year chart.
In the modern era, a new graphic representation has gained enormous
popularity—candlestick charting. In this method, color is added to the chart
by coloring the body of the candlestick—white for rising prices, black for
falling prices (or colors of your choice). Thus, the direction of the trend is
dramatized. Also, candlestick patterns are said to be of value in recognizing
trend reversals and other trend states.
A host of other charting methods exists: Three Line Break, Renko, Kagi...
These may be researched in Nison's book, Beyond Candlesticks. I will not
treat these in this book, but I do include them in an appendix on
examination of Point and Figure charting.
chapter three
The Dow Theory
The Dow Theory is the granddaddy of all technical market studies.
Although it is frequently criticized for being “too late” and occasionally
derided (particularly in the early stages of a Bear Market) by those who
rebel against its verdicts, it is known by name to nearly everyone who has
had any association with the stock market, and it is respected by most.
Many who heed it in greater or lesser degrees in determining their
investment policies never realize that it is purely and simply “technical.” It
is built upon and concerned with nothing but the action of the stock market
(as expressed in certain averages), deriving nothing from the business
statistics on which the fundamentalists dep


association with the stock market, and it is respected by most.
Many who heed it in greater or lesser degrees in determining their
investment policies never realize that it is purely and simply “technical.” It
is built upon and concerned with nothing but the action of the stock market
(as expressed in certain averages), deriving nothing from the business
statistics on which the fundamentalists depend.
There is much in the writings of its original promulgator, Charles H. Dow,
to suggest he did not think of his theory as a device for forecasting the stock
market, or even as a guide for investors, but rather as a barometer of general
business trends. Dow founded the Dow-Jones Financial News Service and
is credited with the invention of stock market averages. He outlined the
basic principles of the theory, which was later named after him, in editorials
he wrote for the Wall Street Journal. Upon his death in 1902, his successor,
William P. Hamilton, as editor of the Journal, took up Dow's principles and,
in the course of 27 years of writing on the stock market, organized and
formulated them into the Dow Theory as we know it today.
Before we proceed to an explanation of the theory, it will be necessary to
examine the stock averages that it employs. Long before the time of Dow,
the fact was familiar to bankers and businessmen that the securities of most
established companies tended to go up or down in price together.
Exceptions—stocks that moved against the general financial tide—were
rare, nor did they as a rule persevere in that contrary course for more than a
few days or weeks at a time. It is true that when a boom was on, the prices
of some issues rose faster and farther than others, and when the trend was
toward depression, some stocks declined rapidly whereas others would put
up considerable resistance to the forces that were dragging down the
market. The fact remained, however, that most securities tended to swing
together. (They still do and always will.)
This fact, as we have said, has long been commonly known and accepted
(so completely taken for granted that its importance is usually overlooked),
for it is important— tremendously important—from many angles in
addition to those that come within the province of this volume. One of the
best reasons for a student of market technics to start with the Dow Theory is
because that theory stresses the general market trend.
Charles Dow is believed to have been the first to make a thorough effort to
express the general trend (or, more correctly, level) of the securities market
in terms of the average price of a selected few representative stocks. As
finally set up in January of 1897, in the form that has continued to date and
used by Dow in his studies of market trends, there were two Dow-Jones
Averages. One was composed solely of the stocks of 20 railroad companies,
for the railroads were the dominant corporate enterprises of his day. The
other, called the Industrial Average, represented all other types of
businesses and was made up, at first, of only 12 issues. This number was
increased to 20 in 1916 and to 30 on October 1, 1928.
The Dow Averages
The stocks included in these two Averages have been changed from time to
time to keep the lists up to date and as nearly representative as possible of
their respective groups. Only General Electric, of the present 30 industrial
stocks, was included in the original Industrial Average, and that was
dropped at one time (in 1898) and subsequently reinserted. In 1929, all
stocks of public utility companies were dropped from the Industrial Average
and a new Utility Average of 20 issues was set up; in 1938, its number was
reduced to 15. The 20 rail, 30 industrial, and 15 utility stocks are now
averaged together to make what is known as the Dow-Jones Stock
Composite. The history of these Averages, the various adjustments that have
been made in them and their method of computation is an interesting story
in itself, which the reader may want to look up elsewhere. EN: See
Appendix B, Resources, for references. Note also there is now a
proliferation of Dow-Jones Averages. For our present purpose, it remains
only to add that the Dow Theory pays no attention to the Utility or
Composite Averages; its interpretations are based on the Rail and Industrial
Averages only. EN: The Rails are now known as Transportations.
In recent years, the values of the Dow-Jones Averages have been computed
for the end of each hour of trading as well as the end of the day. EN: Now
computed in real time and available over the internet, these hourly figures
are published in the Wall Street Journal as well as on all market tickers. In
fact, presently, the Averages are computed in real time, a necessity for
options and futures trading that takes place on them. The Wall Street
Journal also prints in each issue a summary of the important highs and lows
of each average by date for the preceding two or three years. Their daily
closing prices are reported in many other metropolitan daily newspapers.
Basic tenets
To get back to the Dow Theory, here are its basic tenets:
1. The Averages discount everything (except “acts of God”): Since
they reflect the combined market activities of thousands of investors,
including those possessed of the greatest foresight and the best
information on trends and events, the Averages in their day-to-day
fluctuations discount everything known, everything foreseeable, and
every condition that can affect the supply of or the demand for
corporate securities. Even unpredictable natural calamities, when they
happen, are quickly appraised and their possible effects discounted.
2. The Three Trends: The “market,” meaning the price of stocks in
general, swings in trends, of which the most important are its Major or
Primary Trends. These are the extensive up or down movements that
usually last for a year or more and result in general appreciation or
depreciation in value of more than 20%. Movements in the direction of
the Prima


praised and their possible effects discounted.
2. The Three Trends: The “market,” meaning the price of stocks in
general, swings in trends, of which the most important are its Major or
Primary Trends. These are the extensive up or down movements that
usually last for a year or more and result in general appreciation or
depreciation in value of more than 20%. Movements in the direction of
the Primary Trend are interrupted at intervals by Secondary Swings in
the opposite direction— reactions or corrections that occur when the
Primary Move has temporarily “gotten ahead of itself.” (Both
Secondary and the intervening segments of the Primary Trend are
frequently lumped together as Intermediate Movements—a term we
shall find useful in subsequent discussions.) Finally, the Secondary
Trends are composed of Minor Trends or day-to-day fluctuations that
are unimportant to Dow Theory.
3. The Primary Trends: These, as aforesaid, are the broad, overall, up
and down movements that usually (but not invariably) last for more
than a year and may run for several years. So long as each successive
rally (price advance) reaches a higher level than the one before it, and
each Secondary Reaction stops (i.e., the price trend reverses from
down to up) at a higher level than the previous reaction, the Primary
Trend is up. This is called a Bull Market. Conversely, when each
Intermediate Decline carries prices to successively lower levels and
each intervening rally fails to bring them back up to the top level of the
preceding rally, the Primary Trend is down. This is called a Bear
Market. (The terms Bull and Bear are frequently used loosely with
reference, respectively, to any sort of up or down movements, but we
shall use them in this book only in connection with the Major or
Primary Movements of the market in the Dow sense.) Ordinarily—
theoretically, at least—the Primary Trend is the only one of the three
trends with which the true long-term investor is concerned. His aim is
to buy stocks as early as possible in a Bull Market—just as soon as he
can be sure that one has started—and then hold them until (and only
until) it becomes evident it has ended and a Bear Market has started.
He knows he can safely disregard all the intervening Secondary
Reactions and Minor Fluctuations. The trader, however, may well
concern himself also with the Secondary Swings, and it will appear
later on in this book that he can do so with profit.
4. The Secondary Trends: These are the important reactions that
interrupt the progress of prices in the Primary Direction. They are the
Intermediate Declines or corrections that occur during Bull Markets
and the Intermediate Rallies or recoveries that occur in Bear Markets.
Normally, they last for three weeks to many months, rarely longer.
Normally, they retrace from one-third to two-thirds of the gain (or loss,
as the case may be) in prices registered in the preceding swing in the
Primary Direction. Thus, in a Bull Market, prices in terms of the
Industrial Average might rise steadily, or with only brief and minor
interruptions, for a total gain of 30 points before a Secondary
Correction occurred. That correction might then be expected to
produce a decline of not less than 10 points and not more than 20
points before a new Intermediate Advance in the Primary Bull Trend
develops.
Note, however, the one-third/two-thirds rule is not an unbreakable law; it is
simply a statement of probabilities. Most Secondaries are confined within
these limits; many of them stop very close to the halfway mark, retracing
50% of the preceding Primary Swing. They seldom run less than one-third,
but some of them cancel nearly all of it.
Thus, we have two criteria by which to recognize a Secondary Trend. Any
price movement contrary in direction to the Primary Trend that lasts for at
least three weeks and retraces at least one-third of the preceding net move
in the Primary Direction (from the end of the preceding Secondary to the
beginning of this one, disregarding Minor Fluctuations) is labelled as
Intermediate Rank, that is, a true Secondary. Despite these criteria,
however, the Secondary Trend is often confusing in its recognition, and its
correct appraisal at the time it develops, and while it is in process poses the
Dow theorist's most difficult problem. We shall have more to say about this
later.
5. The Minor Trends: These are the brief (rarely as long as three
weeks—usually less than six days) fluctuations that are, so far as the
Dow Theory is concerned, meaningless in themselves, but which, in
toto, make up the Intermediate Trends. Usually, but not always, an
Intermediate Swing, whether a Secondary or the segment of a Primary
between successive Secondaries, is made up of a series of three or
more distinguishable Minor Waves. Inferences drawn from these day-
to-day fluctuations are quite apt to be misleading. The Minor Trend is
the only one of the three trends that can be “manipulated” (although it
is, in fact, doubtful if under present conditions even that can be
purposely manipulated to any important extent). Primary and
Secondary Trends cannot be manipulated; it would strain the resources
of the U.S. Treasury to do so.
Right here, before we go on to state a sixth Dow tenet, we may well take
time out for a few minutes to clarify the concept of the three trends by
drawing an analogy between the movements of the stock market and the
movements of the sea. The Major (Primary) Trends in stock prices are like
the tides. We can compare a Bull Market to an incoming or flood tide that
carries the water farther and farther up the beach until finally it reaches
high-water mark and begins to turn; it then follows the receding or ebb tide,
comparable to a Bear Market. But all the time, during both ebb and flow of
the tide, the waves are rolling in, breaking on the beach, and then receding.
Although the tide is rising, each succeeding wave pushes a little farther up
onto the shore and, as it recedes, does not carry the water


beach until finally it reaches
high-water mark and begins to turn; it then follows the receding or ebb tide,
comparable to a Bear Market. But all the time, during both ebb and flow of
the tide, the waves are rolling in, breaking on the beach, and then receding.
Although the tide is rising, each succeeding wave pushes a little farther up
onto the shore and, as it recedes, does not carry the water quite so far back
as did its predecessor. During the tidal ebb, each advancing wave falls a
little short of the mark set by the one before it, and each receding wave
uncovers a little more of the beach. These waves are the Intermediate
Trends, Primary or Secondary, depending on whether their movement is
with or against the direction of the tide. Meanwhile, the surface of the water
is constantly agitated by wavelets, ripples, and “cat's-paws” moving with or
against or across the trend of the waves—these are analogous to the
market's Minor Trends, its unimportant day-to-day fluctuations. The tide,
the wave, and the ripple represent, respectively, the Primary or Major, the
Secondary or Intermediate, and the Minor Trends of the market.
Tide, wave, and ripple
A shore dweller who had no tide table might set about determining the
direction of the tide by driving a stake in the beach at the highest point
reached by an incoming wave. Then, if the next wave pushed the water up
beyond his stake, he would know the tide was rising. If he shifted his stake
with the peak mark of each wave, a time would come when one wave
would stop and start to recede short of his previous mark; then he would
know that the tide had turned and had started to ebb. That, in effect (and
much simplified), is what the Dow theorist does in defining the trend of the
stock market.
The comparison with tide, wave, and ripple has been used since the earliest
days of the Dow Theory. It is even possible that the movements of the sea
may have suggested the elements of the theory to Dow. But the analogy
cannot be pushed too far. The tides and waves of the stock market are not as
regular as those of the ocean. Tables can be prepared years in advance to
predict accurately the time of every ebb and flow of the waters, but no
timetables are provided by the Dow Theory for the stock market. We may
return to some points of this comparison later, but we must proceed now to
take up the remaining tenets and rules of the Theory.
Major trend phases
1. The Bull Market: Primary Uptrends are usually (but not invariably)
divisible into three phases. The first is the phase of accumulation during
which farsighted investors, sensing that business, although now depressed,
is due to turn up, are willing to pick up all the shares offered by discouraged
and distressed sellers and to raise their bids gradually as such selling
diminishes in volume. Financial reports are still bad— in fact, often at their
worst—during this phase. The public is completely disgusted with the stock
market—out of it entirely. Activity is only moderate but beginning to
increase on the rallies (Minor Advances).
The second phase is one of fairly steady advance and increasing activity as
the improved tone of business and a rising trend in corporate earnings begin
to attract attention. It is during this phase that the technical trader normally
is able to reap his best harvest of profits.
Finally comes the third phase when the market boils with activity as the
public flocks to the boardrooms. All the financial news is good, price
advances are spectacular and frequently make the front page of the daily
papers, and new issues are brought out in increasing numbers. It is during
this phase that one of your friends will call up and blithely remark, “Say, I
see the market is going up. What's a good buy?”—oblivious to the fact it
has been going up for perhaps two years, has already gone up a long way,
and is now reaching the stage at which it might be more appropriate to ask,
“What's a good thing to sell?” In the last stage of this phase, with
speculation rampant, volume continues to rise, but “air pockets” appear
with increasing frequency; the “cats and dogs” (low-priced stocks of no
investment value) are whirled up, but more and more of the top-grade issues
refuse to follow.
2. The Bear Market: Primary Downtrends are also usually (but again, not
invariably) characterized by three phases. The first is the distribution period
(which really starts in the later stages of the preceding Bull Market). During
this phase, farsighted investors sense the fact that business earnings have
reached an abnormal height and unload their holdings at an increasing pace.
Trading volume is still high, although tending to diminish on rallies, and the
public is still active but beginning to show signs of frustration, as hoped-for
profits fade away.
The second phase is the panic phase. Buyers begin to thin out and sellers
become more urgent; the downward trend of prices suddenly accelerates
into an almost vertical drop, whereas volume mounts to climactic
proportions. After the Panic Phase (which usually runs too far relative to
then-existing business conditions), there may be a fairly long Secondary
Recovery or a sideways movement, and then the third phase begins.
This is characterized by discouraged selling on the part of those investors
who held on through the Panic or, perhaps, bought during it because stocks
looked cheap in comparison with prices that had ruled a few months earlier.
The business news now begins to deteriorate. As the third phase proceeds,
the downward movement is less rapid, but it is maintained by more and
more distress selling from those who have to raise cash for other needs. The
“cats and dogs” may lose practically all their previous Bull Advance in the
first two phases. Better-grade stocks decline more gradually, as their owners
cling to them to the last. In consequence, the final stage of a Bear Market is
frequently concentrated in such issues. The Bear Market ends when
everything in the way of po