nces 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
9Chapter two: Charts
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,


s
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
10 Technical Analysis of Stock Trends
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.
11
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 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.
12 Technical Analysis of Stock Trends
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 a

eBooks\Technical Analysis of Stock Trends 11thed\original\Technical Analysis of Stock Trends.pdf


liferation 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 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
13Chapter three: The Dow The ory
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 bri


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.
14 Technical Analysis of Stock Trends
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 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
15Chapter three: The Dow The ory
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 Ma


d 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 possible bad news, the worst to be expected, has been discounted, and it
is usually over before all the bad news is “out.”
 The three Bear Market phases described in the preceding paragraph are not the
same as those named by others who have discussed this subject, but the writers of
this study feel they represent a more accurate and realistic division of the Primary
down moves of the past 30 years. The reader should be warned, however, that no two
Bear Markets are exactly alike, and neither are any two Bull Markets. Some may lack
one or another of the three typical phases. A few Major Advances have passed from
the first to the third stage with only a brief and rapid intervening mark-up. A few
short Bear Markets have developed no marked Panic Phase and others have ended
with it, as in April 1939. No time limits can be set for any phase; the third stage of a
Bull Market, for example, the phase of excited speculation and great public activity,
may last for more than a year or run out in a month or two. The Panic Phase of a Bear
Market is usually exhausted in a very few weeks if not in days, but the 1929 through
16 Technical Analysis of Stock Trends
1932 decline was interspersed with at least five Panic Waves of major proportions.
Nevertheless, the typical characteristics of Primary Trends are well worth keeping
in mind. If you know the symptoms that normally accompany the last stage of a Bull
Market, for example, you are less likely to be deluded by its exciting atmosphere.
Principle of confirmation
 1. The two Averages must confirm: This is the most-often questioned and the most
difficult to rationalize of all the Dow principles. Yet it has stood the test of time; the
fact it has worked is not disputed by any who have carefully examined the records.
Those who have disregarded it in practice have, more often than not, had occasion to
regret their apostasy. What it means is that no valid signal of a change in trend can
be produced by the action of one Average alone. Take, for example, the hypothetical
case shown in Diagram 3.1. In this, we assume that a Bear Market has been in effect
for several months and then, starting at a, the Industrial Average rises (along with the
Rails) in a Secondary Recovery to b . On their next decline, however, the Industrials
drop only to c, which is higher than a, and then turn up to d, which is higher than b.
b
RAIL AVERAGE
a
c
d
c
a
b
dINDUSTRIAL AVERAGE
Diagram 3.1 A hypothetical daily market chart to show how one average may fail to confirm the
other’s Dow signal. Closing prices, indicated by short horizontal dashes, are connected with vertical
lines to make the day-to-day trend easier to follow.
17Chapter three: The Dow The ory
At this point, the Industrials have “signaled” a change in trend from down to up. But
note the Rails during this period: their decline from b to c carried them lower than
a, and their subsequent advance from c to d has not taken them above b. They have
(so far) refused to confirm the Industrials and, hence, the Major Trend of the market
must be regarded as still down. Should the Rails go on to rise eventually above their b,
then, and then only, would we have a definite signal of a turn in the tide. Until such
a development, however, the chances remain that the Industrials will not be able to
continue their upward course alone, that they ultimately will be dragged down again
by the Rails. At best, the direction of the Primary Trend is still in doubt.
 This example illustrates only one of the many ways in which the principle of
confirmation applies. Note also that at c, it might have been said that the Industrials
had thus far not confirmed the Rails in continuing the Downtrend, but this had to do
only with the continuation or reaffirmation of an existing trend. It is not ne


ils. At best, the direction of the Primary Trend is still in doubt.
 This example illustrates only one of the many ways in which the principle of
confirmation applies. Note also that at c, it might have been said that the Industrials
had thus far not confirmed the Rails in continuing the Downtrend, but this had to do
only with the continuation or reaffirmation of an existing trend. It is not necessary
that the two Averages confirm on the same day. Frequently, both will move into new
high (or low) ground together, but there are plenty of cases in which one or the other
lags behind for days, weeks, or even a month or two. One must be patient in these
doubtful cases and wait until the market declares itself in definite fashion.
 2. “Volume goes with the trend”: Those words, which you may often hear spoken
with ritual solemnity but little understanding, are the colloquial expression for the
general truth that trading activity tends to expand as prices move in the direction
of the prevailing Primary Trend. Thus, in a Bull Market, volume increases when
prices rise and dwindles as prices decline; in Bear Markets, turnover increases when
prices drop and dries up as they recover. To a lesser degree, this holds for Secondary
Trends also, especially in the early stages of an extended Secondary Recovery within
a Bear Market, when activity may show a tendency to pick up on the Minor Rallies
and diminish on the Minor Setbacks. But to this rule, again, there are exceptions,
and useful conclusions can seldom be drawn from the volume manifestations of a
few days, much less from a single trading session; it is only the overall and relative
volume trend over a period of time that may produce helpful indications. Moreover,
in Dow Theory, conclusive signals as to the market’s trend are produced in the final
analysis only by price movement. Volume simply affords collateral evidence that may
aid interpretation of otherwise doubtful situations. (We shall have much more to say
in later chapters about volume in specific relation to other technical phenomena.)
 3. “Lines” may substitute for Secondaries: A line in Dow Theory parlance is a sideways
movement (as it appears on the charts) in one or both of the Averages, which lasts
for two or three weeks or, sometimes, for as many months, in the course of which
prices fluctuate within a range of approximately 5% or less (of their mean figure).
The formation of a Line signifies that pressure of buying and selling is more or less
in balance. Eventually, of course, either the offerings within that price range are
exhausted and those who want to buy stocks have to raise their bids to induce owners
to sell, or else those who are eager to sell at the Line price range find that buyers
have vanished and that, in consequence, they must cut their prices to dispose of their
shares. Hence, an advance in prices through the upper limits of an established Line
is a Bullish Signal and, conversely, a breakdown through its lower limits is a Bearish
Signal. Generally speaking, the longer the Line (in duration) and the narrower or more
compact its price range, the greater the significance of its ultimate breakout.
 Lines occur often enough to make their recognition essential to followers of Dow’s
principles. They may develop at important Tops or Bottoms, signaling periods of
distribution or of accumulation, respectively, but they come more frequently as
18 Technical Analysis of Stock Trends
interludes of rest or Consolidation in the progress of established Major Trends.
Under those circumstances, they take the place of normal Secondary Waves. A Line
may develop in one Average while the other is going through a typical Secondary
Reaction. A price movement out of a Line, either up or down, is usually followed
by a more extensive additional move in the same direction than can be counted on
to follow the “signal” produced when a new wave pushes beyond the limits set by
a preceding Primary Wave. The direction in which prices will break out of a Line
cannot be determined in advance of the actual movement. The 5% limit ordinarily
assigned to a Line is arbitrarily based on experience; there have been a few slightly
wider sideways movements that, by virtue of their compactness and well-defined
boundaries, could be construed as true Lines. (Later in this book, we shall see that the
Dow Line is, in many respects, similar to the more strictly defined patterns known as
rectangles that appear on the charts of individual stocks.)
 4. Only closing prices used: Dow Theory pays no attention to any extreme highs or
lows that may be registered during a day and before the market closes, but takes into
account only the closing figures, that is, the average of the day’s final sale prices for the
component issues. We have discussed the psychological importance of the end-of-day
prices under the subject of chart construction and need not deal with it further here,
except to say that this is another Dow rule that has stood the test of time. It works thus:
suppose an Intermediate Advance in a Primary Uptrend reaches its peak on a certain
day at 11:00 a.m., at which hour the Industrial Average figures at, say, 152.45, and then
falls back to close at 150.70. All that the next advance will have to do to indicate the
Primary Trend is still up is register a daily close above 150.70. The previous intraday
high of 152.45 does not count. Conversely, using the same figures for our first advance,
if the next upswing carries prices to an intraday high at, say, 152.60, but fails to register
a closing price above 150.70, the continuation of the Primary Bull Trend is still in
doubt.
 In recent years, differences of opinion have arisen among market students as to
the extent to which an Average should push beyond a previous limit (Top or Bottom
figure) to signal (or confirm or reaffirm, as the case may be) a market trend. Dow and
Hamilton evidently regarded any pene


ails to register
a closing price above 150.70, the continuation of the Primary Bull Trend is still in
doubt.
 In recent years, differences of opinion have arisen among market students as to
the extent to which an Average should push beyond a previous limit (Top or Bottom
figure) to signal (or confirm or reaffirm, as the case may be) a market trend. Dow and
Hamilton evidently regarded any penetration, even as little as 0.01, in closing price
as a valid signal, but some modern commentators have required penetration by a full
point (1.00). We think the original view has the best of the argument—that is, that
the record shows little or nothing in practical results to favor any of the proposed
modifications. One incident in June 1946, to which we shall refer in the following
chapter (EN10: Now in Appendix A), shows a decided advantage for the orthodox “any-
penetration-whatever” rule.
 5. A trend should be assumed to continue in effect until such time as its reversal
has been definitely signaled: This Dow Theory tenet is one that, perhaps more
than any other, has evoked criticism. Yet, when correctly understood, it, like all
the others we have enumerated, stands up under practical test. What it states is
really a probability . It is a warning against changing one’s market position too
soon, against “jumping the gun.” It does not imply that one should delay action
by one unnecessary minute once a signal of change in trend has appeared. But it
expresses the experience that the odds are in favor of the man who waits until he
is sure, and against the other fellow who buys (or sells) prematurely. These odds
cannot be stated in mathematical language such as 2–1 or 3–1; as a matter of fact,
they are constantly changing. Bull Markets do not climb forever and Bear Markets
always reach a Bottom sooner or later. When a new Primary Trend is first definitely
19Chapter three: The Dow Theo ry
signaled by the action of the two Averages, the odds that it will be continued,
despite any near-term reactions or interruptions, are at their greatest. But as this
Primary Trend carries on, the odds in favor of its further extension grow smaller.
Thus, each successive reaffirmation of a Bull Market (new Intermediate high in
one average confirmed by a new Intermediate high in the other) carries relatively
less weight. The incentive to buy, the prospect of selling new purchases at a profit,
is smaller after a Bull Market has been in existence for several months than it was
when the Primary Uptrend was first recognized; this 12th Dow tenet says, “Hold
your position pending contrary orders.”
 A corollary to this tenet, which is not so contradictory as it may at first seem, is this:
a reversal in trend can occur any time after that trend has been confirmed. This can
be taken simply as a warning that the Dow Theory investor must watch the market
constantly if he has any commitment in it.
EN: Modern market importance of Dow Theory and necessity for moving to a new composite
market theory
Dow Theory has much to recommend it. Concepts embodied within Dow Theory retain their
validity to the present day and retain their importance as the foundation thinking for technical
analysis. Concepts of waves, major, secondary, and minor movements are absolutely descriptive of
the reality of the market. Other constructs within Dow Theory are similarly important—that all
information is discounted; that major market movements are like the tide and, as it were, raise all
boats; that trends tend to continue. These are not just theoretical musings, but observations of reality.
In addition to its technical validity, the Dow has now taken on a mythic dimension. It has a
symbolic function that interacts with its originally intended purpose. Dow and Hamilton saw their
measurement of the market as an economic barometer for the entire economy; its use as a tool for
investing in the market came later.
In the opinion of this editor, the Dow Theory is no longer adequate to its original purpose—or
even to its secondary purpose. It is a simple theory propounded in a simple time. Expounders of
Dow Theory have implicitly recognized the necessity for evolutionary changes to the doctrine with
the addition of the Rails (now Transportations) and the Utilities ad infinitum. Thirty stocks may
have been sufficient originally to reflect the U.S. economy. No one would deny that simple paradigm
must be changed to reflect an economic structure geometrically more diverse than that of Dow and
Hamilton. Entering the twenty-first century, the U.S. and global economy require more sophisticated
econometrics than the Dow alone.
For that reason, I consider that to fulfill the functions of the old Dow, we now must consider
a variety of averages and indexes to measure the state of the market—not to mention the economy,
which is another question, although not altogether another question, but at least another question.
Magee foreshadowed some instruments of great value to this end in his writings, specifically on the
Magee Evaluative Index (Chapter 38), which may be used for the entire market, and not just for one
summary index or average. The value and power of this tool are still little used and understood.
In twenty-first-century markets, there are not just broad tides and markets flowing in one direction
as they might on Magee’s Cape Cod. Instead, the currents, riptide, and crosscurrents are like the
economy of the country, moved West. They are now symbolized by the Pacific Ocean roaring in and out
of San Francisco Bay. Although the Dow is in a secondary Downtrend, the broader Standard & Poor’s
500 is going to new highs, and although they are both whipping sideways, the National Association of
Securities Dealers Automated Quotations (NASDAQ) is rocketing into space. For this reason, I now
believe that only a composite of the three indexes can express the true state of the markets as a whole.
And, in addition, to dis


h the Dow is in a secondary Downtrend, the broader Standard & Poor’s
500 is going to new highs, and although they are both whipping sideways, the National Association of
Securities Dealers Automated Quotations (NASDAQ) is rocketing into space. For this reason, I now
believe that only a composite of the three indexes can express the true state of the markets as a whole.
And, in addition, to dissect the entrails of the market, the Magee Evaluative Index should be run across
the three indexes.
20 Technical Analysis of Stock Trends
The Dow Theory required the Rails and Industrial Averages move in harmony to signal Bull or
Bear Markets. In this century, there is a similar need for harmonic convergence among the averages
to indicate to us the state of the markets as a whole.
When all three indexes agree in the direction of their trends, up or down or sideways, Bulls may
be assumed to be safe in general, and vice versa for Bears. Failure of the three to be in harmony is
a clear sign of mixed markets and advises one to arrange his bets and portfolio to correspond with
economic uncertainty. Capital should flow naturally to the most productive area. What reason is
there to ride the Dow down when the NASDAQ is raging up? If the investor follows the philosophy
of this book, he will never sit passively through an extended Downtrend. At the very least, he will be
hedged, if not outright short. (As Edwards and Magee preferred and as this editor prefers.)
EN10: Notes on Edwards’ description of Dow Theory
We must keep in perspective Edwards’ description of Dow Theory. When he speaks of Secondaries
of 10 and 20 points, or a Primary of 30 points, we should be reminded that the entire market could be
accommodated in the backseat of a Packard. The top in 1929 was approximately 386 and the bottom
approximately 64; hence, 10, 20, or 30 points constituted important percentage moves.
Similarly, a primary market move of 20%, although still of importance, hardly describes the
violence and range of modern markets. From March 2009 to November 2017, the Dow moved from
6469.95 to 23,602.12—a move of 17,132.17 or 264%.
21
chapter four
The Dow Theory’s defects
EN10: Figures 2–9 from the ninth edition now appear in Appendix A along with Edwards’ detailed
account of Dow Theory operations.
Our readers, we suspect, heaved a deep sigh of relief when they closed the preceding
chapter (EN10: Chapter 4 in the ninth edition, now Appendix A ), which covered a difficult,
tedious, and, at times, confusing subject. Some may even wish at this point that the Dow
Theory had never been conceived. Others doubtless spotted one or more of its real or
supposed defects and have questions to ask. Before we proceed to more interesting chart
matters, we had better devote a few pages to clearing up these questions.
First, let’s take up the charge of “second-guessing,” which is so often flung at writers
on Dow Theory. It is a charge that will continue to crop up so long as opinions differ
among Dow theorists at critical periods (which, unfortunately, is often the case). Even the
most experienced and careful Dow analysts find it necessary occasionally to change their
interpretations when a stand first ventured is rendered untenable by some subsequent
action of the market. They would not attempt to deny it, but, they say, in the long run,
surprisingly little is lost by such temporary misinterpretations. Many of them publish
their comments regularly and can refer you to the printed files of opinions and advice
expressed before and during the event, as well as after it. Regarding Chapter 4 in the ninth
edition (now Appendix A), the reader, if he cares to check such records, will find that the
interpretations given therein (aside from the remarks made “in retrospect” and so labeled)
were precisely the interpretations published at the time by the best-established Dow
analysts. EN9: Although, in the modern age Richard Russell (now deceased) (dowtheoryletters.
com) was senior in terms of reputation, a host of other Dow theorists (actually trying to round
them up is like herding cats) inhabit the scene, among them Jack Schannep (thedowtheory.com) and
Richard Moroney (dowtheory.com) who must be taken into account when consulting the sacred-
chicken bones. Robert W. Colby (robertwcolby.com) is also currently doing authoritative work in
Dow Theory. Note that it is the chicken that is sacred, and the bones only secondarily.
The Dow Theory is too late
The objection that the Dow Theory is too late is more valid. It is sometimes expressed in the
rather intemperate statement that “the Dow Theory is a surefire system for depriving the
investor of the first third and the last third of every Major Move, and sometimes there isn’t
any middle third!” Or, to give a specific example: A Primary Bull Market started in 1942
with the Industrial Average at 92.92 and ended in 1946 at 212.50, for a total gain of 119.58
Average points, but the strict Dow theorists could not buy until the Industrials were up to
125.88 and could not sell until prices had already declined to 191.04; thus, capturing, at best,
only about 65 points, or not much more than half of the total move. This specific statement
cannot be disputed, yet the answer to the general objection is to “try to find a man who
first bought his stocks at 92.92 (or even within 5 points of that level) and stayed 100% long
throughout the intervening years, and finally sold out at 212.50, or within 5 points thereof.”
22 Technical Analysis of Stock Trends
The reader is welcome to try; he will, in fact, find it very difficult to locate even a dozen who
did as well as the Dow Theory.
A still better answer, because it comprehends all of the hazards of every known kind
of Bull and Bear Market to date, is the overall dollars and cents record of the past 60 years.
We are indebted to Richard Durant for permission to reprint the following computation of
what would, in theory, have re


will, in fact, find it very difficult to locate even a dozen who
did as well as the Dow Theory.
A still better answer, because it comprehends all of the hazards of every known kind
of Bull and Bear Market to date, is the overall dollars and cents record of the past 60 years.
We are indebted to Richard Durant for permission to reprint the following computation of
what would, in theory, have resulted if a fund of only $100 could have been invested in the
stocks of the Dow–Jones Industrial Average on July 12, 1897 , when a Primary Bull Market
was signaled by the Dow Theory, and those stocks were thereafter sold and repurchased
when, and only when, the Dow Theory had definitely confirmed a change in the Major
Trend (see Table 4.1).
Table 4.1 The Dow Theory’s 60-Year Record
Signal Date
Dow Jones
Average
Price
Loss
(√)
Change
(%)
Capital
Gain
Accumulated
Profit
Bought 7/12/1897 44.61 100
Sold 12/16/1899 63.84 43.11 143.11
Bought 10/20/1900 59.44
Sold 6/1/1903 59.59 0.25 0.36 143.47
Bought 7/12/1904 51.37
Sold 4/26/1906 92.44 79.95 114.7 258.18
Bought 4/24/1908 70.01
Sold 5/3/1910 84.72 21.01 54.25 312.42
Bought 10/10/1910 81.91
Sold 1/14/1913 84.96 3.72 11.63 324.05
Bought 4/9/1915 65.02
Sold 8/28/1917 86.12 32.45 105.16 429.22
Bought 5/13/1918 82.16
Sold 2/3/1920 99.96 21.67 92.99 522.21
Bought 2/6/1922 83.7
Sold 6/20/1923 90.81 8.49 44.36 566.56
Bought 12/7/1923 93.8
Sold 10/23/1929 305.85 226.07 1,280.81 1,847.38
Bought 5/24/1933 84.29
Sold 9/7/1937 164.39 95.03 1,755.54 3,602.92
Bought 6/23/1938 127.41
Sold 3/31/1939 136.42 7.07 254.79 3,857.7
Bought 7/17/1939 142.58
Sold 5/13/1940 137.5 √ −3.56 −137.45 3,720.26
Bought 2/1/1943 125.88
Sold 8/27/1946 191.04 51.76 1,925.74 5,646
Bought 10/2/1950 228.94
Sold 4/2/1953 280.03 22.32 1,259.95 6,905.95
Bought 1/19/1954 288.27
Sold 10/1/1956 468.7 62.59 4,322.48 11,228.43
23Chapter four: The Dow The ory’s defects
In brief, an investment of $100 in 1897 would have become $11,228.43 in 1956 simply by
buying the Industrial Average stocks each time the Dow Theory announced a Bull Market
and holding them until the Dow Theory announced a Bear Market. During this period,
the investor would have made 15 purchases and 15 sales, or about one transaction every
two years on average.
The record is not perfect. It shows one losing transaction and three instances in which
reinvestment would have been made at a higher level than the preceding liquidation. But,
at that, it hardly needs defending. Also, it takes no account of commissions and transfer
taxes, but neither does it include the dividends the investor would have received during
the time he held his stocks; the latter would have added many more dollars to the fund.
For the enlightenment of the man who believes in “just buying good stocks and putting
them away,” compare these results with the best that could have been done by buying
shares only once at the lowest price recorded by the Industrial Average during these entire
60 years and selling them only once at the highest: $100 invested at the all-time low, 29.64, on
August 10, 1896, would have become only $1,757 .93 at the then all-time high, 521.05, 60 years
later on April 6, 1956. Compare this to the $11,228.43 gained from the Dow Theory program.
EN: This record of the Dow Theory is updated to end of year 2017 in Table 4.2. I have left this
record as is so that the reader may clearly distinguish my work from that of Edwards.
The Dow Theory is not infallible
The Dow Theory is not infallible. It depends on interpretation and is subject to all the
hazards of human interpretive ability. But, again, the record speaks for itself.
The Dow Theory frequently leaves the investor in doubt
The fact that the Dow Theory frequently leaves the investor in doubt is true in one sense, yet
not in another. There is never a time when the Dow Theory does not afford a presumptive
answer to the question of the direction of the Primary Trend. That answer will be wrong
for a relatively short time at the beginning of each new Major Swing. There will also be
times when a good Dow analyst should say, “The Primary Trend is still presumably up,
but it has reached a dangerous stage, and I cannot conscientiously advise you to buy now.
It may be too late.”
Frequently, however, the above objection simply reflects the inability of the critic
mentally to accept the fundamental concept that the Averages discount all the news and
statistics. He doubts the Dow Theory because he cannot reconcile its message with his own
ideas, derived from other sources, of what stocks should do. The theory is usually more
nearly right.
This criticism in other cases reflects nothing but impatience. There may be weeks or
months (as, e.g., during the formation of a Line) when the Dow Theory cannot “talk.”
The active trader quite naturally rebels, but patience is a virtue in the stock market as
elsewhere—in fact, essential if serious mistakes are to be avoided.
The Dow Theory does not help the Intermediate Trend investor
It is perfectly true that the Dow Theory does not help the Intermediate Trend investor, as
it gives little or no warning of changes in Intermediate Trend. Yet, if a fair share of these
can be captured, the profit amounts to more than can be derived from the Primary Trend
alone. Some traders have worked out supplementary rules on the basis of Dow principles
24 Technical Analysis of Stock Trends
Table 4.2 The Dow Theory’s 121-Year Record
Signal Date
Average
Price
Loss
(√)
Percentage
Change (%)
Capital
Gain
Accumulated
Wealth
1 Buy 7/12/1897 44.61 100.00
2 Sell 12/16/1899 63.84 43.11 143.11
3 Buy 10/20/1900 59.44
4 Sell 6/1/1903 59.59 0.25 0.36 143.47
5 Buy 7/12/1904 51.37
6 Sell 4/26/1906 92.44 79.950 114.70 258.18
7 Buy 4/24/1908 70.01
8 Sell 5/3/1910 84.72 21.01 54.25 312.42
9 Buy 10/10/1910 81.91
10 Sell 1/14/1913 84.96 3.72 11.63 324.05
11 Buy 4/9/1915 65.02
12 Sell 8/28/1917 86.12 32.45 105.16 429.22
13 Buy 5/13/1918 82.16
14 Sell 2/3/1920 99.


Sell 12/16/1899 63.84 43.11 143.11
3 Buy 10/20/1900 59.44
4 Sell 6/1/1903 59.59 0.25 0.36 143.47
5 Buy 7/12/1904 51.37
6 Sell 4/26/1906 92.44 79.950 114.70 258.18
7 Buy 4/24/1908 70.01
8 Sell 5/3/1910 84.72 21.01 54.25 312.42
9 Buy 10/10/1910 81.91
10 Sell 1/14/1913 84.96 3.72 11.63 324.05
11 Buy 4/9/1915 65.02
12 Sell 8/28/1917 86.12 32.45 105.16 429.22
13 Buy 5/13/1918 82.16
14 Sell 2/3/1920 99.96 21.67 92.99 522.21
15 Buy 2/6/1922 83.7
16 Sell 6/20/1923 90.81 8.49 44.36 566.56
17 Buy 12/7/1923 93.8
18 Sell 10/23/1929 305.85 226.07 1280.81 1,847.38
19 Buy 5/24/1933 84.29
20 Sell 9/7/1937 164.39 95.03 1755.54 3,602.92
21 Buy 6/23/1938 127.41
22 Sell 3/31/1939 136.42 7.07 254.79 3,857.70
23 Buy 7/17/1939 142.58
24 Sell 5/13/1940 137.5 × −3.56 −137.45 3,720.26
25 Buy 2/1/1943 125.88
26 Sell 8/27/1946 191.04 51.76 1925.74 5,646.00
27 Buy 10/2/1950 228.94
28 Sell 4/2/1953 280.03 22.32 1259.95 6,905.95
29 Buy 1/19/1954 288.27
30 Sell 10/1/1956 468.7 62.59 4322.48 11,228.43
31 Buy 5/2/1958 459.56
32 Sell 3/3/1960 612.05 33.18 3725.79 14,954.22
33 Buy 2/23/1961 654.42
34 Sell 4/26/1962 678.68 3.71 554.37 15,508.59
35 Buy 11/9/1962 616.13
36 Sell 5/5/1966 899.77 46.04 7139.49 22,648.08
37 Buy 1/11/1967 822.49
38 Sell 10/24/1967 888.18 7.99 1808.84 24,456.92
39 Buy 10/1/1968 942.32
40 Sell 2/25/1969 899.8 × −4.51 −1103.56 23,353.36
41 Buy 10/27/1969 860.28
42 Sell 1/26/1970 768.88 × −10.62 −2481.17 20,872.19
(Continued)
25Chapter four: The Dow The ory’s defects
Table 4.2 (Continued) The Dow Theory’s 121-Year Record
Signal Date
Average
Price
Loss
(×)
Percentage
Change (%)
Capital
Gain
Accumulated
Wealth
43 Buy 9/28/1970 758.97
44 Sell 7/28/1971 872.01 14.89 3108.68 23,980.87
45 Buy 2/10/1972 921.28
46 Sell 2/23/1973 959.89 4.19 1005.02 24,985.88
47 Buy 1/27/1975 692.66
48 Sell 10/24/1977 802.32 15.83 3955.70 28,941.58
49 Buy 6/6/1978 866.51
50 Sell 7/2/1981 959.19 10.70 3095.53 32,037.11
51 Buy 10/7/1982 965.97
52 Sell 1/25/1984 1231.89 27.53 8819.43 40,856.54
53 Buy 11/6/1984 1244.15
54 Sell 10/15/1987 2355.09 89.29 36482.07 77,338.61
55 Buy 2/29/1988 2071.62
56 Sell 10/13/1989 2569.26 24.02 18578.11 95,916.72
57 Buy 6/4/1990 2935.19
58 Sell 8/3/1990 2809.65 × −4.28 −4102.42 91,814.30
59 Buy 1/18/1991 2646.78
60 Sell 10/5/1992 3179 20.11 18462.21 110,276.51
61 Buy 11/25/1992 3266.22
62 Sell 8/4/1998 8487.31 159.85 176278.26 286,554.76
63 Buy 11/2/1998 8706.5
64 Sell 9/23/1999 10318.59 18.52 53058.30 339,613.06
65 Buy 11/8/2001 9587.52
66 Sell 6/25/2002 9126.8 × −4.81 −16319.81 323,293.25
67 Buy 1/6/2003 8773.57
68 Sell 11/21/2007 12799.04 45.88 148332.69 471,625.94
69 Buy 4/18/2008 12849.36
70 Sell 9/29/2008 10365.45 × −19.33 −91170.02 380,455.93
71 Buy 4/9/2009 8083.38
72 Sell 6/30/2010 9774.02 20.92 79572.41 460,028.33
73 Buy 9/27/2010 10812.04
74 Sell 8/2/2011 11866.62 9.75 44870.04 504,898.37
75 Buy 12/23/2011 12294
76 Sell 6/4/2012 12101.46 −1.57 −7907.36 496,991.01
77 Buy 1/18/2013 13649.7
78 Sell 8/20/2015 16990.69 24.48 121646.78 618,637.78
79 Buy 10/19/2015 17084.49
80 Sell 1/6/2016 16906.51 −1.04 −6444.74 612,193.04
81 Buy 4/20/2016 18053.6 ×
82 Sell 6/24/2016 17400.75 −3.62 −15926.29 596,266.75
83 Buy 9/7/2016 18526.14
84 Sell 12/29/2017 24719.22 33.43 199325.26 795,592.01
26 Technical Analysis of Stock Trends
that they apply to Intermediate Movements, but these have not proved to be satisfactory.
The remainder of our book is devoted to a better approach to this problem.
The Dow Theory is a mechanical device designed to tell the direction of the Primary
Market Trend, which is important because, as said at the beginning of this book, most
stocks tend to go with the trend. The Dow Theory does not and cannot tell you which
individual stocks to buy, aside from those stocks that make up the Averages. That, again,
is a problem for the remainder of this book.
EN: An old criticism, irrelevant in modern markets.
“The Dow Theory does not tell you which stocks to buy.” This was true at the time Edwards
wrote this, but in modern markets, the investor can buy substitute instruments that almost perfectly
mimic its behavior (DIA). This is possible because the investor can trade in surrogates for the Dow
Averages in present markets (see Chapter 15).
The Dow Theory in the 20th and 21st centuries
As may be seen in Table 4.2, augmenting Table 4.1, the Dow Theory continued to provide its
user an advantage over the unaware Buy-and-Hold Investor. From its original investment
of $100 in 1897 , the Dow Theory investment would have grown to $795,592.01 by December
29, 2017 , with the long trade still open. Table 4.2 shows the details, including the post-2000
bust drawdown. To my mind, this table is a powerful demonstration of the effectiveness
of methodical technical investing, be it Dow Theory or some other robust method—which
I will discuss in Chapter 5.
By contrast, the buy-and-hold investment of $100, if bought at the low, 29.64, and sold
at the close, December 29, 2017 , would have grown to $55,411.83.
I am indebted to Jack Schannep of TheDowTheory.Com ( http:/ /www.thedowtheory.
com) for the data recapitulated here. On Schannep’s website, a clear exposition of the Dow
Theory and its record may be found—much more complete than that which is found here,
outside of Edwards’ magisterial presentation.
Minor discrepancies are acknowledged within these and others’ data, a point that will
be raised by purists. This is occasioned by disagreements within the priestly circles of those
who keep the sacred records. That is, not all theorists are in 100% agreement as to the exact
date or nature of the signals. (Some will say the reentry date of October 1, 1956 should have
been October 7 , 1957 , for example.) Meaning some judgment is involved in interpretation of
the entrails. The Dow Theory is not a 100% objective algorithm, just as chart analysis is not
reducible to an objective algorithm. (I am allowed to jest at the priesthood as I am a minor
acolyte in these matters. It would not be


e signals. (Some will say the reentry date of October 1, 1956 should have
been October 7 , 1957 , for example.) Meaning some judgment is involved in interpretation of
the entrails. The Dow Theory is not a 100% objective algorithm, just as chart analysis is not
reducible to an objective algorithm. (I am allowed to jest at the priesthood as I am a minor
acolyte in these matters. It would not be seemly for the uninitiated to burlesque.)
In brief, an investment of $100 in 1897 would have become $795,592.01 simply by buying
the Industrial Average stocks each time the Dow Theory announced a Bull Market and
holding them until the Dow Theory announced a Bear Market, and then selling, with the
entire equity reinvested on each trade.
The Technical Investor would have had this amount in pocket marked to market at the
end of 2017 , as opposed to the $55,411.83 of his dozing counterpart, or the Trust Department
of the Rip Van Winkle Bank of Sleepy Hollow. And, in addition, he would not have been
illiquidified during Bear Markets.
Whether the Dow Theory retains its validity over the market as a whole, there can be
no question that it still calls the turn for its sector of the market, which as Jack Schannep
correctly notes, has five times the capitalization of the NASDAQ (see Table 4.2).
As Mark Twain observed, everybody talks about the Dow Theory, but nobody does
anything about it. Perhaps that is not precisely what Twain said, but close enough for
27Chapter four: The Dow The ory’s defects
government work. As further inquiry into the inner workings of the Dow Theory, I initiated
a series of studies of the record with Brian Brooker, who holds a master’s of science in
finance from Golden Gate University, and Matt Mullens, and Nehemiah Brown III my
graduate students at Golden Gate University. Included here are some of the results of our
study, from the book, Sacred Chickens, the Holy Grail and Dow Theory (Amazon).
It seems obvious that the risk characteristics of Dow Theory investing are unique, and I
will belabor the obvious. The Buy-and-Hold Investor mentioned above for comparison with
the Dow Theory Investor not only realized less profit over the period of his investment but
also experienced greatly expanded risk over the life of the investment. At first blush, all the
profits garnered by the reversing investor in Table 4.3 represent risk actually experienced
by the Buy-and-Hold Investor—but that is only first blush. A little deeper thought reveals
the true extent of the Buy-and-Hold Investor’s risk is measured by maximum drawdowns
over any given period of time. It is not necessary to theorize about this question; the
measurement is empirical.
When viewed in perspective, these risks are startling. From the top in 2000 to the low
in 2002, a 39% drawdown occurred. Is this disquieting? A 41% drawdown occurred during
the Reagan crash of 1987 . A mere bagatelle. The Hoover drawdown from 1929 to 1932 was
89%. Such things are unlikely to happen again. The big guys would step in and support
the market.
Clearly, the way to reduce market risk to zero is to be out of the market. Less obviously,
or perhaps blatantly, the second most important way to reduce risk is to be right about the
trend—or to not be wrong. Moreover, because of the nature of the Dow Theory, much time
is spent on the sidelines by the Dow investor. This is a natural reduction of risk. In fact, of
the total days from 1897 to 2018, 44,193, the Dow Investor spent 15,492 (or about 35% of the
time) days at the beach or at the S&L. But his accumulated profits have not been credited
with interest, as this is a “pure” study.
As will be readily apparent, Table 4.3 is much richer in data than just the duration of
investments in the long side of the market. Acting on the maxim (my own) that it is unwise
to invest on only one side of the market, I have computed the accumulated profits gained
by trading the Dow long and short. After all, the market goes down as well as up, and for
a reversing system a liquidation of longs is a signal to go short. If the record on the long
side is impressive, showing accumulated profits to 2018 of $795,592.01, how much more
impressive is the accumulated profit of $5,757 ,390.17 garnered from trading both sides of
the Dow, long and short?
The reader who listens carefully will hear the metamessage. For the great majority of
investors, it is the long run that is important. In the right-now culture of the internet and
computer age and the get-rich-quick mentality, one wonders whether there are still such
investors, outside of the very rich and very intelligent. Perhaps there are still a few aging
readers of early editions of this book, and, not to despair, perhaps some new converts.
A note of caution is in order here: beware of spreadsheets run amuck. As the spreadsheet
serenely grinds through a trade it doesn’t care how it may be creating a fantasy universe.
Likewise, the more transactions the greater the eventual figure as the compounding effect
of reinvesting the total bankroll on every roll of the dice. This being said, putting the matter
into mathematical perspective and discounting inflated totals still makes the performance
impressive—much more so considering most professional fund managers can’t beat the
market.
28 Technical Analysis of Stock Trends
Table 4.3 Performance of Dow Theory through 2017: Longs and Shorts
Trade# Signal Date Price PL%
Accumulated
Profit Bull Bear
1 Long 7/12/1897 44.61 100.00
2 Short 12/16/1899 63.84 43.11 143.11 887
3 Long 10/20/1900 59.44 6.89 152.97 308
4 Short 6/1/1903 59.59 0.25 153.36 954
5 Long 7/12/1904 51.37 13.79 174.51 407
6 Short 4/26/1906 92.44 79.95 314.04 653
7 Long 4/24/1908 70.01 24.26 390.24 729
8 Short 5/3/1910 84.72 21.01 472.23 739
9 Long 10/10/1910 81.91 3.32 487.89 160
10 Short 1/14/1913 84.96 3.72 506.06 827
11 Long 4/9/1915 65.02 23.47 624.83 815
12 Short 8/28/1917 86.12 32.45 827.60 872
13 Long 5/13/1918 82.16 4.60 8


97 308
4 Short 6/1/1903 59.59 0.25 153.36 954
5 Long 7/12/1904 51.37 13.79 174.51 407
6 Short 4/26/1906 92.44 79.95 314.04 653
7 Long 4/24/1908 70.01 24.26 390.24 729
8 Short 5/3/1910 84.72 21.01 472.23 739
9 Long 10/10/1910 81.91 3.32 487.89 160
10 Short 1/14/1913 84.96 3.72 506.06 827
11 Long 4/9/1915 65.02 23.47 624.83 815
12 Short 8/28/1917 86.12 32.45 827.60 872
13 Long 5/13/1918 82.16 4.60 865.66 258
14 Short 2/3/1920 99.96 21.67 1,053.20 631
15 Long 2/6/1922 83.7 16.27 1,224.52 734
16 Short 6/20/1923 90.81 8.49 1,328.54 499
17 Long 12/7/1923 93.8 −3.29 1,284.79 170
18 Short 10/23/1929 305.85 226.07 4,189.28 2147
19 Long 5/24/1933 84.29 72.44 7,224.02 1309
20 Short 9/7/1937 164.39 95.03 14,088.94 1567
21 Long 6/23/1938 127.41 22.50 17,258.28 289
22 Short 3/31/1939 136.42 7.07 18,478.73 281
23 Long 7/17/1939 142.58 −4.52 17,644.33 108
24 Short 5/13/1940 137.5 −3.56 17,015.68 301
25 Long 2/1/1943 125.88 8.45 18,453.66 994
26 Short 8/27/1946 191.04 51.76 28,005.93 1303
27 Long 10/2/1950 228.94 −19.84 22,449.90 1497
28 Short 4/2/1953 280.03 22.32 27,459.79 913
29 Long 1/19/1954 288.27 −2.94 26,651.78 292
30 Short 10/1/1956 468.7 62.59 43,333.29 986
31 Long 5/2/1958 459.56 1.95 44,178.32 578
32 Short 3/3/1960 612.05 33.18 58,837.46 671
33 Long 2/23/1961 654.42 −6.92 54,764.35 586
34 Short 4/26/1962 678.68 3.71 56,794.52 198
35 Long 11/9/1962 616.13 9.22 62,028.94 197
36 Short 5/5/1966 899.77 46.04 90,584.42 1273
37 Long 1/11/1967 822.49 8.59 98,364.60 251
38 Short 10/24/1967 888.18 7.99 106,220.70 286
39 Long 10/1/1968 942.32 −6.10 99,745.90 343
40 Short 2/25/1969 899.8 −4.51 95,245.10 147
41 Long 10/27/1969 860.28 4.39 99,428.35 244
42 Short 1/26/1970 768.88 −10.62 88,864.63 91
(Continued)
29Chapter four: The Dow The ory’s defects
Table 4.3 (Continued) Performance of Dow Theory through 2017: Longs and Shorts
Trade# Signal M/D/Y Price PL%
Accumulated
Profit Bull Bear
43 Long 9/28/1970 758.97 1.29 90,010.00 245
44 Short 7/28/1971 872.01 14.89 1,03,415.97 303
45 Long 2/10/1972 921.28 −5.65 97,572.80 197
46 Short 2/23/1973 959.89 4.19 101,661.99 411
47 Long 1/27/1975 692.66 27.84 129,964.33 588
48 Short 10/24/1977 802.32 15.83 150,539.92 1084
49 Long 6/6/1978 866.51 −8.00 138,495.90 225
50 Short 7/2/1981 959.19 10.70 153,309.11 135
51 Long 10/7/1982 965.97 −0.71 152,225.45 572
52 Short 1/25/1984 1231.89 27.53 194,131.30 415
53 Long 11/6/1984 1244.15 −1.00 192,199.27 462
54 Short 10/15/1987 2355.09 89.29 363,819.94 475
55 Long 2/29/1988 2071.62 12.04 407,611.06 362
56 Short 10/13/1989 2569.26 24.02 505,526.50 997
57 Long 6/4/1990 2935.19 −14.24 433,526.27 84
58 Short 8/3/1990 2809.65 −4.28 414,984.06 645
59 Long 1/18/1991 2646.78 5.80 439,039.89 234
60 Short 10/5/1992 3179 20.11 527,322.94 60
61 Long 11/25/1992 3266.22 −2.74 512,855.15 124
62 Short 8/4/1998 8487.31 159.85 1,332,659.97 2799
63 Long 11/2/1998 8706.5 −2.58 1,298,243.21 42
64 Short 9/23/1999 10318.59 18.52 1,538,625.09 373
65 Long 11/8/2001 9587.52 7.08 1,647,636.37 777
66 Short 6/25/2002 9126.8 −4.81 1,568,460.62 229
67 Long 1/6/2003 8773.57 3.87 1,629,163.97 195
68 Short 11/21/2007 12799.04 45.88 2,376,653.39 1780
69 Long 4/18/2008 12849.36 −0.39 2,367,309.47 149
70 Short 9/29/2008 10365.45 −19.33 1,909,684.83 149
71 Long 4/9/2009 8083.38 22.02 2,330,123.36 192
72 Short 6/30/2010 9774.02 20.92 2,817,468.97 447
73 Long 9/27/2010 10812.04 −10.62 2,518,248.26 89
74 Short 8/2/2011 11866.62 9.75 2,763,872.05 309
75 Long 12/23/2011 12294 3.60 2,863,413.76 143
76 Short 6/4/2012 12101.46 −1.57 2,818,568.99 164
77 Long 1/18/2013 13649.7 12.79 3,179,171.86 228
78 Short 8/20/2015 16990.69 24.48 3,957,326.79 944
79 Long 10/19/2015 17084.49 0.55 3,979,173.89 60
80 Short 1/6/2016 16906.51 −1.04 3,937,720.30 79
81 Long 4/20/2016 18053.6 6.78 4,204,890.74 105
82 Short 6/24/2016 17400.75 −3.62 4,052,834.47 65
83 Long 9/7/2016 18526.14 6.47 4,314,950.73 75
84 MtoMkt 12/31/2017 24719.22 33.43 5,757,390.17 480
85 15417

31
chapter five
Replacing Dow Theory with John Magee’s
Basing points Procedure
I have humorously compared the interpretation of the market using Dow Theory to the
ancient Roman practice of haruspication—that is, the examination of animal or bird entrails
to forecast the future. Dow Theory analysts examine the market and venture their expert
opinions as to whether Dow Theory says the market is a buy, a sell, or a hold. Sometimes
it seems as if they might be sitting on a tripod at Delphi and inhaling substances legal in
California but forbidden in Washington, D.C. Additionally, from the same data they often
extract different conclusions. (No disrespect of Dow theorists is intended. Some of my
best friends are Dow analysts.) From this observation came the motivation to look for a
better way. That better way is found in Chapter 28 in which Magee outlined (and I have
further articulated) a method that is eminently adaptable to long-long term investing. We
are talking about investments that might last for years. One reason the rich get richer is
they practice this kind of investing. They correctly assess business conditions and economic
circumstances and take deeply entrenched positions that, in secular bull markets, return
them profits beyond the hope of swing traders and midterm traders. Perhaps in some cases
they even use Dow Theory. Whatever they use, they are not chased from the market, except
by true changes in the major trend.
Investing on this time scale has never been easy—except for the well-capitalized
mature and patient investor. Using Magee’s Basing Points Procedure, it is now possible for
the general investor to invest on the Dow Theory (or longer) time scale. To demonstrate the
power of this procedure, I undertook a number of studies. The first and most important of
these was a study of the Dow Industrials since 1900 using Dow Theory. By studying the
Industrials, we have an excellent benchmark in the performance of Dow Theory over that
time.
The fractal nature of the market
A fact that all traders


o invest on the Dow Theory (or longer) time scale. To demonstrate the
power of this procedure, I undertook a number of studies. The first and most important of
these was a study of the Dow Industrials since 1900 using Dow Theory. By studying the
Industrials, we have an excellent benchmark in the performance of Dow Theory over that
time.
The fractal nature of the market
A fact that all traders know in their bones was enunciated by the polymath, Benoit
Mandelbrot, who stated market price behavior is fractal. Fractal literally means self-similar
at all scales. In other words, a two-minute bar chart exhibits the same kind of formations and
characteristics as a daily chart, and so does a weekly chart. If you were presented a chart
and told to determine the time scale, you would be unable to answer from the data alone.
When you read about moving average systems in Chapter 36, you will see—as you probably
know already—that a 10-day moving average system trades 10 times as much as a 200-day
moving average system. The closer you are to the market, the more prone you are to be led
astray by noise. This is one reason day traders are so seldom successful—noise and random
price activity make for difficult data to analyze. Important traders of my acquaintance trade
on weekly data: in other words, they trade using one bar to represent a week of market
activity. Not surprisingly, they trade infrequently compared with daily bar traders.
32 Technical Analysis of Stock Trends
Considering these facts, I constructed a Basing Points Procedure using weekly bars to
test the method. Instead of using “three-days-away” data to determine Basing Points, I used
“three-bars-away” data. I took all the Industrials data and back studied it to see what the
performance would have been using Magee’s procedure. The results are impressive; not
eye-popping in terms of profits but sufficient. Furthermore, when considering operating
characteristics overall, especially in ease of operation, the Magee method wins hands down.
The results of using Magee’s simple-as-pie method are superior to the results obtained
by using the complex and often obtuse Dow Theory. Later in this chapter, I will summarize
the results of the study and illustrate the tables.
• Profits produced by the Magee Procedure are superior to those produced by the Dow
Theory: $1,147 ,486.52 as opposed to $795,592.01.
• Profits produced by Variant 2 of the Magee Procedure were $2,982,577 .83.
• Compound Annual Growth Rates (CAGR) were also similar: 7 .9% (Variant 1) versus
7 .87% and 8.37% for Variant 2.
• Risk profiles were also quite similar: average drawdown for Dow Theory was 13.78%
and for the Magee Procedure was 16%. Maximum drawdown was 25.3% for Dow
Theory and 30% for the Magee Procedure.
• Also pertinent to risk, considering long-side trades only, the Dow Theory was out of
the market 36% of the time and the Magee Procedure 35%. This is a little remarked
fact about Dow Theory—and unknown before this about Magee’s Procedure. This
is a radically important fact; it means each procedure is risk-free more than a third
of the time. Calculating the out-of-market returns is such a hairy process, it was not
undertaken.
• As a result of differences in drawdowns and stop methods, Magee’s Procedure is
operationally superior to Dow Theory. Since 1900, the Dow Theory has made 42
trades, the Magee Procedure has made 25. Considering the similarity of risk and
profit characteristics, a system that trades less is preferable—less cost, less slippage,
fewer chances to lose market position. This is to say, better control of the vigorish.
In short, the Magee Basing Points Procedure represents the best alternative to the Dow
Theory for the true long-term investor. It can be used on weekly bars, in which case its
full long-term power is evidenced. It also can be used on daily bars for a more sensitive
approach.
The Basing Points Procedure may be operated in two ways, which I call Variant 1
and Variant 2. Variant 1 sets stops based on wave lows. Variant 2, in addition to wave
lows, uses new wave highs (see Chapter 28). Table 5.1 denotes trades for the Basing Points
Procedure, Variant 1. Table 5.2 denotes trades for the Basing Points Procedure, Variant 2.
Keys to trades are shown in Figures 5.2 and 5.3. Readers, and investors in general, have
every right to be skeptical of academic studies. Every morning, the mailbox is full of “can’t
fail” “get-rich-quick” systems being sold by Wall Street hucksters who always show mouth-
watering profits. Yet these are always paper studies. By contrast, the Magee Basing Points
Procedure has been in operation in the market for some years, and its effectiveness has
been demonstrated. It exited, and shorted, the market in January 2008 and remained short
until March 2009. In 2011, the Procedure exited longs and went short in late July before the
Greek debt crisis. Letters written in real time during these events are in the http:/ /www.
edwards-magee.com archives and are available for audit. Charts made at the time follow
here. (See Figures 5.2 and 5.3. Figure 5.1 shows a detailed chart of the analysis of the top of
the 2007 market and the short that resulted in early 2008.)
33Chapter five: Replacin g Dow Theory with John Magee’s Basing points Procedure
Table 5.1 Trades Made by the Magee Basing Points Procedure, Variant 1
Date Signal
Wave
High
Wave
Low
Stop
Price
P/L
Long %
Accum
Lng
Risk
pts Risk %
Duration
Long
Duration
Short
9/24/1900 Long 53.00 50.35 143.1
6/17/1901   78.30 371
9/30/1901 Short 64.03 11.03 20.81 172.88 14.27 18.22
11/2/1903   42.20
7/11/1904 Long 52.02 1015
1/15/1906   103.00
8/5/1907 Short 76.76 24.75 47.57 255.13 26.24 25.48 1120
1/11/1907   53.00
3/23/1908 Long 67.77 231
9/27/1909   100.50
1/31/2010 Short 91.11 23.34 34.43 342.97 9.39 9.34 679
9/25/1911   72.90
4/22/1912 Long 88.58 812
9/30/1912   94.20
12/9/1912 Short 85.88 −2.70 −3.05 332.52 8.32 8.83 231
12/21/1914   53.20


.03 20.81 172.88 14.27 18.22
11/2/1903   42.20
7/11/1904 Long 52.02 1015
1/15/1906   103.00
8/5/1907 Short 76.76 24.75 47.57 255.13 26.24 25.48 1120
1/11/1907   53.00
3/23/1908 Long 67.77 231
9/27/1909   100.50
1/31/2010 Short 91.11 23.34 34.43 342.97 9.39 9.34 679
9/25/1911   72.90
4/22/1912 Long 88.58 812
9/30/1912   94.20
12/9/1912 Short 85.88 −2.70 −3.05 332.52 8.32 8.83 231
12/21/1914   53.20
3/29/1915 Long 60.26 840
11/13/1916   110.13
8/27/1917 Short 84.65 24.40 40.49 467.14 25.48 23.14 882
12/17/1917   65.90
8/19/1918 Long 84.56 357
11/3/1919   119.60
8/9/1920 Short 83.72 −0.84 −0.99 462.50 35.88 30.00 721
8/22/1921   63.90
10/24/1921 Long 72.10 441
3/19/1923   105.40
7/23/1923 Short 87.40 15.30 21.22 560.65 18.00 17.08 637
10/22/1923   85.76
1/21/1924 Long 96.51 182
9/2/1929   386.10
10/21/1929 Short 319.30 222.79 230.84 1854.86 66.80 17.30 2100
7/4/1932   40.60
4/24/1933 Long 70.97 1281
3/8/1937   195.60
9/6/1937 Short 166.54 95.57 134.67 4352.85 29.06 14.86 1596
3/28/1938   97.50
7/18/1938 Long 136.89 315
9/11/1939   157.80
5/13/1940 Short 135.95 −0.94 −0.68 4323.06 21.85 13.85 665
4/27/1942   92.70
7/6/1942 Long 105.99 784
5/27/1946   213.4
9/16/1946 Short 172.43 66.44 62.69 7033.17 40.97 19.20 1533
6/13/1949   160.6
10/24/1949 Long 184.27 1134
4/9/1956   524.4
9/23/1957 Short 468.26 283.99 154.12 17872.73 56.14 10.71 2891
10/21/1957   416.2
(Continued)
34 Technical Analysis of Stock Trends
Table 5.1 (Continued) Trades Made by the Magee Basing Points Procedure, Variant 1
Date Signal
Wave
High
Wave
Low
Stop
Price
P/L
Long %
Accum
Lng
Risk
pts Risk %
Duration
Long
Duration
Short
6/23/1958 Long 465.77 273
1/4/1960   688.2
9/26/1960 Short 582.64 116.87 25.09 22357.51 105.56 15.34 826
10/24/1960   564.2
4/3/1961 Long 664.66 189
11/13/1961   741.3
5/7/1962 Short 654.46 −10.20 −1.53 22014.44 86.84 11.71 399
6/25/1962   524.6
12/31/1962 Long 640.66
1/17/1966   1000.6 238
5/9/1966 Short 878.18 237.52 37.07 30176.13 122.42 12.23 1225
10/10/1966   735.7
10/14/1968 Long 937.71 889
12/2/1968   994.7
6/9/1969 Short 895.4 −42.31 −4.51 28814.51 99.30 9.98 238
5/25/1970   627.5
1/11/1971 Long 827.40 581
1/8/1973   1067.2
5/14/1973 Short 871.25 43.85 5.30 30341.63 195.95 18.36 854
12/2/1974   572.1
12/10/1975 Long 713.58 940
9/20/1976   1026.3
5/23/1977 Short 904.12 190.54 26.70 38443.24 122.18 11.90 530
2/27/1978   742.13
8/14/1978 Long 875.60 448
9/4/1978   907.73
3/24/1980 Short 780.15 −95.45 −10.90 34252.39 127.58 14.05 588
4/21/1980   759.13
8/4/1980 Long 930.96 133
3/30/1981   1030.98
8/3/1981 Short 877.8 −53.16 −5.71 32296.66 153.18 14.86 364
8/9/1982   769.98
10/4/1982 Long 902.82 427
8/24/1987   2746.7
10/19/1987 Short 2071.51 1,168.69 129.45 74104.67 675.19 24.58 1841
8/24/1987   1616.2
1/23/1989 Long 2234.53
7/20/1998   9367.94 462
8/24/1998 Short 8141.86 5,907.33 264.37 270011.56 1,226.08 13.09 3500
7/20/1998   7402.61
3/8/1999 Long 9015.28 196
1/10/2000   11750.28
2/21/2000 Short 9889.28 874.00 9.69 296188.21 1,861.00 15.84 350
10/7/2002   7197.49
9/1/2003 Long 9314.67 1288
10/8/2007   14198.1
1/7/2008 Short 12503.04 3,188.37 34.23 397572.06 1,695.06 11.94 1589
3/2/2009   6469.95
(Continued)
35Chapter five: Replacin g Dow Theory with John Magee’s Basing points Procedure
Table 5.2 Trades Made by the Magee Basing Points Procedure, Variant 2
Date Signal Stop Profit %
Accumulated
Profit
Duration
Long
Duration
Short
9/25/1900 Buy 143.10
6/18/1901 371
10/1/1901 Sell 64.03 11.03 20.81 172.88
11/3/1903
7/12/1904 Buy 52.02 1015
1/16/1906
8/6/1907 Sell 76.76 24.75 47.57 255.13 1120
1/12/1907
3/24/1908 Buy 67.77 231
9/28/1909
2/1/1910 Sell 91.11 23.34 34.43 342.97 679
9/26/1911
4/23/1912 Buy 88.58 812
10/1/1912
12/10/1912 Sell 85.88 −2.70 −3.05 332.52 231
12/22/1914
3/30/1915 Buy 60.26 840
11/14/1916
8/28/1917 Sell 84.65 24.40 40.49 467.14 882
12/18/1917
8/20/1918 Buy 84.56 357
11/4/1919
8/10/1920 Sell 83.72 −0.84 −0.99 462.50 721
8/23/1921
10/25/1921 Buy 72.10 441
3/20/1923
7/24/1923 Sell 87.40 15.30 21.22 560.65 637
10/23/1923
1/22/1924 Buy 96.51 182
9/3/1929
10/22/1929 Sell 337.92 241.41 250.14 1963.03 2100
7/5/1932
(Continued)
Table 5.1 (Continued) Trades Made by the Magee Basing Points Procedure, Variant 1
Date Signal
Wave
High
Wave
Low
Stop
Price
P/L
Long %
Accum
Lng
Risk
pts Risk %
Duration
Long
Duration
Short
5/4/2009 Long 8564.52 484
12/31/2009   10428.05
12/29/2017 Mark to
market
12/29/17
16928.03 24719.22 16154.70 749914.46 188.62 1147486.52 14291.17 137.05% 3161
36 Technical Analysis of Stock Trends
Table 5.2 (Continued) Trades Made by the Magee Basing Points Procedure, Variant 2
Date Signal Stop Profit %
Accumulated
Profit
Duration
Long
Duration
Short
4/25/1933 Buy 70.97 1281
3/9/1937
9/7/1937 Sell 166.54 95.57 134.67 4606.69 1596
3/29/1938
7/19/1938 Buy 136.89 315
9/12/1939
5/14/1940 Sell 135.95 −0.94 −0.68 4575.16 665
4/28/1942
7/7/1942 Buy 105.99 784
5/28/1946
9/17/1946 Sell 172.43 66.44 62.69 7443.31 1533
6/14/1949
10/25/1949 Buy 184.27 1134
4/10/1956
9/24/1957 Sell 468.26 283.99 154.12 18914.98 2891
10/21/1957
6/24/1958 Buy 465.77 273
1/5/1960
9/27/1960 Sell 582.64 116.87 25.09 23661.29 826
10/25/1960
4/4/1961 Buy 664.66 189
11/14/1961
5/8/1962 Sell 654.46 −10.20 −1.53 23298.21 399
6/26/1962
1/1/1962 Buy 640.66
1/18/1966 238
5/10/1966 Sell 878.18 237.52 37.07 31935.85 1225
10/11/1966
10/15/1968 Buy 937.71 889
12/3/1968
6/9/1969 Sell 895.40 −42.31 −4.51 30494.83 238
5/26/1970
1/12/1971 Buy 827.40 581
1/9/1973
5/15/1973 Sell 871.25 43.85
5.30 32111.01 854
12/3/1974
12/11/1975 Buy 713.58 940
9/21/1976
5/24/1977 Sell 904.12 190.54 26.70 40685.06 530
2/28/1978
8/15/1978 Buy 875.60 448
9/5/1978
3/25/1980 Sell 780.15 −95.45 −10.90 36249.82 588
4/22/1980
(Continued)
37Chapter five: Replacin g Dow Theory with John Magee’s Basing points Procedure
This study and the use of Magee’s Basing Points Procedure to replace Dow Theory
is explained in exquisite detail in the book Sacred Chickens, the Holy Grail and Dow Theory
(available at http:/ /www.amazon.com).
Tabl


15/1978 Buy 875.60 448
9/5/1978
3/25/1980 Sell 780.15 −95.45 −10.90 36249.82 588
4/22/1980
(Continued)
37Chapter five: Replacin g Dow Theory with John Magee’s Basing points Procedure
This study and the use of Magee’s Basing Points Procedure to replace Dow Theory
is explained in exquisite detail in the book Sacred Chickens, the Holy Grail and Dow Theory
(available at http:/ /www.amazon.com).
Table 5.2 (Continued) Trades Made by the Magee Basing Points Procedure, Variant 2
Date Signal Stop Profit %
Accumulated
Profit
Duration
Long
Duration
Short
8/5/1980 Buy 930.96 133
3/31/1981
8/4/1981 Sell 877.80 −53.16 −5.71 34180.04 364
8/10/1982
10/5/1982 Buy 902.82 427
8/25/1987
10/20/1987 Sell 2458.46 1555.64 172.31 93075.78 1841
8/25/1987
1/24/1989 Buy 2234.53
7/21/1998 462
8/25/1998 Sell 8141.86 5907.33 264.37 339135.65 3500
7/21/1998
3/9/1999 Buy 9015.28 196
9/21/1999
9/21/1999 Sell 10470.08 1454.80 16.14 393862.09 196
1/3/2000
10/15/2002 Buy 8138.30 1120
10/1/2002
1/28/2003 Sell 7984.95 −153.35 −1.88 386440.54 105
10/8/2006
3/18/2003 Buy 8220.90 49
5/11/2004 Sell 9966.41 1745.51 21.23 468491.88 420
2/28/2005 Buy 10887.90
7/30/2007 Sell 13110.42 2222.52 20.41 564123.97 882
10/1/2007
3/23/2009 Buy 7411.89
3/2//2009 602
12/29/2017 Mark to
Market
24719.22 17307.33 233.51 1881396.57 3262
38 Technical Analysis of Stock Trends
Figure 5.1 How the 2008 top in the Industrials was managed with Basing Points.
Certainly, one of the most interesting charts of the last 20 years. Here we can see the stairstops
rising as higher wave lows are made. Moreover, one—or two—of those instances of surprising
serendipity occurs. The Basing Point stop is quite close to a stop that would have been calculated
from the neckline of the head-and-shoulders formation. The very long-term trendline from 2003
intersects prices very near the Basing Point calculated stop, calling to mind the “rule of multiple
techniques,” which states any conclusion arrived at by multiple techniques is much more probable
than that using only one method. This Basing Points system—or method, or what-have-you—
remained short until March 2009.
39Chapter five: Replacin g Dow Theory with John Magee’s Basing points Procedure
1924 - 1934
DOW JONES
116.47 116.47
336.96 336.96
96.26
104.04
19241924
15
19251925 19261926 19271927 19281928 19291929
?
19301930 19311931 19321932 19331933
17
19
19341934
Figure 5.2 The Dow-Jones Industrials 1924–1934. This is a period of the chart covered in Figure 5.3 .
40 Technical Analysis of Stock Trends
Figure 5.3 This is one of the most interesting charts ever made of the Dow-Jones Industrials. It shows every trade made by Dow Theory since the
beginning and also shows trades made by Magee’s Basing Points Procedure.
41
chapter six
Important Reversal Patterns
In our discussion of certain deficiencies in the Dow Theory from the point of view of the
practical trader, we mentioned the fact that it did not tell us what specific stocks to trade
in. (EN9: Obviously, no longer a problem as the investor may buy the DIA and trade the Average
like a stock.) A conservative and wealthy investor, more interested in safety than maximum
profit, can solve this problem by making up a comprehensive and thoroughly diversified
list of sound, well-seasoned “blue chip” issues and handing his broker an order to buy the
lot when the Dow Theory signals a Bull Trend. Some of his selections will do better than
others; some may “go sour,” but wide diversification will ensure he gets a fair Average
result. Better results should be obtained if we can find a way to select for purchase the
most favorably situated issues at any given time and can manage to sell them promptly and
switch to others whenever the prospects for the first have been fully discounted.
There is the possibility, too, of increasing our gains if we can, at times, buy with safety
earlier in an uptrend than the Dow theorist does, and sell before the market has reacted far
enough to give a Dow Bear Signal.
We mentioned also the fact that the Dow Theory is of little or no assistance in trading
on the Intermediate Trends. There is obviously more money to be made if we can get the
benefit of each up move without having to write off some of our profits in each reaction. Or,
if we can profit both ways by trading on both the “long side” and “short side” of the market.
Finally, although all stocks tend to move with “the market” as typified in the Averages,
there are, in fact, wide variations in the price paths of individual issues. An average, after all,
is just that, a device for expressing in one figure a diversity of other figures. A Primary Bull
Market ended in the Dow–Jones Industrial Average on May 29, 1946, but United Airlines
registered its highest price in December 1945; General Motors saw its peak in January 1946;
Goodyear in April, DuPont in June, and Schenley in August. Is there a way of capitalizing
on these divergences?
Technical analysis of the charts of individual stocks definitely answers the first and
most important of these four problems: the matter of selection. It frequently, but not always,
gives us a running start on the Dow Theory; it also, in large part, takes care of the question
of the Intermediate Trend, although there are certain reservations as to policy and risk
in connection with both these points that will be taken up in due course. Finally, careful
technical analysis should, in nearly every case, get us out of a stock that “tops out” ahead of
the Averages long before it has suffered any considerable decline, often in time to transfer
funds to other issues that have yet to complete their advances.
Just as the Averages constantly discount all known and foreseeable factors affecting
the future of security prices in general, the market action of an individual issue reflects all
the factors affecting its individual future. Among these factors, and expressed in its chart,
are the general market conditions that influence all stock


funds to other issues that have yet to complete their advances.
Just as the Averages constantly discount all known and foreseeable factors affecting
the future of security prices in general, the market action of an individual issue reflects all
the factors affecting its individual future. Among these factors, and expressed in its chart,
are the general market conditions that influence all stocks to a greater or lesser degree, as
well as the particular conditions applying to the particular stock, including the operations
of “insiders.”
Let us assume right from the start that you, the reader, are not a member of that mysterious
inner circle known to the boardrooms as “the insiders.” Such a group—genuinely entitled to
42 Technical Analysis of Stock Trends
be called insiders, thoroughly informed on every fact, figure, and development that might
determine the fortunes of a certain corporation—may exist from time to time and may
influence the market price of its stock (EN9: and wind up in prison). But it is fairly certain that
there are not nearly so many “insiders” as the amateur trader supposes and that they do not
cause one-tenth of the market movements for which the public blames them. It is even more
certain that insiders can be wrong; they would, in fact, be the first to admit it. Frequently,
their plans are upset by some development that they could not foresee or by some blind
force that puts to scorn all expert estimates of value. Any success they have, however, can be
accomplished only by buying and selling on the floor of the Exchange. [EN9: No longer strictly
true. Insiders sold stock to their companies in the tulip (dot.com) bubble, which went unreported
publicly for up to a year. Still, only an isolated problem.] They can do neither without altering the
delicate poise of supply and demand that governs prices. Whatever they do is sooner or later
reflected on the charts where you, the “outsider,” can detect it, or at least detect the way in
which the supply–demand equation is being affected by insiders’ operations, plus all other
prevailing market factors. So, you do not need to be an insider to ride with them frequently.
Important Reversal Patterns
Stock prices move in trends. Some of those trends are straight, some are curved; some are
brief and some are long-continued; some are irregular or poorly defined and others are
amazingly regular or “normal,” produced in a series of action and reaction waves of great
uniformity. Sooner or later, these trends change direction; they may reverse (as from up to
down), or they may be interrupted by some sort of sideways movement and then, after a
time, proceed again in their former direction.
In most cases, when a price trend is in the process of reversal, either from up to down or
from down to up, a characteristic area or pattern takes shape on the chart, which becomes
recognizable as a Reversal Formation. Some of these chart pictures are built and completed
quickly, whereas others may require several weeks to reach a stage at which one can surely
say a Reversal of Trend is definitely indicated. Speaking in broad generalities, the greater the
Reversal Area—the wider the price fluctuations within it, the longer it takes to build, and
the more shares transferred during its construction—the more important its implications.
Thus, roughly speaking, a big Reversal Formation suggests a big move to follow and a small
pattern, a small move. Needless to say, the first and most important task of the technical
chart analyst is to learn to know the important Reversal Formations and to judge what they
may signify in terms of trading opportunities.
There is one recognized Reversal Pattern that appears and is completed within a single
day’s trading, and is, in consequence, named the “One-Day Reversal.” At times, it has great
significance—such as calling a halt, at least temporarily, to any up or down move—but in
its ordinary manifestations, it does not imply much of an immediate move in the opposite
direction. It is a useful pattern, and we shall have more to say about it later, but the price
formations from which extensive new trends proceed take time to build. One does not
bring instantly to a stop a heavy car moving at 70 miles an hour and, all within the same
split second, turn it around and get it moving back down the road in the opposite direction
at 70 miles an hour.
Time required to reverse a trend
We do not need to lean on a racing automobile analogy to explain why it takes time (and
volume and price action) to produce an important Trend Reversal. The logic of it is plain
43Chapter six: Importa nt Reversal Patterns
enough if we take but a moment to examine it. We can do so most easily by describing
what might have (and, doubtless, many times has) happened in specific terms. Suppose
a certain well-informed and well-financed coterie (EN9: A congerie of mutual funds, for
example) decides the shares of a certain company, now selling around 40, are cheap; that
this company’s affairs are progressing so satisfactorily that, before long, it will attract the
attention of many investors; and that its stock will be in demand at much higher levels,
perhaps at 60 or 65. Our group realizes if they manage their market operations skillfully, if
nothing unforeseen intervenes to upset their calculations, they can “take” 20 points out of
the situation. So they proceed to buy in all offerings, going about this business as quietly
as possible, until they have accumulated their line, which may run to several thousand
shares and represent practically all of the current floating supply of the issue. Then they
wait. Professionals become suspicious and the rumor circulates that there is “something
doing in PDQ,” or other canny bargain hunters discover the company’s bright prospects,
or chart analysts detect the signs of accumulation in the stock’s action. Buyers now find
the stock is scarce; there are few offerings