great contributions of the great established exchanges like the CBOT ® and the
Chicago Mercantile Exchange is their institutionalization of contract terms and relationships
277Chapter seventeen: A summary a nd concluding comments
is known as “fungibility.” Any one futures contract for corn, or an index, or any other
commodity is substitutable for another of the same commodity. Similarly, the Exchange has
negated counterparty risk by placing a Clearing Corporation between all parties to trades.
Thus, even if the other party to a trade went broke, the Clearing Corporation would assume
his liability and, using the mechanism of daily settlement, whereby losers pay winners
daily, the danger of major default is avoided.
Futures “margins” (or “earnest money”) are deposited with the broker on opening
a trade. The leverage obtainable is quite extreme for a stock trader. The initial margin
is usually 3%–5% of the total value of the contract. Each day thereafter, margins vary
according to the process described above of marking-to-market.
As the reader can see, the purchase or sale of a Dow Future is the equivalent of a fairly
large portfolio transaction, with the understanding it is a transaction that will be closed in
the future, unlike a stock purchase, which may be held indefinitely.
Differences between cash and futures
The main two differences between the cash and the futures transactions are as follows:
 1. In cash, the value of the portfolio must be paid up front or financed in a stock margin
account.
 2. The owner of the cash portfolio receives cash dividends.
These are not the only differences. The leverage employed in the futures transaction is
a two-edged sword. If the trader has no reserves, a minor move in the index wipes him out.
Such a minor move would be barely noticed by the owner of a cash portfolio.
Dow Index futures
The price of the future and the price of the index are closely linked. Any price anomaly
is quickly corrected by arbitragers. On any significant price difference, arbitragers will
buy the underpriced and sell the overpriced, bringing the relationship back in line.
Their prices are not exactly the same because the futures contract value must reflect
the costs of short-term financing of stocks and the dividends paid by index stocks until
futures expiration, known as the “cost of carry.” The “theoretical value” of the future
should equal the price of the index plus the carrying cost, what is called the “fair” or
“theoretical” value.
Using stock index futures to control exposure to the market
The owner of a cash portfolio in the Dow, or of DIAMONDS, can control his exposure,
his risk, by using futures to hedge. If, for example, he is pessimistic about the market,
or more to the point, a lot of uptrend lines have been broken and the technical situation
seems to be deteriorating, he can sell a futures contract equivalent to his portfolio and
be flat the market.
Readers will immediately recognize the advantages of this strategy. Tax consequences
on the cash portfolio are avoided, as are the other negative consequences of trading—
slippage, errors, and so on. Long-term positions are better left alone. By flattening his
position, the investor has now insured the future value of his portfolio, and the capital
involved is now earning the money market rate of return.
278 Technical Analysis of Stock Trends
What happens if the forecast market decline occurs? The portfolio is protected from
loss and the capital earns the market rate of return; however, the investor should monitor
his hedge closely, lifting it when he calculates the correction has run its course. Taxes will
then be due on the profits on the hedge.
In monitoring the hedge, the possibility the market rises instead of falls must
be considered. In planning the hedge in the first place, the investor must plan for this
eventuality and determine at which point he will lift the hedge on the losing side. At worst,
the investor has surrendered portfolio appreciation. Not considering cash flow implications.
It is worth emphasizing, in fact strongly emphasizing, that these techniques require
knowledge, expertise, and study. Careless use of techniques of this nature can bloody the
amateur investor. Hence, it is probably best to have a professional guide for the first several
of these expeditions and to execute first a number of paper transactions.
The canny investor can increase his exposure to the market and the risk to his capital
by buying index futures. But the canny investor must be careful not to turn into a burned
speculator. Futures trading, because of the extreme leverage, is an area for dedicated and
experienced speculators.
A Dow futures transaction costs less than if you had to buy or sell a whole basket
of stocks. Professional fund managers—as well as other professionals—regularly use
futures for asset allocation and reallocation. In all likelihood, they are not using the
extreme leverage afforded by futures. In other words, if they have a $1 million cash
portfolio, they do not buy $10 million worth of futures. It is not the leverage in which
they are interested, but rather it is the extreme convenience and agility offered by doing
short-term allocations in futures. The ability to almost instantaneously move in and out
of the market without disturbing the underlying portfolio is a powerful feature of these
“proxy markets.”
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Figure 17.3 Diamonds and Futures. The 2% plus break at the arrow of an 11-month trendline is
an unmistakable invitation to hedge the DIAMONDS by shorting the futures. Profits on the short
would have offset losses in the DIAMONDS. This convenient drill would have pres


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Figure 17.3 Diamonds and Futures. The 2% plus break at the arrow of an 11-month trendline is
an unmistakable invitation to hedge the DIAMONDS by shorting the futures. Profits on the short
would have offset losses in the DIAMONDS. This convenient drill would have preserved liquidity,
postponed capital gains taxes, and avoided loss of equity. Notice the return to the trendline after the
break. More of the foolish virgin syndrome?
279Chapter seventeen: A summary a nd concluding comments
Investment uses of Dow Index futures
The following examples describe the basic mechanics of using Dow futures contracts.
These can be used to adjust equity exposure in anticipation of volatile market cycles and
to rebalance portfolios among different asset classes. The futures also may be used for other
purposes not illustrated here. The following examples are not intended to be absolutely
precise, but only to illustrate the mechanics involved. For the sake of simplicity, mark-to-
market payments and cost of carry have been eliminated from the examples.
Situation 1: Portfolio protection
You are a long-term Magee-type investor and you have old and profitable positions with which
you are satisfied. Yet, you have seen the broadening top of the Dow Jones (ca. 2000) and it is
almost October, so you would not be surprised to see a little bloodshed. You have $400,000
in the Dow and $100,000 in money market instruments. You decide to reverse this ratio, but
you do not want to liquidate the Dow portfolio, as there is no sign of a confirmed downtrend,
only that of consolidation. You sell $300,000 of index futures, leaving yourself with a $100,000
kicker in case you are wrong about the market’s declining. At the time, the market is 10,000
and the futures are 10,500, meaning the cost of carry is approximately 0.5% (10,500/10,000 – 1).
You sell three futures contracts [$300,000/($10 × 10,000)]. You now have reversed your
position and are long $100,000 Dow stocks and long $400,000 money market equivalents.
Validating your technical analysis, the market has begun to swing in broad undulations
and, at the expiration of the futures, the Dow is at 10,000. On your stocks, you have a return
of –0.5%, and the money market position has a rate of return of 0.5%.
What would have been the situation had you not hedged?
Stock Portfolio $400,000 × 0.95 $380,000
Money Market + 100,000 × 1.005 $100,500
Total $480,500
How the futures position affects the portfolio:
Short three futures 3 × $10.00 × (10,000–9,500) +$15,000
Total $495,000
Value of portfolio with reallocation of assets in cash market:
Stocks $100,000 × 0.95 $95,000
Money market + $400,000 × 1.005 $402,000
Total $497,000
By hedging in the futures market, you now have the equivalent of a $100,000 investment
in Dow futures stocks and a $400,000 investment in the money market instrument. The
stock market decline now affects only $100,000 of your stock portfolio rather than $400,000;
in addition, you earn a money market rate of return of 0.5% on the $300,000 difference.
Without the futures transaction, the portfolio is worth $480,500. The $15,000 profit on
the short futures position offsets the loss on the $300,000 of the portfolio that was moved
out of equities by the short futures position. In brief, by selling futures, you are able to
protect $300,000 of your initial portfolio value from a stock price decline, nearly breaking
280 Technical Analysis of Stock Trends
even, an achievement given these market conditions. Had you been more confident of the
market decline, you might have completely neutralized the equity risk on the portfolio
by selling more futures contracts. This would have converted the entire stock position to
a $400,000 investment in the money market. The amount of protection you should obtain
depends on your assessment of the market and your tolerance for risk.
Situation 2: Increasing exposure with futures
Now let us look at the other side of the coin. The market has come off its highs in a
predictable and controlled secondary reaction and your technical analysis is that the Bull
Market will continue. At 10,000, it appears headed for 11,000, and you want to increase your
commitment. Your portfolio is as previously described, split 80/20 between Dow stocks
and money markets. It is time to go whole hog, you decide. You are acutely aware of the
market maxim (bulls make money and bears make money and hogs wind up slaughtered),
but there is also a market maxim that no market maxim is true 100% of the time, which is
also true of this maxim.
Rather than liquidate your money market holdings, you buy one futures contract,
which puts you long another $100,000 of stocks. The rate of return on the money markets
in your portfolio is 0.5%. To get a $500,000 exposure in blue chips, you buy the following
number of contracts: $100,000/($10 × 10,000) = 1 contract.
Results: Your technical analysis of the direction of the market is correct, and the Dow
future rises to 11,000 at the September expiration, or by 10%.
Value of portfolio with passive management:
Stocks $400,000 × 1.10 $440,000
Money market+ $100,000 × 1.005 $100,500
Total $540,500
Value of portfolio with futures position:
Long DJIA futures 1 × $10.00 × (11,000 – 10,000) $10,000
Total $550,500
Value of portfolio with reallocation of assets in cash market:
Stocks $500,000 × 1.10 $550,000
Money market $0
Total $550,000
In buying Dow Index futures, you are able to “equitize” $100,000 of your money market
investment, effectively increasing your return from the money market rate of 0.5%–10%. If
you had not bought futures, the total value of your portfolio at the September expiration
would have been $540,500 instead of $550,500. Not only do you have a $10,000 extra gain
in your portfolio, but also you have taken advantage of the market’s continuing upward

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“equitize” $100,000 of your money market
investment, effectively increasing your return from the money market rate of 0.5%–10%. If
you had not bought futures, the total value of your portfolio at the September expiration
would have been $540,500 instead of $550,500. Not only do you have a $10,000 extra gain
in your portfolio, but also you have taken advantage of the market’s continuing upward
climb without having to adjust your portfolio.
Situation 3: Using bond and index futures for asset allocation
Speculation in bonds can be quite profitable, notwithstanding David Dreman’s assertion
that long-term investments in bonds are net losers. (EN9: An oversimplification of a sophisticated
281Chapter seventeen: A summary a nd concluding comments
thesis by an important figure .) Subsequently, it is not unusual for an investor to have both
bonds and stocks in his portfolio. In this event, the portfolio can be managed with facility
by using both Index futures and Treasury bond futures.
Many investors consider it prudent to reallocate their capital commitments based
on inflation rates, interest rates, and the reported expression on Alan Greenspan’s (or
Bernanke’s) face before congressional testimony.
An efficient and inexpensive way to reallocate assets between stocks and bonds is to
put on spreads of Treasury bond futures and Dow Index futures.
Analysis of recent long- and medium-term trends in the market, however, has led you
to consider increasing your equity portfolio and decreasing your bond portfolio. You have
$200,000 invested in Dow stocks and $200,000 invested in Treasury bonds. You would like
to take advantage of the sustained market rally by increasing your equities exposure to 75%
and decreasing your bond holdings to 25%.
As for tactics, you can reallocate both sides of your portfolio—buying $100,000 of stocks
and selling $100,000 of bonds—with the sale of Treasury bond futures and the purchase
of Dow Index futures.
The Treasury bonds in your portfolio have a market price of 103–20. The price of
September Treasury bond futures is 102–20 per $100 of face value, and $100,000 of face
value must be delivered against each contract. The value of the Dow futures is 10,000, and
the price of the Dow Index futures contract is 10,000 (ignoring the cost of carry).
The number of T-bond futures to sell is: short T-bond futures: $100,000/
(102 – 20 × $1,000) = 1 (number of futures is rounded to the nearest whole number). The
number of stock index futures to buy is as follows: long stock index futures: $100,000/
($10.00 × 10,000) = 1 (number of futures is rounded to the nearest whole number).
Results: at the September futures expiration, the value of the Dow future is 11,000, a
rate of return of 10%, and the market value of the bonds is 101–08, a rate of return of –1%.
Portfolio value with no market action taken:
Stocks $200,000 × 1.10 $220,000
Money market $200,000 × 0.99 $198,000
Total $418,000
Value of futures positions:
Long Dow futures $10 × 1 × (11,000 – 10,000) $10,000
Short bond futures +$1000 × 1 × (102–20 – 101–08) $1375
Total $11,375
Grand total $429,375
Value of portfolio had transaction been done in cash market:
Stocks $300,000 × 1.10 $330,000
Bonds +$100,000 × 0.99 $99,000
Total $429,000
By this simple maneuver, you have quickly and easily changed your market posture
to add an additional $100,000 exposure to stocks and subtract $100,000 exposure to bonds.
282 Technical Analysis of Stock Trends
Having correctly analyzed market trends, your action results in an increase in portfolio
value from $418,000 to $429,375. You could have accomplished the same result by buying and
selling bonds and stocks, but not without tax consequences and the attendant transaction
headaches. The use of futures to accomplish your goals allowed you to implement your
trading plan without disturbing your existing portfolio.
Perspective
Although there can be no argument about the importance of CBOT® DJIASM Index futures—
they are markets of enormous usefulness and importance—there can also be no doubt the
futures novice should thoroughly prepare himself before venturing into these pits. In such
a highly leveraged environment, mistakes will be punished much more severely than an
error in the stock market. By the same token, ignorance of this vital tool is the mark of an
investor who is not serious about his portfolio, or who is less intense in his investment
goals. “They” (the infamous “they”) use all the weapons at their disposal; so should “we.”
Options on Dow Index futures
The buyer of this instrument has the choice, or the right, to assume a position. It is his option
to do so—unlike a futures contract in which he has an obligation once entered. There are
two kinds of options: calls (the right to buy the underlying instrument) and puts (the right
to sell). Also, options can be bought (long) or sold (short) like futures contracts.
A long call option on Dow Index futures gives the buyer the right to buy one futures
contract at a specified price which is called the “exercise” or “strike” price. A long put option
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Figure 17.4 Dow–Jones Futures and Options. A put purchased at the arrow on the break would have
protected patiently won gains over the previous 11 months. The increase in the value of the put can
be seen as futures track declining Dow cash. A theoretical drill, but theoretical drills precede actual
tactics in the market.
283Chapter seventeen: A summary a nd concluding comments
on Dow Index futures gives the buyer the right to sell one futures contract at the strike
price. For example, a call at a strike price of 10,000 entitles the buyer to be long one futures
contract at a price of 10,000 when he exercises the option. A put at the same strike price
entitles the buyer to be short one f


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tactics in the market.
283Chapter seventeen: A summary a nd concluding comments
on Dow Index futures gives the buyer the right to sell one futures contract at the strike
price. For example, a call at a strike price of 10,000 entitles the buyer to be long one futures
contract at a price of 10,000 when he exercises the option. A put at the same strike price
entitles the buyer to be short one futures contract at 10,000. The strike prices of Dow Index
futures options are listed in increments of 100 index points, giving the trader the flexibility
to express his opinions about upward or downward movement of the market.
The seller, or writer, of a call or put is short the option. Effectively selling a call makes
the writer short the market, just as selling a put makes the writer long the market. As in a
futures contract, the seller is obligated to fulfill the terms of the option if the buyer exercises.
If you are short a call, and the long exercises, you become short one futures contract at
10,000. If you are short one put and the long exercises, you become long one futures contract
at 10,000.
Buyers of options enjoy fixed risk. They can lose no more than the premium they pay
to go long an option. On the other hand, sellers of options have potentially unlimited risk.
Catastrophic moves in the markets often bankrupt imprudent option sellers.
Option premiums
The purchase price of the option is called the option premium. The option premium is
quoted in points, each point being worth $100. The premium for a Dow Index option is paid
by the buyer at initiation of the transaction.
The underlying instrument for one CBOT
® futures option is one CBOT® DJIASM futures
contract; so the option contract and the futures contract are essentially different expressions
of the same instrument, and both are based on the Dow–Jones Index.
Options premiums consist of two elements: intrinsic value and time value. The
difference between the futures price and strike price is the intrinsic value of the option. If
the futures price is greater than the strike price of a call, the call is said to be “in-the-money.”
In fact, you can be long the futures contract at less than its current price. For example, if the
futures price is 10,020 and the strike price is 10,000, the call is in-the-money and immediate
exercise of the call pays $10.00 times the difference between the futures and strike price,
or $10 × 20 = $200. If the futures price is less than the strike price, the call is “out-of-the-
money.” If the two are equal, the call is “at-the-money.” A put is in-the-money if the futures
price is less than the strike price and out-of-the-money if the futures price is greater than
the strike price. It is at-the-money when these two prices are equal.
Since a Dow Index futures option can be exercised at any date until expiration, and
exercise results in a cash payment equal to the intrinsic value, the value of the option must
be at least as great as its intrinsic value. The difference between the option price and the
intrinsic value represents the time value of the option. The time value reflects the possibility
that exercise will become more profitable if the futures price moves farther away from the
strike price. Generally, the more time until expiration, the greater the time value of the
option because the likelihood of the option becoming profitable to exercise is greater. At
expiration, the time value is zero and the option price equals the intrinsic value.
Volatility
The degree of fluctuation in the price of the underlying futures contract is known as
“volatility” (see Appendix B, Resources, for the formula). The greater the volatility of the
futures, the higher the option premium. The price of a futures option is a function of the
futures price, the strike price, the time left to expiration, the money market rate, and the volatility
284 Technical Analysis of Stock Trends
of the futures price. Of these variables, volatility is the only one that cannot be observed
directly. Considering all the other variables are known, however, it is possible to infer from
option prices an estimate of how the market is gauging volatility. This estimate is called the
“implied volatility” of the option. It measures the market’s average expectation of what the
volatility of the underlying futures return will be until the expiration of the option. Implied
volatility is usually expressed in annualized terms. The significance and use of implied
volatility is potentially complex and confusing for the general investor, professionals having
a decided edge in this area. Their edge can be removed by serious study.
Exercising the option
At expiration, the rules of optimal exercise are clear. The call owner should exercise the
option if the strike price is less than the underlying futures price. The value of the exercised
call is the difference between the futures price and the strike price. Conversely, the put
owner should exercise the option if the strike price is greater than the futures price. The
value of the exercised put is the difference between the strike price and the futures price.
To illustrate, if the price of the expiring futures contract is 7 ,600, a call struck at 7 ,500
should be exercised, but a put at the same or lower strike price should not. The value of the
exercised call is $1,000. The value of the unexercised put is $0.00. If the price of the expiring
futures contract is 7 ,500, a 7 ,600 put should be exercised but not a call at 7 ,600 or a higher
strike. The value of the exercised put is $1,000 and that of the unexercised call is $0.00.
The profit on long options is the difference between the expiration value and the option
premium. The profit on short options is the expiration value plus the option premium.
The expiration values and profits on call and put options can often be an important tool
in an investment strategy. Their payoff patterns and risk parameters make options


$1,000 and that of the unexercised call is $0.00.
The profit on long options is the difference between the expiration value and the option
premium. The profit on short options is the expiration value plus the option premium.
The expiration values and profits on call and put options can often be an important tool
in an investment strategy. Their payoff patterns and risk parameters make options quite
different from futures. Their versatility makes them good instruments to adjust a portfolio
to changing expectations about stock market conditions. Moreover, these expectations
can range from general to specific predictions about the future direction and volatility of
stock prices. Effectively, there is an option strategy suited to virtually every set of market
conditions.
Using futures options to participate in market movements
Traders must often react to rapid and surprising events in the market. The transaction
costs and price impact of buying or selling a portfolio’s stocks on short notice inhibit many
investors from reacting to short-term market developments. Shorting stocks is an even
less palatable option for average investors because of the margin and risks involved and
semantical prejudices.
The flexibility that options provide can allow one to take advantage of the profits from
market cycles quickly and conveniently. A long call option on Dow Index futures profits
at all levels above its strike price. A long put option similarly profits at all levels below its
strike price. Let us examine both strategies.
Profits in rising markets
In August, the Dow Index is 10,000 and the Dow Index September future is 10,050. You
expect the current Bull Market to continue, and you would like to take advantage of the
trend without tying up too much capital and also undertake only limited risk.
285Chapter seventeen: A summary a nd concluding comments
You buy a September call option on Dow Index futures. These options will expire
simultaneously with September futures, and the futures price will be the same as the cash
index at expiration.
Your analysis is bullish, so the 10,500 call (out-of-the-money strike price) is a reasonable
alternative at a quoted premium of 10.10. You pay $1,010 for the call ($100 × 10.10).
The payoff: at the September expiration, the value of the Dow Future is 10,610. Now, your
call is in-the-money, and you exercise it and garner the exercise value less the premium, or
$90.00 = $10.00 × (10,610 – 10,500) – $100 × (10.10) = $1,100 – $1,010. If the Dow future stays
at or below 10,500, you let the call expire worthless and simply lose the premium. This is
the maximum possible loss on the call. If the Dow future increases by 101 points above the
strike price, you break even.
Instead of buying the call option, the trader could have invested $100,500 directly in
the Dow stocks. Given a value of the Dow future of 10,110 in September, he would have had
a gain of $3,030. If he had invested directly in the stocks, however, an unexpected market
decline would have led to a loss.
Exploiting market reversals
The trader expects a reversal of the Bull Market now at 7 ,800 and would like some downside
protection.
He buys a put with a strike price of 7 ,700 (out-of-the-money). The put premium is 9.80,
for a total cost of $980 = $100 × 9.80. If the Index decreases to 7 ,600, with a corresponding
decrease in the futures contract in September, the put is worth $1,000. The maximum loss
is the premium cost, which is lost if the Dow future is above 7 ,700 at expiration. The trader
breaks even if the Dow future decreases by 98 points below the strike price.
Using puts to protect profits in an appreciated portfolio
During a sustained Bull Market, investors often search for ways to protect their paper profits
from a possible market break. Even when fundamental economic factors tend to support a
continued market upside, investors have to guard against unpredictable “technical market
corrections” and market over-reactions to news.
Selling stocks to reduce downside risk is costly in fees and taxes and sacrifices potential
price gains. What is desirable in a sideways market environment is an instrument that
protects the value of a portfolio against a market drop but does not constrain upside
participation. This is precisely what put options are designed to do.
Situation 1
The market is in an uptrend in August, which is when the market lives with the anxiety the
Federal Reserve will tighten short-term interest rates further in the coming months. The
trader has $78,000 invested in the Dow portfolio, and the Dow Future is at 7 ,800.
To hedge his portfolio, he purchases a put option on September futures against a
possible market downturn. He buys a 7 ,600 put at a premium of 6.60, cost $100 × 6.60 = $660.
Buying the put places a floor on the value of the portfolio at the strike price. Buying a
put with a strike price of 7600 effectively locks in the value of the portfolio at $76,000. Above
its strike price, a put is not exercised and the portfolio value is unconstrained. If the trader is
wrong, and the market goes up, he loses the premium paid for the put. Depending on which
strike price he chooses, he increases or decreases downside risk. He breaks even when the
286 Technical Analysis of Stock Trends
Dow future reaches a value of 7 ,534 = 7 ,600 – 66, the strike price less the put premium. At
this level, the unprotected and put-protected portfolios are equally profitable.
The similarity to life insurance is striking. If you do not die, the premium is wasted.
But if you do…
Improving portfolio yields
Situation 2
All markets, as the reader is perhaps aware, are not trending. Days, weeks, months,
sometimes years can pass while the markets grind up and down in what are euphemistically
known as trading range markets. When the astute technician identifies one of these market
doldrums and judges that it will continue, he can reap other returns on his portfolio by
s


do…
Improving portfolio yields
Situation 2
All markets, as the reader is perhaps aware, are not trending. Days, weeks, months,
sometimes years can pass while the markets grind up and down in what are euphemistically
known as trading range markets. When the astute technician identifies one of these market
doldrums and judges that it will continue, he can reap other returns on his portfolio by
selling puts and calls on Dow Index futures.
For example, when the Dow Index is 10,000 and the trader calculates it will not break
out for the next month above 10,200, he sells calls at a strike price of 10,200. The quoted
premium of the 10,200 call is, say, 10.10; selling a 10,200 call generates $1010 income.
The trader pockets the entire premium as a profit if the index remains below 10,200 at the
September expiration. The downside of this trade is that the trader gives up price appreciation
above 10,200. Above 10,200, the combined value of the portfolio and short call premium is
$101,010. The break-even point is 10,301, where the Dow Future is equal to the sum of the strike
price and call premium. Above this point the covered call portfolio becomes less profitable
than the original portfolio. Since the short call is covered by the portfolio, this strategy is not
exposed to the risk represented by a naked call. The main risk is the trader giving up the profit
potential above the strike price of the call. As is obvious to the technician, this is a bad strategy
in trending markets. Only in clearly range-bound markets would an enlightened trader want
to write covered calls. The call premium collected is some compensation for this risk, but cold
comfort when the trader has misanalyzed the market. The best strike price of the call depends
on the probabilities you have assigned to future increases and behavior of the Dow.
Using option spreads in high- or low-volatility markets
Long and short stock positions reflect definite market opinions or analyses. The market will
go up or the market will go down and the moderately competent technician should be right
about this more often than the unwashed general public. In markets of coiling volatility (i.e.,
lower than average volatility and declining), it is sometimes possible to exploit uncertainty
by putting on a long straddle. The long straddle combines a long put and a long call at the
same strike price. This spread generates a return over two ranges of market values: values
below the strike price of the put and values above the strike price of the call. It is a profitable
strategy given sufficient volatility; the editor’s company used such a strategy immediately
before the crash of 1987 for managed accounts and collected disproportionate profits on a
very low-risk position. Experienced speculators and traders generally sell high-volatility
markets and try to backspread (go long) in chosen less-volatile markets, expecting volatility
to return to the mean. Sometimes they do this by writing a short straddle, a position with
a short put and a short call at the same strike price.
Situation 3
In August, a technical analysis predicts that volatility will increase, and the market is in
a coiling process. The direction of prices is uncertain but potentially explosive. The trader
287Chapter seventeen: A summary a nd concluding comments
buys a straddle of a long put at 7 ,800 and a long call at 7 ,800. The quoted call premium is 18.90
and the quoted put premium is 13.90. The total cost of the straddle is $3280 = $100 × 32.80.
This is the maximum loss if the Dow Future stalls at 7 ,800.
The straddle makes a profit when the Dow Future moves enough to recover the cost
of the straddle, either below 7 ,472 = 7 ,800 – 328 or above 8,128 = 7, 8 0 0 + 328. The potential
upside profit is unlimited. The maximum profit on the downside is $10.00 × (7 ,800 – 328),
or $74,720, if the Dow future goes to zero (somewhat unlikely, but one never knows what
Chicken Little the investor will do if he thinks the sky is falling).
Situation 4
In August, the investor calculates options are overvalued and volatility will be lower than
implied volatility. He expects a dormant market to continue through the end of the summer.
He decides to sell the September put and call at 7 ,800, collecting $3,280. The return on this
short straddle will turn negative if the Dow future in September goes below 7 ,472 or above
8,128. The maximum loss on the downside is $10.00 × (7 ,800 – 328), or $74,720, and the loss
on the upside is unlimited. The investor, however, perceives the risk as limited because he
believes the Dow future will neither increase nor decrease to these levels within the next
month when the options expire. In these cases, the trader must also consider catastrophic
risk—as, for example, the editor’s client who was short puts in the crash of 1987 and lost
$57 million.
Perspective
(EN9: Once again, do not practice the methods and techniques described in this chapter without
complete confidence in their use. A course in futures and options is recommended, or professional
consultation.)
I like to tell these stories so prospective options traders and general investors are made
dramatically aware of the potential dangers, as well as the potential profits. As stated
elsewhere in this book, the novice should work to achieve competence and experience before
attempting advanced tricks in futures and options. On the other hand, the investment use
of these instruments for prudent hedging and insurance is recommended to the investor
willing to do his homework, acquire competence, and grow in investment skills.
Dow Index futures and futures options present new techniques of portfolio protection
and profit-making for the general investor. Numerous strategies can be practiced by the
moderately competent investor using these instruments. Keep in mind always that all
the methods of analytical investing espoused in this book are the base discipline—that
is


cquire competence, and grow in investment skills.
Dow Index futures and futures options present new techniques of portfolio protection
and profit-making for the general investor. Numerous strategies can be practiced by the
moderately competent investor using these instruments. Keep in mind always that all
the methods of analytical investing espoused in this book are the base discipline—that
is, knowledge of the instruments and their use, prudent trade management, stop–loss
discipline, and close attention to the dynamics of the situation. Above all, the existence
of these instruments allows the most conservative of investors insurance and hedging
techniques not previously available.
In summation, knowledge of the DJIA futures and options on futures is absolutely
essential for the competent technical investor and trader.
Recommended further study
In view of the importance of this chapter, noted here are references to advanced material,
which are also found in Appendix B, Resources.
288 Technical Analysis of Stock Trends
The CBOE has a website explaining the math behind hedging. To hedge a portfolio of
$500,000 tracking the S&P 500, you need four puts. The address for the calculation of the
hedging ratio is available at http:/ /www.cboe.com/portfoliohedge.
For further study, see the following:
• Options as a Strategic Investment by Lawrence Macmillan, http://www.optionstrategist.
com
• Chicago Board Options Exchange, http:/ /www.cboe.com
• Chicago Board of Trade, 312-435-3558 or 800-THE-CBOT; 312-341-3168 (fax); h t t p : //
www.cbot.com
part two
Trading tactics
Midword
As a kind of foreword to Section II of this book, we might mention a commentary, “On
Understanding Science: An Historical Approach,” by James Bryant Conant, president
emeritus of Harvard.
Dr. Conant points out that, in school, we learn science is a systematic collection of
facts that are classified in orderly array, broken down, analyzed, examined, synthesized,
and pondered; and then lo! a Great Principle emerges—pat, perfect, and ready for use in
industry, medicine, or what-have-you.
He further points out that all of this is a mistaken point of view held by most laymen.
Discovery takes form little by little, shrouded in questioning, and only gradually assumes
the substance of a clear, precise, well-supported theory. The neat tabulation of basic data,
forming a series of proofs and checks, does not come at the start but much later. In fact, it
may be the work of other men entirely, men who, being furnished with the conclusions, are
then able to construct a complete, integrated body of evidence. Theories of market action
are not conceived in a flash of inspiration; they are built, step by step, out of the experience
of traders and students, to explain the typical phenomena that appear over and over again
through the years.
In market operations, the practical trader is not concerned with theory as such. The
neophyte's question, “What is the method?” probably means, actually, “What can I buy to
make a lot of money easily and quickly?” If such a trader reads this book, he may feel there
is “something in it.” He may feel “It's worth a try” (a statement, incidentally, that reflects
little credit on his own previous tries). He may also start out quite optimistically, without
any understanding of theory or any experience in these methods, and without any basis
for real confidence in the method.
In such cases, the chances are great he will not immediately enjoy the easy success he
hopes for. His very inexperience in a new approach will result in mistakes and failures. Yet,
even with the most careful application of these methods, in correctly entered commitments,
he may encounter a series of difficult market moves that may give him a succession of
losses. Whereupon, having no solid confidence in what he is doing, he may sigh, put the
book back on the shelf, and say, “Just as I thought. It's no damn good.”
Now, if you were about to go into farming for the first time, you might be told (and it
would be true) the shade tobacco business offers spectacular profits. But you would not
expect to gain these profits without investing capital, without studying how shade tobacco
is grown and in what kinds of soils and what localities, nor without some experience with
290 Trading tactics
the crop. Furthermore, you would need confidence—faith in the opportunity and also in
the methods you were using. If your first season's crop were blighted (and these things do
happen), you would naturally be disappointed. If it should happen that your second year's
crop were destroyed by a hailstorm, you would be hurt and understandably despondent.
Moreover, if your third season's crop were to be a total loss because of drought, you would
probably be very gloomy indeed (and who could blame you?). But you would not say,
“There's nothing to it. It's no damn good.”
You would know (if you had studied the industry and the approved cultivation
methods) that you were right, regardless of any combination of unfavorable circumstances,
and you would know the ultimate rewards would justify your continuation, no matter how
hard the road, rather than turn to some easier but less potentially profitable crop.
So it is with technical methods in the stock market; anyone may encounter bad seasons.
The Major Turns inevitably will produce a succession of losses to Minor Trend operators
using the methods suggested in this book. There will also be times when a man who has
no understanding of basic theory will be tempted to give up the method entirely and look
for a “system” that will fit into the pattern of recent market action nicely, so he can say, “If
I had only averaged my trades … . If I had fo llowed the Dream Book … . If I had ta ken
Charlie's tip on XYZ … . If I had done i t this way or that way, I would have come out with
a neat profit.”
It would be better, and safer, to understand at the start that no method ever devised


entirely and look
for a “system” that will fit into the pattern of recent market action nicely, so he can say, “If
I had only averaged my trades … . If I had fo llowed the Dream Book … . If I had ta ken
Charlie's tip on XYZ … . If I had done i t this way or that way, I would have come out with
a neat profit.”
It would be better, and safer, to understand at the start that no method ever devised
will unfailingly protect you against a loss, or sometimes even a painful succession of losses.
You should realize what we are looking for is the probability inherent in any situation.
Likewise, just as you would be justified in expecting to draw a white bean from a bag
which you knew contained 700 white beans and 300 black beans (even though you had just
drawn out 10 black beans in succession!), so too you are justified in continuing to follow the
methods that, over long periods, seem most surely and most frequently to coincide with
the mechanism of the market.
Thus, this book should not be given a quick “once-over” and adopted straightaway as
a sure and easy road to riches. It should be read over and over, a number of times, and it
should be consulted as a reference work. Furthermore, and most importantly, you will need
the experience of your own successes and failures so you will know what you are doing
is the only logical thing you can do under a given set of circumstances. In such a frame
of mind, you will have your portion of successes and your failures, which you can take in
stride, as part of the business, will not ruin either your pocketbook or your morale.
In short, the problem stated and analyzed through this whole volume is not so much a
matter of “systems” as it is a matter of philosophy. The end result of your work in technical
analysis is a deep understanding of what is going on in the competitive free auction, what is
the mechanism of this auction, and what is the meaning of it all. Be mindful this philosophy
does not grow on trees; it does not spring full-bodied from the sea foam either. It comes
gradually from experience and from sincere, intelligent, hard work.
Section II of this book, which follows, is concerned with tactics. Up to this point, we
have been studying the technical formations and their consequences. We should have a
good general understanding of what is likely to happen after certain manifestations on the
charts. Knowing that, however, we will still need a more definite set of guides as to when
and how it is best to execute this or that sale.
These chapters are based on one man's experience and his analysis of thousands of
specific cases. It takes up questions of method, of detail, and of application, and should
provide you with a workable basis for your actual market operations. As time goes on, you
will very likely adopt refinements of your own or modify some of the suggested methods
291Trading tactics
according to your own experience. However, the authors feel the suggestions made here
will enable you to use technical analysis in an intelligent and orderly way that should help
to protect you from losses and increase your profits.
John Magee

293
chapter eighteen
The tactical problem
(EN: In this chapter, Magee addresses the question of tactics for the “speculator” who follows short
and medium-term trends. The later sections of the chapter address the question of strategy and tactics
for the long-term investor and provide a discussion of the term “speculator.”)
It is possible (as many traders have discovered) to lose money in a Bull Market—and,
likewise, to lose money trading short in a Bear Market. You may be perfectly correct in
judging the Major Trend; your long-term strategy, let us say, may be 100% right. Except,
without tactics, without the ability to shape the details of the campaign on the field, it is
not possible to put your knowledge to work to your best advantage.
There are several reasons why traders, especially inexperienced traders, so often do so
poorly. At the time of buying a stock, if it should go up, they have no objectives and no idea
of what policy to use in deciding when to sell and take a profit. If it should go down, they
have no way of deciding when to sell and take a loss. Result: they often lose their profits;
and their losses, instead of being nipped off quickly, run heavily against them. Also, there
is this psychological handicap: the moment a stock is bought (or sold short), commissions
and costs are charged against the transaction. The trader knows the moment he closes the
trade there will be another set of charges. Also, since he is not likely to catch the extreme
top of a rally or the extreme bottom of a reaction, he is bound, in most cases, to see the
stock running perhaps several points against him after he has made his commitment. Even
on a perfectly sound, wise trade, he may see a 10% or more paper loss before the expected
favorable move gets under way (see Figure 18.1). Obviously, if he weakens and runs for
cover without sufficient reason before the stock has made the profitable move he looked
for, he is taking an unnecessary loss and forfeiting entirely his chance to register a gain.
The long-term investor who buys in near the bottom and remains in the market to a
point near the top, to later liquidate and remain in cash or bonds until (perhaps several
years later) there is another opportunity to buy in at the bottom, does not face the continual
problem of when to buy and when to sell. This assumes one can tell precisely when such
a bottom has been reached and when the trend has reached its ultimate top (and those are
very broad assumptions indeed). The long-term investment problem for large gains over
the Major Trends is by no means as simple as it sounds when you say, “Buy them when
they’re low, and sell them near the top.” However, such large gains have been made over
the long pull, and they are very impressive. (EN: Note the record of the Dow Theory in Chapters


reached its ultimate top (and those are
very broad assumptions indeed). The long-term investment problem for large gains over
the Major Trends is by no means as simple as it sounds when you say, “Buy them when
they’re low, and sell them near the top.” However, such large gains have been made over
the long pull, and they are very impressive. (EN: Note the record of the Dow Theory in Chapters
4 and 5.)
This section of the book is concerned more particularly with the speculative purchase
and sale of securities.
There are some basic differences between the “investment” point of view and the
“speculative.” It is a good thing to know these differences and make sure you know exactly
where you stand (see Figure 18.2). Either viewpoint is tenable and workable, but you can
create serious problems for yourself, and sustain heavy losses, if you confuse them.
One difference is a speculator deals with stocks as such. A stock, to be sure, represents
ownership in a company, but the stock is not the same thing as the company. The securities
294 Technical Analysis of Stock Trends
of a strong company are often weak, and sometimes the securities of a very weak concern
are exceedingly strong. It is important to realize the company and the stock are not precisely
identical. The technical method is concerned only with the value of the stock as perceived
by those who buy, sell, or own it.
A second difference is in the matter of dividends. The “pure investor,” who, by the way,
is a very rare person, is supposed to consider only the “income” or potential income from
stocks—the return on his investment in cash dividends. (EN: This rara avis is largely extinct
now.) Nevertheless, there are many cases of stocks that have maintained a steady dividend
while losing as much as 75% or more of their capital value. There are other cases in which
stocks have made huge capital gains while paying only nominal dividends or none at all. If the
dividend rate were as important as some investors consider it, the only research tool one would
need would be a calculator to determine the percentage yields of the various issues; hence,
their “value,” which, on this basis, stocks paying no dividends would have no value at all.
From the technical standpoint, “income,” as separate from capital gains and losses,
ceases to have any meaning. The amount realized in the sale of a stock, less the price paid
and plus total dividends received, is the total gain. Whether the gain is made entirely in
capital increase, entirely in dividends, or in some combination of these, makes no difference.
In the case of short sales, the short seller must pay the dividends. Although, here again,
this is simply one factor to be lumped with the capital gain or loss in determining the net
result of the transaction.
CUDAHY PACKINGC UX
1928
SS
SS
H
H
JULY AUGUSTS EPTEMBER OCTOBERN OVEMBERD ECEMBER
76
72
68
64
60
Sales
100’s
125
100
75
50
25
7 14 21 28 4 11 18 25 1 8 15 22 29 6 13 20 27 3 10 17 24 1 8 15 22 29
Figure 18.1 It is possible to lose money owning stocks in a Bull Market. Notice this Major Top
Formation did not occur in 1929, but in the summer of 1928. For more than a year after this, a
majority of stocks and the Averages continued the Bull Market Advance. But Cudahy declined
steadily, reaching a price below 50 well before the 1929 Panic, and continued in its Bearish course
for more than four years, ultimately selling at 20. Except for the somewhat unusual volume on the
head on August 21, this is a typical Head-and-Shoulders Pattern with a perfect Pullback Rally in
mid-November. It underscores what we have mentioned before—a Head-and-Shoulders Top in a
stock, even when other stocks look strong, cannot safely be disregarded.
 The Head-and-Shoulders Pattern, either in its simple form or with multiple heads or shoulders, is
likely to occur at Major and Intermediate Tops, and in reverse position at Major and Intermediate
Bottoms. It has the same general characteristics as volume, duration, and breakout as the Rectangles
and the Ascending and Descending Triangles. In conservative stocks, it tends to resemble the
Rounding T urns.
295Chapter eighteen: The tactical p roblem
Suppose you had bought HT after the decline from its 1929 high of 93 1/2, say at 56,
in the belief that the 37-point drop had brought it into a “bargain” range. On your daily
chart, you would have seen the pattern shown above (which you will now recognize as
a Descending Triangle) taking shape in the early months of 1930. Would you have had a
protective stop at 51? Would you have sold at the market the day after HT broke and closed
below 54? Or would you have hoped for a rally, perhaps even bought more “bargains” at
50, at 48, at 40? Would you still have been holding onto your “good long-term investment”
when HT reached 25 1/2 in June? Would you still have been holding HT when it reached its
ultimate 1932 bottom at less than 3 (see Figure 8.22)? (EN: See Figure 18.4 for a recapitulation
of the lesson from the 2000s.)
There is a third source of confusion; very often, the “pure investor” will insist he has no
loss in the stock he paid $30.00 for, which is now selling at $22.00, because he has not sold it.
Usually he will tell you he has confidence in the company and he will hold the stock until
it recovers. Sometimes he will state emphatically that he never takes losses.
How such an investor would justify his position if he had bought Studebaker at more
than $40.00 in 1953 and still held Studebaker Packard at around $5.00 in 1956 (EN: Or
HUDSON MOTORS HT
1930
JANUARY FEBR UARY MARCHA PRILM AY JUNE
60
56
52
48
44
40
38
36
34
32
30
28
26
Sales
100’s
50
40
30
20
10
4 11 18 25 1 8 15 22 1 8 15 22 29 5 12 19 26 3 10 17 24 31 7 14 21 28
Figure 18.2 What would you have done with Hudson Motors? The great Panic Move of October–
November 1929 carried the Dow–Jones Industrial Average down from its September all-time high
of 386.10 to a November low of 1


HT
1930
JANUARY FEBR UARY MARCHA PRILM AY JUNE
60
56
52
48
44
40
38
36
34
32
30
28
26
Sales
100’s
50
40
30
20
10
4 11 18 25 1 8 15 22 1 8 15 22 29 5 12 19 26 3 10 17 24 31 7 14 21 28
Figure 18.2 What would you have done with Hudson Motors? The great Panic Move of October–
November 1929 carried the Dow–Jones Industrial Average down from its September all-time high
of 386.10 to a November low of 198.69. A rally, bringing the Average back to 294.07 in April 1930,
recovered 95 points, or 51% of the ground lost, a perfectly normal correction.
296 Technical Analysis of Stock Trends
Osborne at $25.00 and $0.00 in the 1980s or Visacalc at similar prices in the same decade. EN9: Or
Enron and WorldCom in the 2000s. Or Bear Stearns, or Lehman, or … ) is hard to say; however,
for him, the loss does not exist until it becomes a “realized” loss.
Actually, his faith the stock will eventually be worth what he paid for it may be no more
than a speculative hope—and a forlorn one at that.
Furthermore, one may question whether his reasoning is always consistent. For
example, suppose another stock this investor had bought at $30.00 was now selling at
$45.00. Would he tell you he did not consider a profit or loss until the stock was sold? Or
would he be tempted to speak of the “profit” he had in this purchase?
It is all right to consider gains or losses either on the basis of “realized” or completed
transactions, or on the basis of the market values “accrued” at a particular time? Yet, it is
not being honest with yourself to use one method to conceal your mistakes and the other
method to accentuate your successes. The confusion of these concepts is responsible for
many financial tragedies. (EN: One might almost say, in the modern context, such confusion
amounts to willful or neurotic behavior. Given the easy availability of portfolio software that marks-
to-market positions, avoidance of this knowledge can only be regarded as self-defeating.)
As a trader using technical methods, you will probably find the most realistic view is
to consider your gains and losses “as accrued.” In other words, your gain or loss at a given
time will be measured with reference to the closing pricing of the stock on that day.
Recapitulating, it is important (1) to avoid regarding a stock and the company it
represents as identical or equivalent; (2) to avoid the conscious or unconscious attribution
of “value” to a stock on the basis of dividend yield, without regard to market prices; and
(3) to avoid confusing “realized” and “accrued” gains or losses.
The technical trader is not committed to a buy-and-hold policy. There are times when it
is clearly advantageous to retain a position for many months or for years, but there are also
times when it will pay to get out of a stock, either with a profit or with a loss. The successful
technician will never, for emotional causes, remain in a situation that, on the evidence at
hand, is no longer tenable.
An experienced trader using technical methods can take advantage of the shorter
Intermediate Trends, and it can be shown that the possible net gains are larger than the
entire net gains on the Major Trend, even after allowing for the greater costs in commissions
and allowing for the greater income tax liability on short-term operations.
It should be understood that any such additional profits are not easily won. They can be
obtained only by continual alertness and adherence to systematic tactical methods. For the
market, regarded as a gambling machine, compares very poorly with stud poker or roulette,
and it is not possible to “beat the market” by the application of any simple mathematical
system. If you doubt this, it would be best to stop at this point and make a careful study
of any such “system” that may appeal to you, checking it against a long record of actual
market moves. Ask yourself whether you have ever known anyone who followed such a
system alone, as a guide to market operations, and was successful. (EN: After Magee wrote
this, many successful traders, aided by computer technology and advances in finance theory, have
created algorithmic systems that have been successful in the financial markets. However, the markets
usually become aware of the success of these systems and develop counterstrategies to defeat them. So
there is a tendency for the performance of mechanical systems to degenerate or totally fail over time.
It is the happy combination of the system with markets hospitable to it that makes mechanical
systems successful over defined periods of time.)
The practice of technical analysis, on the other hand, is not a mathematical process,
although it does involve mathematics. It is intended to search out the significance of market
moves in the light of past experience in similar cases, by means of charts, with a full
297Chapter eighteen: The tactical p roblem
recognition of the fact that the market is a sensitive mechanism by which all of the opinions
of all interested persons are reduced by a competitive democratic auction to a single figure,
representing the price of the security at any particular moment. The various formations
and patterns we have studied are not meaningless or arbitrary. They signify changes in real
values, the expectations, hopes, fears, developments in the industry, and all other factors
that are known to anyone. It is not necessary to know, in each case, what particular hopes,
fears, or developments are represented by a certain pattern. It is important to recognize the
pattern and understand what results may be expected to emerge from it.
The short-term profits are, you might say, payment for service in the “smoothing out”
of inequalities of trends, and for providing liquidity in the market. As compared with
the long-term investor, you will be quicker to make commitments and quicker to take
either profits or (if necessary) losses. You will not concern yourself with maintaining
“position” in a market o


xpected to emerge from it.
The short-term profits are, you might say, payment for service in the “smoothing out”
of inequalities of trends, and for providing liquidity in the market. As compared with
the long-term investor, you will be quicker to make commitments and quicker to take
either profits or (if necessary) losses. You will not concern yourself with maintaining
“position” in a market on any particular stocks (although, as you will see, we will try to
maintain a certain “total Composite Leverage” [or risk and profit exposure] according
to the state of the market, which accomplishes the same result). You will have smaller
gains on each transaction than the long-term investor, but you will have the advantage
of being able to frequently step aside and review the entire situation before making a
new commitment.
Most particularly, you will be protected against Panic Markets. There are times (and
1929 was by no means the only time) (EN: 1987 and 1989 also come to mind. EN9: Add 2001–
2002, if you please: May 2, 2001, Dow 11,350; September 17, 2001, 8,062; March 18, 2002, 10,673;
and July 22, 2002, 7,532), when the long-term investor stands to see a large part of his slowly
accumulated gains wiped out in a few days. The short-term trader, in such catastrophes,
will be taken out by his stop-loss orders, or his market orders, with only moderate losses,
and will still have his capital largely intact to use in the new trend as it develops. (EN: The
best technical analysts’ opinion in “modern times” is that even long-term investors should not grin
and bear a Bear Market. This is a necessity only for bank trust departments and believers in Burton
Malkiel.)
Finally, before we get on with the subject of tactics, the operations we are speaking
of are those of the small and midsize trader. The methods suggested here, either for
getting into a market or getting out of it, will apply to the purchase or sale of odd lots, 100
shares, 200 shares, and sometimes up to lots of thousands of shares or more of a stock,
depending on the activity and the market for the particular issue. The same methods
would not work for the trader who was dealing in 10,000-share blocks (except in the
largest issues) because, in such cases, his own purchases or sales would seriously affect
the price of the stock. Such large-scale operations are in a special field governed by the
same basic trends and strategy, but that requires a different type of market tactics (see
Figure 18.3). (EN: Or, put another way, as Magee said to me one time, a mouse can go where
an elephant cannot .)
Strategy and tactics for the long-term investor—
What’s a speculator? What’s an investor?
In the years since Magee wrote the original Chapter 18 , some different connotations have
attached themselves to the terms “speculator” and “investor.” A great cultural shift has also
occurred. The days when the New Haven (New York, New Haven, and Hartford Railroad)
was a beacon of respectability (and lent luster to its investor) and paid “good dividends”
are gone forever; as is the New Haven. In fact, after the turn of the century, corporations
saw a change in investor sentiment about dividends. Investors wanted capital appreciation
298 Technical Analysis of Stock Trends
and cared less for dividends. In fact, it has lately been considered the mark of a “growth
stock” not to pay dividends. Evidently, the days of the New Haven are gone forever, when
an “investor” was one who bought, held, and collected dividends, and “speculators” were
slightly suspect men like Magee who played the medium-term trends and bought “unchic,
speculative” stocks. It all has a sepia tone to it. Yesterday’s Magee speculator might be called
a medium-term investor today.
Although the term “speculator” could still be applied to anyone who “trades” the
market, today that old-time speculator and his kind would more likely be called traders
than speculators. Commodity traders who have no business interest in the contracts they
exchange are always referred to as speculators, as opposed to commercials, who are hedgers
and users of the commodities they trade. Now “day traders” might be considered the
equivalent of the old-time speculators—except that day trading veers dangerously close to
gambling. And only the passive, in the opinion of this editor, never trade at all and sit on
their holdings during Bear Markets.
On the spectrum of investors, from investor to gambler, the old “New Haven Investor”
who “wants his dividends” is pretty rare these days, and, again, may be one of those trust
departments that does not want to get sued and so stays out of stocks that go up. After all,
prudent men do not “trade in volatile stocks” but “invest in safe issues, like bonds,” which
only lose about 1.5%–2.0% of their purchasing value per year but preserve the illusion of
having “preserved principal.”
ENE LAST-Weekly 01/11/200290
7050
40
30
20
10
1998 1999 2000 2001
Created with TradeStation 2000i by Omega Research 1999
Figure 18.3 If an investor only learned one thing from this book, it would be that one thing might
be the salvation of his portfolio or his retirement plan (if all his assets in the investment plan were
shares of Enron). Instead, the employees of Enron made a major mistake in not having a diversified
retirement portfolio—they had all their eggs in one basket, their income and savings came from one
source. But diversification is not even the crucial lesson here; the lesson is get out of the stock when
it reverses. The corollary of that lesson is never buy a stock in a downtrend. However, the more
important lesson is never buy a stock when it is in a swan dive. So obvious you say, but not so obvious
at the time for portfolio managers for the University of Miami who continued to accumulate Enron
stock even as it neared earth at 100 miles an hour. Of course, they had a sophisticated (?) company;
the Motley Fools had a death grip on the stock


r buy a stock in a downtrend. However, the more
important lesson is never buy a stock when it is in a swan dive. So obvious you say, but not so obvious
at the time for portfolio managers for the University of Miami who continued to accumulate Enron
stock even as it neared earth at 100 miles an hour. Of course, they had a sophisticated (?) company;
the Motley Fools had a death grip on the stock all the way to the bottom.
299Chapter eighteen: The tactical p roblem
One definition of the long-term investor
Let us take as a long-term investor now one who expects to at least track market returns,
for it has been demonstrated over a relatively long period of time that this can be done by
passive indexing. At the turn of the century, as this is written, it would seem neither long-
term, medium-term, nor short-term investors think about the risks involved in matching
the market because, entering the third millennium, it has been so many years since we have
had a really vicious Bear Market. Dow 36,000? This is a passing phase. As each Bull Market
reaches higher and higher, the odds are lower and lower that it will continue— historic Bull
Markets of the 1990s notwithstanding.
What then are the strategy and tactics for the long-term investor to achieve a goal of
matching the market? (EN9: Is it necessary to remind the reader of Chapter 4 and the Dow Theory?)
Let us remark immediately that the tactics Magee described for the speculator—or
trader if you will—are not at all in conflict with the short-term tactics used occasionally
by the long-term investor. As buying or selling time approaches the stops of the long-term
investor, that investor becomes a trader who can and should adopt the trader’s tactics.
Sooner or later, the focus even narrows to real time at the moment of trade execution.
Interestingly, the charting techniques we have described here work on tick-by-tick data in
real time also. Hence, if the trader wants to enter into the real-time environment, he can
attempt to time his trade right down to the real-time chart formations. Only the really active
and skilled long-term investor will be concerned with squeezing the last half point or points
out of his position. This illustration of the time focus is addressed to any investor or trader
or speculator to demonstrate the fractal nature of both price data and the applicability of
Magee-type technical analysis to it.
The strategy of the long-term investor
The strategy of the long-term investor is to catch the long trends—to participate in trades
that lasts months and years. However, this strategy does not intend to be sucked into
long Bear Markets. Rather, portfolios are liquidated or hedged when Bear Market signals
are received. As has been previously seen in examples of the performance of (more or
less) mechanical Dow Theory (see Chapter 4), this kind of performance can be quite
satisfactory—better indeed than buy-and-hold strategies that have come much into vogue
because of the Clinton–Gore Bull Markets of the 1990s.
If the goal is to beat not only the markets but also the mutual funds (only 20% of which
outperform the market over the long term anyway—and sometimes none of them make
money), then passive indexing is the most likely strategy. This may be done in a number of
ways—index funds, buying the basket, buying the futures, and so on. Nevertheless, the most
attractive method might be the use of the Standard & Poor’s Depositary Receipts (SPDRs;
SPY) and DIAMONDS™ (DIA) and the like. The tactics may be calibrated to the risk tolerance
and character of the investor. He might hedge or sell on Dow Theory signals, or on breaks
of the 200-day moving average, or on breaks of the long-term or intermediate trendlines
with a filter (Magee recommended 2%, and this might be calibrated to the character of the
markets and increased to 3% or a factor relevant to actual market volatility). Basing Points
(see Chapter 28) is also a powerful method. Instruments we have previously discussed—
SPDRs, DIAMONDS, index futures, and options—can be used to execute these tactics.
Suffice it to say that every strategy must provide for the plan gone wrong, in other
words, the dreaded Bear Market. Bear Markets would not be so fearsome if the average
investor did not insist on seeing only the long side of the market. Long-term strategies go
300 Technical Analysis of Stock Trends
out the window quickly when blood runs on the floor of the New York Stock Exchange. The
well-prepared technical investor has a plan that provides for the liquidation of positions
gone bad and presumably the discipline to execute it.
This involves the regular recomputation of stops as markets go in the planned direction,
and ruthless liquidation of losers that do not perform. One may think of a portfolio as a
fruit tree. Weak branches must be pruned to improve the yield. Stop computation is treated
in a number of places in this book (see Chapters 27 and 28). For the investor trading long
term, this may be, as an example only and not as a recommendation, the breaking of the
200-day moving average or the breaking of a long-term trendline. The 200-day moving
average is widely believed to be the long-term trend indicator, for which believing will
sometimes make it come true. (EN9: Let me emphasize here that “200” is a parameter and an
example. Personal research may fit a better parameter to the actual market.)
In reality, more than just the 200-day moving average or a manually drawn trendline
should be looked at. The chart patterns comprising the portfolio should be considered also,
as well as charts of major indexes and averages. Also, consider the condition of the averages
and their components—their technical state—whether they are topping, consolidating, or
trending as indicated by their charts.
Moreover, it would be impossible not to mention Magee’s Basing Points Procedure (see
Chapter 28). Possibly the most powerful trailing stop method in


should be considered also,
as well as charts of major indexes and averages. Also, consider the condition of the averages
and their components—their technical state—whether they are topping, consolidating, or
trending as indicated by their charts.
Moreover, it would be impossible not to mention Magee’s Basing Points Procedure (see
Chapter 28). Possibly the most powerful trailing stop method in existence.
Rhythmic investing
In addition, if Chapter 31 on “Not All in One Basket” is weighed seriously, one might be
rolling a portfolio from long to short gradually in natural rhythm with the markets and in
harmony with the Magee Evaluative Index described there. That is the preferred strategy
of the authors and editor of this book.
These things all depend on the goals, temperament, and character of the investor. If
he is going to spend full time on the markets, he is probably not a long-term investor. Such
men eat well and sleep soundly at night. The trader is lean and hungry—not necessarily for
money, but for activity. It behooves one to know his type as a trader or investor. Knowing
one’s type or character is best established before finding it out in the markets, as the markets
can be an expensive place to search for self-knowledge.
There is no inherent conflict in holding long-term positions and also attempting to
profit from intermediate trends, depending on the amount of capital in hand and how
much time, energy, and capital the investor wants to put into trading. A long-term strategy
can be implemented with a modicum of time and energy, as follows: pay attention to the
major indexes and averages and buy on breakouts, at the bottoms of consolidations and
on pullbacks; sell or hedge on the breaking of trendlines, calculated on Basing Points (see
Chapter 28) and the penetration of support zones.
The long-term investor will accept greater swings against his position than the
intermediate-term trader or speculator. As an example with the method of using Basing
Points in Chapter 28, the speculator is using a three-days-away rule, whereas a long-term
investor might be using a three-week Basing Point or some such analogy. Plus, if interested,
when he suspects or analyzes a long Bull Market is approaching a climax, he might adopt
the three-days rule also, or even begin following his stock with a daily stop just under the
market. Beware though, as professionals look for stops just under the close of the previous
day in situations such as these.
It would be wise not to confuse long-term investing with “buy and hold,” or as it was
expressed in one investment fad in the 1970s, “one-decision investing.” As an example of this
301Chapter eighteen: The tactical p roblem
misguided thinking, in 1972, the “best and brightest” investment analysts (fundamental)
on the Street picked a portfolio of stocks for the generation, or 20 years. The companies
would be difficult to argue with as the crème de la crème of American business. After all, who
could kvetch at Avon, Eastman Kodak, IBM, Polaroid (unless he happened to look at Figure
37 .27), Sears Roebuck, and Xerox? Even today, if you did not have a close eye on the market,
you would immediately respond, “blue chips.” Consider the following table showing the
stocks and the results achieved over the long term.
Price Price Percent
Stock 4/14/72 12/31/92 Change
Avon Products 61.00 27.69 (54.6)%
Eastman Kodak 42.47 32.26 (24.0)%
IBM 39.50 25.19 (36.2)%
Polaroid 65.75 31.13 (52.7)%
Sears Roebuck 21.67 17.13 (21.0)%
Xerox 47.37 26.42 (44.2)%
In 2017 , the vagaries of unsupervised portfolios is again seen: Avon 2.50; Kodak 7 .75; IBM
141; Polaroid unlisted; Sears 7 .21; Xerox 32.64. Beware of pundits and mindless investing.
Charts (Figures 18.4 and 18.5) showing activity for IBM and Xerox appear on the
following pages.
45
40
35
30
25
20
15
10
1970 1975 1980 1985 1990
IBM LAST-Monthly 02/26/1993
Figure 18.4 The questionable—even bizarre—results of “one-decision investing” (i.e., buy and hold)
are amply illustrated by this chart. First of all, the “best and brightest” recommended IBM at a
decade high to see it decline by more than 50%. It subsequently recovered to double from their
original recommendation. Ah, sweet justification! Only, unfortunately, at the end of 20 years to see
it rest approximately 40% beneath the recommendation. The analytical lines give some hint of how
a technician might have traded the issue. I like to say that there are bulls, bears, and ostriches, and
anyone who followed this one-decision investment proves my case.
302 Technical Analysis of Stock Trends
Summary
The long-term investor attempts to catch major market moves—those lasting hundreds, if
not thousands, of Dow points and stay in trades for many months if not years.
Within this time frame, he expects to take secondary trends against his position.
Depending on his temperament and inclination, he may attempt to hedge his portfolio
upon recognizing secondary market moves against his primary direction.
His preference for stocks and portfolio will be for market leaders, for baskets that
reproduce the major indexes (or Index Shares) as the ballast for his portfolio, and he may
choose some speculative stocks to add spice to his portfolio.
In spite of his penchant for long-lasting trades he will not tolerate weak, losing, or
underperforming stocks. They are the shortest of his trades. He will cut losses and let
profits run, the truest of the market maxims and the least understood by unsuccessful
investors. The other maxim least understood by investors is “buy strength, sell weakness.”
Truly sophisticated investors attempt to participate in Bear Market trends also. This is
the greatest difference between professional and general investors—professionals have no
bias against the short side.
For the convenience of day traders, the URL of Gamblers Anonymous is noted: h t t p : //
www.gamblersanonymous.org.
Figure 18.5 Like IBM in the previo


estors is “buy strength, sell weakness.”
Truly sophisticated investors attempt to participate in Bear Market trends also. This is
the greatest difference between professional and general investors—professionals have no
bias against the short side.
For the convenience of day traders, the URL of Gamblers Anonymous is noted: h t t p : //
www.gamblersanonymous.org.
Figure 18.5 Like IBM in the previous figure, Xerox was recommended at a place at which it should
have been sold instead of bought. The comments there might apply to the chart here. The foolishness
of “buy and hold” or “one-decision investing” is amply illustrated by observing the long-term swings
of the stock and thus of the investor’s equity. Technical analysis is intended to be an antidote to such
foolishness.
303
chapter nineteen
The all-important details
In this chapter and the one following, we take up a number of elementary suggestions
intended largely for the benefit of those who have never kept charts before. Much of this
will seem obvious and repetitive to the advanced student, although even he may find some
thoughts that will simplify his work. The beginner should read these chapters carefully
and use them for later reference.
The details of how and when you keep the charts will not guarantee you profits, but
if you fail to work out these details in such a way as to make your work easy, as part of
a regular systematic routine, you cannot expect to keep up your charts properly or make
any profits.
Charting and analyzing your charts is not a difficult process, nor will it take too much
of your time if you have determined a reasonable number of charts and have arranged for
doing the work regularly, meaning every day without fail.
You will need a source of data—the day’s market prices and volume. If you live in a
big city, your evening paper will carry the complete list, and you can plan to set aside a
certain period before dinner, or after dinner, or during the evening. If you cannot allot such
a period and keep it sacred against all other social or business obligations, then plan to
do the charting in the morning. The key is to set a definite time and let nothing interfere,
ever, or you are lost. (EN: This process is radically simplified by automated computer downloading
procedures and access to data sources and internet sites, but the principle is the same.)
You should have a suitable place to work and keep your charts. If it is at home, in the
dining room or living room, other members of the family should understand that what you
are doing is important. You should be able to shut the door and work without interruption.
The light should be bright and as free from shadows as possible. (It makes a big difference,
especially if you are keeping a large number of charts.) The ordinary desk lamp throws
a reflected glare directly across the paper and into the eyes. It can be a strain if you are
doing much of this close work. Better to have an overhead light, placed just a few inches
in front of your head and a convenient distance above; and if this light can be a fluorescent
fixture using two 40-watt lamps, you will get almost perfect shadowless lighting. These
suggestions apply in case you are not working by daylight.
Additionally, have plenty of room. A big desk top or a dining room table with a large
clear space for chart books, extra sheets, pencils, scratch paper, ruler, calculator, computer
equipment, and anything else you need. If your working surface is fairly low, say 28 or 29
inches from the floor, it will be less tiring than the usual 30-inch desk height.
Whether you are working in ink or in pencil, pick out the writing tool that is easiest for
you to use. If you are using pencils, try several different makes and degrees of hardness.
Find one that is hard enough not to smudge too easily, and yet is not so hard you have to
bear down to make a clean black mark. The wrong kind of pencil can tire you and irritate
you more than you realize. Also, have plenty of pencils, a dozen at least, well-sharpened,
so as soon as one becomes a trifle dull and you are not getting a clean, fine line, you can
simply lay it aside and continue at once with another freshly-sharpened pencil.
304 Technical Analysis of Stock Trends
Keep your charts in loose leaf books with big enough rings to make turning the pages
easy. Do not overcrowd the books; get new books if a volume is too crowded. Finished
charts may be kept in file folders. The only ones that need to be in the books are the current
sheets and the sheets for the immediately preceding period. If possible, use a seven-ring
binder. Pages are easily torn loose from two- and three-ring binders, but seven rings will
hold the pages safely and you will seldom have one tear out.
The charts you keep will become increasingly valuable to you as the chart history
builds up. The old chart sheets will be very helpful to you for reference. Provide a file or
space where they can be indexed and kept in chronological order, and also have file folders
for brokers’ slips, dividend notices, corporate reports, clippings and articles, notes on your
own methods, and analyses and special studies of the work you are doing.
In this connection you will, of course, keep a simple but complete record of each
purchase, sale, dividend, and so on, on stocks you have bought or sold. This record will
make your work much easier when the time comes to figure out income taxes. It will
also give you all the statistical information you need to judge the results of your trading
operations.
(EN: At the beginning of my investment career, and often in the middle of it, I thought the above
was cracker-barrel wisdom. The longer I last the more I think that homespun wisdom might be the
best kind to have in investing—somewhat like Mark Twain, who was astounded at how much his
father increased in wisdom the older Twain himself got.
We may restate the modest homilies above: Be serio


ions.
(EN: At the beginning of my investment career, and often in the middle of it, I thought the above
was cracker-barrel wisdom. The longer I last the more I think that homespun wisdom might be the
best kind to have in investing—somewhat like Mark Twain, who was astounded at how much his
father increased in wisdom the older Twain himself got.
We may restate the modest homilies above: Be serious. Be methodical. Be disciplined. Be business-
like. Anyone who succeeds in investing without these qualities is the recipient of blind luck and will
be fortunate not to fall into a hole before his career is over.
These thoughts occur when one is wondering how Magee would have viewed the advent of the
microcomputer and its impact on technical analysis and investing. Might he have said, “What hath
this tool wrought?! Wonders and abominations!!”
Given the possibilities for complicating analysis and operations when confronted with all the
bells and whistles of the average computer software package, the investor must maintain perspective.
What, then, are the all-important details in practicing technical analysis with the aid of a computer?)
The simplest and most direct way to use
a computer for charting analysis
In reality, the computer can be used as a simple tool to do a simple job. There is nothing inherently
complicated about keeping a chart on a computer. All computer software packages enable bar
charting and many, if not most, enable many other kinds of charting, from candlesticks to oscillator
charting. The process, in almost all commercially available packages, is so simple that explaining
it here would be superfluous (see Appendix B, Resources, for demonstrations), except to generally
say it consists of retrieving data, updating the program’s price database, and clicking an icon to
run a chart. The software packages themselves explain their features better than can be done here.
What is important here is to give perspective. Even simpler when the whole process takes place
on the internet, as at http://www.stockcharts.com or http://www.bigcharts.com , or http://www.
tradestation.com.
In this respect, charting can be done with quite expensive programs and also on publicly available
free programs or freeware. Charting can also be done with interactive charting programs on many
internet sites. The basic bar chart can be enhanced with an unending number of technical studies—
moving averages, oscillators, and so on. Therein lies the danger. Chart analysis in itself is a qualitative
process. Decorating graphic charts with number-driven information and studies can lead the general
investor astray—and into confusion and indecision.
305Chapter nineteen: The all-i mportant details
Thus, the first preference of this analyst is to keep the process as simple as possible. Get the
data, draw a chart, analyze the patterns, consider the volume, and draw the appropriate analytical
lines—this can usually be done by the program on the screen. Often a better graphic picture may be
obtained by printing the chart and hand-drawing the analytical lines. This brings to the fore one of
the main problems of almost all the software packages—screen graphics are poor and, at least to old
chartists, disorienting. They are especially befuddling to analysts who are accustomed to working
on TEKNIPLAT™ chart paper. With passing editions of Resources, this problem will be dealt with.
(EN9: In the intervening years since the eighth edition, two things have occurred: the editor
adjusted to modern technology and the technology achieved a level of excellence acceptable
to a carping analyst. Internet technical analysis sites such as http:/ /www.stockcharts.com
and http:/ /www.thinkorswim.com improved to be surprisingly valuable resources at
unbelievably low prices—even free.)
The question of graphic representation of the facts is worth noting as a persistent one. To a
certain extent, the individual analyst will solve this conundrum by adapting his eye and mind to a
graphic environment, using one graphic method consistently and seeing how it relates to the facts
in the market. John Magee–oriented solutions to this problem will be available on the website http://
www.edwards-magee.com.
In Appendix B, Resources, the reader may see some examples of simple and inexpensive software
packages and internet sites that are quite adequate to the required tasks of charting technical analysis,
as well as more complex number-driven analysis.
Summary
The computer is an invaluable tool for analysis. Use of it will enable the following:
• Data may be acquired automatically via internet or dial-up sites at little or no cost. Some of
these even offer real-time data, which is a way for the unsophisticated trader to go broke in real
time, but which the general investor may desire on the day of executing a trade. Many of these
sites offer every kind of analysis from respectable technical analysis (usually too complicated)
to extraterrestrial channeling.
• A computer package and internet portfolio sites will give the analyst virtually effortless
portfolio accounting and mark-to-market prices—a valuable device to have to keep the investor
from mixing his cash and accrual accounting, as Magee says.
• The computer will enable processing of a hitherto unimaginable degree. An unlimited number
of stocks may be analyzed. Choosing those to trade with a computer will be dealt with in
Chapters 20 and 21.
• Appendix B, Resources, contains information on software packages that the reader may try
and purchase at quite reasonable prices. In all likelihood, the least expensive of these will be
adequate to the needs of most general investors. In addition, I present a brief discussion of
internet sites and resources.

307
chapter twenty
The kind of stocks we want:
the speculator’s viewpoint
The specifications of the kind of stock we want to chart are fairly simple and few. We want
a stock that will enable us to make a profit


es. In all likelihood, the least expensive of these will be
adequate to the needs of most general investors. In addition, I present a brief discussion of
internet sites and resources.

307
chapter twenty
The kind of stocks we want:
the speculator’s viewpoint
The specifications of the kind of stock we want to chart are fairly simple and few. We want
a stock that will enable us to make a profit through trading operations, meaning a stock
whose price will move over a wide enough range to make trading worthwhile. There are
those who are concerned mainly with safety of principal and the assurance of income
from a stock. For them, there are (EN9: or were) stocks that afford a considerable degree
of stability. You may (and probably will) want to keep a substantial part of your total
capital in stocks of this type. They move in a narrow price range; are extremely resistant
to downside breaks in the market; are also (and necessarily) unresponsive to fast upside
moves in the market as a whole, and are highly desirable for the conservative investor.
They are not, however, the most suitable issues for trading operations, because their swings
are small, and commissions would tend to diminish the narrow trading profits that could
be taken. Also, they do not make the sharp, clear chart patterns of the more speculative
issues, but move in rounding, sluggish undulations. (EN9: These remarks reflect a bygone
time. The described stocks by and large went the way of the Dodo. When T can disappear from the
market as a factor, there is no place to hide, except in bonds, which, when stagnant, only lose real
value at the rate of inflation and loss of purchasing power of the dollar. Even bonds should be subject
to frequent reevaluation using the tools described in this book.) (For illustrations in this chapter,
see Figures 20.1 through 20.4.)
To amplify this comment and explain a bit about what underlies what we are doing,
let us assume a certain company has two issues of stock, a preferred and a common. We
will assume the concern has a certain steady minimum profit it has earned for years,
sufficient to pay the preferred dividend, the continuance of these dividends seems
practically assured. The dividends on the preferred are fixed at, let us say, 6%. Now
the common stock gets all that is left. In one year, there may be $0.50 a share for the
common stockholders. The next year, there may be $2.00 a share or four times as much.
In a case like this, if there are no other factors, you would expect the preferred stock to
sell at a fairly steady price without much change, whereas the common stock is subject
to a “leverage” and might shoot up to four times its former value. The more speculative
issues represent either a business that is, by its nature, uncertain as to net profit from year
to year, where the volume of business or the profit margin fluctuates widely, or one in
which the majority of the “sure” net profit has been sheared off for the benefit of senior
obligations. There are also other factors that affect the speculative swing of a stock, and,
as a result, one issue may be very sensitive and another extremely conservative, and
between them there would be all shades and degrees of sensitivity or risk. It is enough
here to note briefly the nature of the business itself does not always account for the habits
of the stock because the other factors may be very important. Most stocks have a fairly
well-defined “swing” power, which can usually be determined by past performance of
308 Technical Analysis of Stock Trends
GOODYEAR TIRE
COMMON
1943 1944 1945 1946 1947
76
72
68
64
60
56
52
48
44
40
36
32
28
GOODYEAR TIRE
1ST PREFERRED
1943 1944 1945 1946 1947
120
112
104
96
88
80
Figure 20.1 Opportunity vs. Security. Here (at left) is Goodyear Common, representing the residual
interest in all profits after senior obligations have been met, compared (at right) with the Goodyear
$5.00 Preferred, which carries a high degree of assurance that the $5.00 dividend will be met, but
no promise of further participation in profits. Monthly range of each stock for the same 54-month
period is shown on a ratio scale. As the Common makes an advance of more than 300%, the Preferred
advances about 25%, leveling off at a point that represents the maximum price investors are willing
to pay for the sure $5.00 dividend.
SPX LAST-Monthly
Created with TradeStation www.TradeStation.com
88 89 90 91 92 93 94 95 96 97 98 99 00
1500
1400
1300
1200
1100
1000
900
800
700
600
500
400
300
Figure 20.2 S&P . Here the benefits of relaxed long-term investing may be seen, buttressed, of course,
by the longest and handsomest Bull Market in American history in the Clinton–Gore years. At the
end of this record, the effects of public enthusiasm (or as Chairman Greenspan of the Fed said,
“irrational exuberance” vide tulipomania) can be seen in the wide undisciplined swings (best seen
in Figure 20.3). The dotted line represents 150-day (approximately) Moving Average. Just using the
Moving Average as a signal (or the Basing Points Procedure) would have beaten the market and 99%
(the 99%) of other investors.
309Chapter twenty: The kind of st ocks we want: the speculator’s viewpoint
SPY LAST-Daily
Created with TradeStation www.TardeStation.com 144.999
139.999
134.999
129.999
124.999
119.999
114.999
109.999
104.999
99.999
94.999
2400000
2000000
1600000
1200000
8000000
4000000
5/19986/19987/19988/19989/1998 10/1998 11/1998 12/1998 992/1999 3/19994/19995/1999 6/1999 7/19998/1999 9/1999 10/1999 11/1999 12/1999 00
Figure 20.3 SPY. For illustration, here is a chart of the AMEX Index Share, the SPY, or ETF based
on the S&P 500. After the crash of 1998 (the Asian Economic Flu crash), the fan lines tell a story, as
does the last phase of the chart where the market whips in what appears a Broadening Top. (EN9:
Note this Broadening Top was identified in 1999–2000 before the crash as documented in the http:/ /www.
edw