he 1946 Rounding Top at more than 70 (seeFigure 33.3).
If you had been holding the stock, you would have been watching for a substantial corrective move afterthe advance from 12 to 20. In late February and the first week of March, “DG” went into a new BullMarket high-ground, reacted to Support around 19 to 19 1/2, and then advanced again in the week ofMarch 17, failing in this move to make a new high. Ten days later, “DG” had reacted to 18 1/2, closingbelow the previous Minor Bottom. An inexperienced observer, at this point, might have commented“Double Top” and planned to sell “DG” at once or even to make a short sale. The pattern, however, wasnot large enough in duration or extent of price movement to qualify as a Double Top, nor did it conformto any other recognizable pattern of Reversal. Nor was the volume as high as one would expect on animportant Top.
The rally in early April carried through to a decisive breakout of more than 3% in the move that reached22 7/8 on April 18. This move was a near penetration of the middle Top and confirmed the uptrend. If youstill held your long stock, you would not rest easier, and in any case, you would have looked for a chanceto buy on a reaction after the breakout. If you had tried to buy at the 21 1/2 Support Level, you wouldhave been left behind, but if you had put your order in a little higher, say at 22, you would have had a niceprofit on the advance to 25 7/8, where you would have sold on a tight stop at 25 3/4.
Complex or multiple Head-and-Shoulders
The same tactical suggestions apply to these as to the simple Head-and-Shoulders. Definitions and specialfeatures of these formations are covered in Chapter 7.
Rounding Tops and Bottoms
It is difficult to set precise rules for trading on these gradual changes of trend. In the case of RoundingTops, if one is long the stock, the general appearance of a Rounding Formation, extending over a periodof several weeks, leveling off from the rise and then turning down, very likely with a tapering off ofvolume nearing the top of the rise and a pick-up of volume as the turn starts down, would suggest gettingout of the stock at the market as soon as the picture looks more or less definite. A short sale of a RoundingTop could be very profitable; but no exact rule could be stated except, in the absence of fixed BasingPoints, one would want to be very certain the formation was unmistakably a Rounding Top. It would needto be well formed and following a long rise and extending over a period of some weeks in its formation. Itwould also need to be protected with a stop above the Top of the curve, as explained in the chapter onstops.
104
96
88
Sales
100's
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Figure 33.11 A Diamond Pattern in American Can. The daily chart covers the period from December 3,1946, through May 1947, inclusive. For background on this situation, keep in mind that “AC” made itsBull Market Peak in October 1945 when it reached 112. The tendency of high-grade, high-priced stocksto top out early at the end of a Bull Market has already been noted. The first decline carried nearly to 90and was followed by a rally to 106. The stock then dropped to below 80 and a second rally brought us tothe situation we see here.
You will notice at once the moves have a gradual “rounding” appearance, due to the fact, at this price,conservative stocks do not make large percentage moves. If charted on a scale having larger verticalintervals, the patterns would look very much like those in more speculative stocks.
The first part of the pattern is similar to a Broadening Top. The first Minor Peak at 96 is followed by areaction to 92. The second peak carries even higher, to 98; and the reaction this time goes down to 91 1/4.A third rally takes “AC” to 99. So far, we have the five Reversal points of a Broadening Top, needingonly a close below 91 1/4 to confirm the Bearish indications. The next decline fails to break out of thepattern, however, and for several weeks, we have a narrowing picture like a Symmetrical Triangle.
Eventually, the stock makes a clean breakout to 89, which is the signal to get out of longs and to considershort sales on the next rally. As a matter of fact, the three-week rally that started never made an upsidepenetration of the Resistance Level at 94, the level of the apex of the converging lines bounding the latterpart of the Diamond.
American Can did not make a spectacular move down from this point, which is not surprising consideringthe markdown that had already taken place in “AC,” the habits and price of the stock, and the generalcondition of the market. It did not, however, again rise to the level shown here and, in fact, retreated tothe 80 level.
To review the nature of the Diamond—it is not a common pattern. It is somewhat like a Complex Head-and-Shoulders with a bent neckline. It resembles, at the start, a Broadening Top, and its latter phasenarrows like a Symmetrical Triangle.
30
28
26
24
22
20
19
18
17
16
15 Sales 100's 250 200 150 100
50
GULF MOBILE & OHIO RR.
FEBRUARY
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Figure 33.12 Gulf, Mobile, and Ohio builds a beautiful Wedge, as shown on this daily chart for the firsthalf of 1945. This was the move that terminated the spectacular rise of “GFO,” its final Bull Market Top.
Immediately after the downside breakdown from the Wedge, “GFO” came down to 18 3/4, and from thisIntermediate low,


AY
: 6 13 20 27 3 10 17 24 3 10 17 24 31 7 14 21 28 5 42 19 26 2 9 16 23 30
Figure 33.12 Gulf, Mobile, and Ohio builds a beautiful Wedge, as shown on this daily chart for the firsthalf of 1945. This was the move that terminated the spectacular rise of “GFO,” its final Bull Market Top.
Immediately after the downside breakdown from the Wedge, “GFO” came down to 18 3/4, and from thisIntermediate low, which was reached in August, rallied into a long Rectangle between 23 3/4 and 26 3/4from which it eventually broke down in a series of crashes that found it, in May 1947, selling for 6 1/8!
It is rather hard, with a formation of this sort, to say at what precise point the convergence of the trends isestablished. The breakout move late in April was normal; the stock was a buy on the next reaction. Thefollowing advance in May, which reached 23 1/2, did not carry out a Parallel Trend Channel, and we sawa tendency to converge as prices retreated on the reaction. The next three advances all repeated andconfirmed the Wedge picture, and at the top, we see a sort of “bunching up” as prices make little or noheadway. The chances are at 11 an alert trader would have taken profits on long commitments after thehigh volume appeared at the top of the Minor Move ending June 4 and 5. In any case, he would havemaintained a protective stop at all times to take him out if and when a downside breakout occurred.
You would not be likely to be short a stock on a Rounding Bottom. The long and gradual roundingappearance with dull volume, followed by a sudden revival on greatly increased volume, would be signalenough to cover if you should find yourself in this uncomfortable position. Purchases would be justifiedin a stock whose chart showed a Rounded Bottom or Saucer, after the first spasm of activity following along, dull period of dormancy. You would buy, according to the rules we have given for purchases onreactions, not on the breakout, but on the reaction following it, which would almost surely come.
24
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Figure 33.13 A Pennant in Martin-Parry. This type of pattern is fairly common in fast-moving markets.The extraordinary point about Flags and Pennants (and sometimes other Consolidation Patterns in fastmoves) is their tendency to form almost exactly halfway between Bottom and Top.
Just before this move, “MRT” had built a Rectangle between 10 and 12 lasting seven months, whichfollowed the 1944 rise from around 4 to 12. The May breakout on heavy volume carried “MRT” right tothe top of the Pennant without any adequate reaction. Note the increase of volume at the top of that rise.For three weeks prices drifted off with a drying up of volume that is clearly shown in the chart. Thepattern did not correct the entire first phase but found Support at the Minor Peak at 14 1/2.
Suddenly, on high volume, the move was resumed and this time went right up to 24 3/4. The chances aretraders who were still long their original stock or who had bought in around 15 on the Pennant wouldhave sold after the high volume of June 6 when “MRT” reached 19 7/8.
Symmetrical Triangles
A. If you already have a position in the stock. During the formation of
a Symmetrical Triangle, you may be unable to make any change in
your holdings. Let us say you have bought the stock on a reaction after
a Bullish Move. The next upsurge fails to make a new high and gives
no sufficient volume signal to cause you to sell out. The next reaction
fails to carry below the previous one. You are “locked” into the
Triangle, and you cannot safely sell, because the Triangle that has
formed may eventually break out in the original direction and show
you a good profit (in fact, the odds favor that it will break out in that
direction). In case of a breakout move (which must be on increased
volume on the upside), you can close it out for a profit (according to
the rules for trading we have already given) and immediately mark it
as a rebuy on the next reaction. If the breakout is down (whether or not
on increased volume), with a closing outside the Triangle, you should
protect yourself with a tight (1/8 point) stop the next day and continue
to set such tight progressive stops under each day's close until it is
sold.
If you are short the stock, the same rules would apply in reverse, except the
breakout in the right direction (down) would require no volume
confirmation while the adverse breakout (up) would need such increased
volume.
Figure 33.14 This daily chart of Lehigh Valley R.R. through late 1945 and
early 1946 shows a variety of gaps. At this particular time, “LV” was
completing a Secondary Corrective Move before making one more (and as
it turned out, final) effort to exceed the 1945 Top just above 17.

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


direction (down) would require no volume
confirmation while the adverse breakout (up) would need such increased
volume.
Figure 33.14 This daily chart of Lehigh Valley R.R. through late 1945 and
early 1946 shows a variety of gaps. At this particular time, “LV” was
completing a Secondary Corrective Move before making one more (and as
it turned out, final) effort to exceed the 1945 Top just above 17. This long-
term situation could be used for a discussion of Double Tops because the
Bottom of the intervening move was violated in the summer of 1946 and
the stock continued a downward course to below the 5 level.
Not all gaps are significant, as displayed in the first gap on October 3, when
the stock was moving in a narrow range on low volume. The gap on
Saturday, November 3, however, is important because the Saturday volume
(when doubled) is high. The move failed to qualify by a 3% new high
closing as a true breakout, but the implications of the move were Bullish
and might well have justified purchases on Minor Reactions. The low-
volume gaps on these reactions were of no particular interest.
It is not until the third week of January that we see another gap that looks
like a real breakaway. On January 14, with high volume, “LV” moved up
and out in a rush that took it to 15 7/8 on January 16, closing at 15 1/2. The
second appearance of volume here would have suggested application of
progressive stops, and long trades would have been closed out at 15 3/8.
New purchases could have been made on the reaction at 14 1/2. A second
advance accompanied by a Breakaway Gap developed on January 23. If we
consider the second gap (of January 24) a Runaway or Measuring Gap, we
would estimate the probable top of this move at around 17 3/4. When a
third gap appeared on January 28 with a One-Day Reversal and climactic
volume, it would be clear this move was about finished and progressive
stops would be used to clear out longs at 16 3/4.
Note the attempt to rally after the sharp drop and the One-Day Island
formed by two gaps as “LV” fails to hold at the 15 level.
B. If you do not have a position in the stock. Stay away from any
stocks making Symmetrical Triangles until a clear and definite
breakout close has been made. After such a breakout, if on the upside,
buy on the next reaction if the Major Trend is up; on the downside, sell
short on the next rally if the Major Trend is down. Rules for making
such commitments have already been given.
Note: Avoid breakouts from Symmetrical Triangles of the type that have
continued to narrow until the breakout point comes far out toward the apex.
The most reliable breakouts occur about two-thirds along the Triangle.
Right-Angle Triangles
The same rules would apply to Right-Angle Triangles as to Symmetrical
Triangles (see Chapter 8, Important reversal patterns: the triangles). Early
breakouts are more dependable here, as in the case of Symmetrical
Triangles. Volume confirmation is more important on upside breakouts from
Ascending Triangles and is not strictly required on downside breakouts
from Descending Triangles. Commitments already made are retained until
the breakout and then closed out in the same way as any transaction that
shows a gain.
As the Ascending and Descending Triangles carry a directional forecasting
implication that the Symmetrical Triangles do not have, it is possible to
make new commitments on reactions within an Ascending Triangle or
rallies within a Descending one. Since the flat horizontal side of one of
these Triangles represents a supply or demand area of unknown magnitude,
and because such a Triangle can be (and sometimes is) turned back before
the horizontal line has been decisively penetrated, it might be better policy
to note such formations in the making and wait until the decisive breakout
before making the new commitment.
Broadening Tops
Presumably, you would not be long a Broadening Top. The early Reversals
in the pattern would have taken you out of the stock, if you follow the
tactical rules based on trendlines, as previously outlined, long before
completion of the pattern. Neither would you be tempted to buy into such a
pattern because the trend indications would be clearly against a move.
On the other hand, a Broadening Top, after its completion, offers excellent
opportunities for a short sale. After downside penetration and a close below
the fourth point of Reversal in the pattern, you are justified in selling short
on a rally of about 40% of the distance covered from the extreme top (fifth
point of Reversal) and the lowest point reached on the breakout move. The
stop would be placed at the proper distance above the fifth Reversal, that is,
the extreme top of the pattern.
Rectangles
A. If you already have a commitment in the stock. The early moves of a
Rectangle may provide no volume signals to permit you to get out. There
will be no “breakout” moves during the formation of a Rectangle that will
allow you to take a profit. However, as soon as the character of the
Rectangle is well established (which requires at least four Reversals to set
up a clear Top and Bottom), you may trade on the Tops and Bottoms— that
is, sell at or near the Top, or buy at or near the bottom. For, as in the case of
Symmetrical Triangles, there is a definite presumption in such formations
that they are more likely to lead to continuous moves than to Reversals, this
would mean you would probably pass up your first opportunity to get out
(on the fifth Reversal) and would indeed probably decide to “ride along” in
the expectation of a continuation of the original move, which will be in the
“right” direction for your commitment. In the case of a breakout in the right
direction, you would dispose of your commitment according to the rules for
trading already stated. If in the wrong direction, use the tight (1/8 point)
progressive stops, the same as with the Triangles.
B. If you are not committed in the stock. Trades can be made within the
Rectangle on the fifth and subsequ


ll be in the
“right” direction for your commitment. In the case of a breakout in the right
direction, you would dispose of your commitment according to the rules for
trading already stated. If in the wrong direction, use the tight (1/8 point)
progressive stops, the same as with the Triangles.
B. If you are not committed in the stock. Trades can be made within the
Rectangle on the fifth and subsequent Reversals. Due to the slight
probability, the move will eventually continue in the same direction as the
preceding move leading up or down to the Rectangle; thus, it might be best
to wait until the sixth Reversal for new commitments, which would set your
interests in the same direction as a continuation. Also, short sales can be
made after any downside breakout close from a Rectangle or purchases
after an upside breakout close with increased volume. Both the short sales
and the long purchases would be made on the Corrective Move following
the breakout.
Double Tops and Bottoms
Double and Multiple Tops or Bottoms are not valid unless they conform to
the requirements for such formations. Chapter 9 on these patterns should be
read carefully in this context.
A. If you are long a stock. On penetration and close at a price lower than the
extreme Bottom of the pattern between the Multiple Tops, dispose of the
stock on tight (1/8 point) progressive stops.
B. If you are short a stock. On penetration of the highest point of the
Inverted Bowl or rise between the Bottoms, with a close above that point,
close out the short sale on tight stops.
C. If you are not committed in the stock. Consider a penetration and
close beyond the limit of the correction between the Tops (or Bottoms)
as a signal of Reversal and make new commitments on rallies or
reactions.
Right-Angled Broadening Formations
The handling of these on breakouts through the horizontal side would be
similar to what has been said about Multiple Tops and Bottoms, and Right-
Angle Triangles.
The Diamond
If you are sure what you have is a valid Diamond Pattern, the rules for
trading will be the same as those we have already covered in connection
with breakouts from Symmetrical Triangles. As in the case of such
Triangles, new commitments should wait for a definite breakout.
Commitments already in force would have to remain until such a breakout
had occurred, either declaring a Reversal or indicating a probable
continuation of the original trend.
Wedges
There is no need to set forth detailed rules for policy within a Wedge and
during its formation because the general principles taken up in connection
with trendlines and Support and Resistance would take you out of such a
situation at the first opportunity after the convergent nature of the pattern
became clear. At the very worst, your stops (which we hope you maintain
faithfully in all situations) will take you out before the consequences
become serious.
Regarding new purchases (from a Falling Wedge breakout) or short sales
(from a Rising Wedge), the same volume characteristics would be expected:
notably increased volume on an upside breakout from a Falling Wedge and
less pronounced volume action on the first stages of breakout from a Rising
Wedge. New commitments, in line with the implications of the breakout,
may be placed on rallies or reactions after a clear breakout closing occurs,
carrying beyond the trendlines forming the Wedge.
One-Day Reversals
One-Day Reversals are not technical patterns suitable for trading in the
same sense as the important Reversal and Consolidation pictures we have
examined. They are mainly useful as a gauge in helping to find the precise
Top or Bottom of a Minor Move to protect profits on commitments
previously made. The One-Day Reversal, the Exhaustion Gap, and the day
of exceptionally heavy volume following several days of movement in a
Minor Trend are strong indications that the move may have run out. Any of
these three signals is worth watching for; any two of them together carry
more weight than one alone; and the appearance of all three carries very
strong implications of a Minor (EN: or even a Major) Top or Bottom.
Regarding trading on movements signaled by One-Day Reversals, this type
of trading would lie almost in the field of gambling, or at least trading for
quick, small profits on short moves. It would not be the same kind of
trading at all that we have been studying in the greater part of this book.
The indications and some suggestions for trading on those one-day moves
are covered in their discussion in Chapter 10.
Flags and Pennants
In many cases, the total decline from a Flag in an uptrend will bring the
price back to a point at which the stock may be bought according to our
regular trading tactics, namely, the decline may carry down to the Basic
(Red) Trendline, to the Blue Parallel, or make a 40% to 50% correction of
the rising “mast” preceding the Flag. If the “mast” move is the first such
move out of a level or only moderately rising trend, and if the Major Trend
of the market is Bullish, we would be justified in buying at the first
opportunity, which would be on the Blue Parallel. In such a case we would
expect, and ordinarily get, some further reaction, but it is important to get in
early because sometimes the reaction is very brief and does not meet either
of the other requirements for the correction. It is most important in a
situation like this that the volume drop off sharply. Volume must decrease
and remain slight; any increase of volume during the formation of the Flag
should be reviewed as casting suspicion on the entire pattern, except the
increasing volume that characteristically attends the start of the breakout
drive. This drive is usually so virile that we would be safe in placing a tight
(1/8 point) stop under the close of any day during formation of a Flag or
Pennant that showed notably increased volume. Hence, if the volume
indicated failure of the pattern, we would be taken out at once; but if the
breakout was under way, we would pro


g volume that characteristically attends the start of the breakout
drive. This drive is usually so virile that we would be safe in placing a tight
(1/8 point) stop under the close of any day during formation of a Flag or
Pennant that showed notably increased volume. Hence, if the volume
indicated failure of the pattern, we would be taken out at once; but if the
breakout was under way, we would probably be left in because the stock
would ordinarily move up then without a reaction, very often making a
Breakaway Gap.
In downward movements, when the Major Trend of the market is Bearish,
the same suggestions would apply, with one difference. The final high day
of the Flag type of rally may be on high volume and also may show the
Exhaustion Gap or One-Day Reversal. If a short sale has been made into
such a day showing high volume, gap, or One-Day Reversal, a stop order
placed above the peak of the Flag will protect you should the advance be
resumed unexpectedly.
In either the up-moving or down-moving manifestations of this type of
action, there may be Flags having horizontal Tops and Bottoms, which are
Rectangles. If the drying-up of volume and other aspects of the picture,
including the sharp upward or downward move preceding it, suggest a Flag-
type Consolidation, you would be justified in making a commitment on the
sixth Reversal point, or for that matter, at almost any point in the pattern
(because you cannot expect this pattern to continue very long).
Flags and Pennants continuing too long (more than three weeks) are open to
question. Stops should then be set at the usual computed distance above or
below their extreme Tops or Bottoms (as the case may be). The fairly
frequent appearance of Flag-like Formations that eventually fail is
unfortunate because it is particularly hard to give up hoping with this kind
of pattern, and it is necessary to set the three-week time limit to prevent the
stock from drifting all the way back to previously established stop levels.
On the other hand, breakout moves from these patterns, when completed
normally, are among the fastest and most profitable forms of market action.
The question remains what to do in the case of stocks you may be holding
as they go into Flag or Pennant Formation. Obviously, they should be held
if you are long and the move leading to the Flag is up; or short positions
should be retained if the move is down. This would not happen ordinarily,
however, if you had followed the trading rules strictly. In most cases, your
signals calling for tight (1/8 point) progressive stops would have appeared
during the formation of the “mast.” You would have been taken out of the
picture somewhere along the way, possibly at the extreme top of the mast
(although ordinarily, you could not count on being so fortunate).
If no signal should appear and you still are holding a position as the Flag
starts to make its appearance, by all means hold your position. The odds
favor a continuation of the original move.
Now, if you have been holding the stock long (in a Bull Market) and have
seen it break out and start leaping to new highs, say from 20 to 32, and you
have been stopped out at 30, and then you see the price advance, halt, and
during the next several days retreat, with the rather high previous volume
drying up to practically nothing (it must be a drastic drying-up, and no
mistake about it), then you are justified in buying right back in again, even
at a higher price than you received only a few days before.
Gaps
If you are long a stock that is in a well-marked pattern formation, or in an
area of dull movement within fairly narrow limits, and the stock suddenly
breaks out on the upside with high volume and a gap, that is a Bullish
indication. You will hold the stock until signs of exhaustion appear as the
rise continues, or reappearance of high volume, or another gap or One-Day
Reversal. Then, particularly if two or all three of these indications show up
at the same time, you can protect your commitment with tight progressive
stops. You will have to consider whether a second gap should be considered
an exhaustion gap or a continuation gap, depending on the volume and the
speed of the rise, as discussed in the chapters on gaps and their measuring
implications.
19
18
16
15
14
17
Figure 33.15 This daily chart in Northern Pacific, covering six months
during 1944, shows several examples of Support and Resistance. The entire
chart covers only part of the series of Consolidations that took place in 1943
and 1944 preceding the 1945-1946 advance that carried beyond 38.
Support and Resistance phenomena appear on many, in fact, on most of the
charts in this book, and you will find them on the charts you set up for
yourself. There is nothing unique or even unusual about the Support-
Resistance action in “NP.”
Starting at the left in April, after the downside move on volume to 14 1/4,
notice the recovery to 15 5/8 where the move stops at the Resistance Level
of the preceding two weeks. After the formation of the Symmetrical
Triangle, there is a breakaway move with a gap that runs right on up to
above 17, where a small Rectangle is built during the next three weeks. The
stock ultimately breaks down from this pattern on considerable volume. It is
doubtful whether one would want to trade on this as a normal reaction after
the breakout from the Triangle because of the downside volume and the
implications of the Rectangle.
Note, however, how the reaction stops cold at the 15 line, the apex level of
the Triangle, and then moves right on up. Rather surprisingly, there is only a
three-day hesitation at the Bottom of the Rectangle, but a little setback
occurs at the Top of that pattern.
The July Top might be classed as a Head-and-Shoulders or Complex or
Rounding Top; in fact, it is almost a Rectangle, and after the downside
breakout, prices hesitate at the level of the Top of the May Rectangle,
continue down, find temporary Support again at the April Support Shelf
around 16, a


e-day hesitation at the Bottom of the Rectangle, but a little setback
occurs at the Top of that pattern.
The July Top might be classed as a Head-and-Shoulders or Complex or
Rounding Top; in fact, it is almost a Rectangle, and after the downside
breakout, prices hesitate at the level of the Top of the May Rectangle,
continue down, find temporary Support again at the April Support Shelf
around 16, and ultimately wind up a bit under 15. Although “NP” actually
did penetrate and close slightly below the apex of the Triangle, the violation
was barely 3%, and it is interesting to note this September Bottom was the
lowest point reached. From here, the stock started its climb to the 38 level,
which was reached in December 1945.
Ordinarily, after a Breakaway Gap, regardless of whether you sell on the
next Minor Top, you would consider the move Bullish and would prepare to
make a purchase on the next reaction.
Now if you are long a stock and during the course of a sharp rise it develops
a gap after several days of the move, you must make your decision as to
whether or not it is a Continuation (Runaway) Gap. If so, you would
prepare to hold the stock for a further rise approximately equal to the rise
up to the gap. You would watch the approach to the ultimate objective
indicated very closely; on the appearance then of Reversal signals, you
could protect your holding with tight stops.
If you are satisfied a gap following a good rise is actually an Exhaustion
Gap, then you should protect your stock with a tight progressive stop at
once.
In Bear Markets, you would apply these same rules in reverse to your short
sales, remembering a downside breakaway is not necessarily accompanied
by the high volume you expect on an upside breakaway.
Where you are long or short a stock that is moving in a Pattern Formation
and the stock then makes a Breakaway Gap in the adverse direction, the
commitment should be closed out immediately at the market, or on tight
progressive stops.
38
36
34
30
28
26
32

Figure 33.16 Trendlines in American Steel Foundries. This daily chart
shows the tendency of trendlines to develop along straight channels. We
have already pointed out that these channels are frequently easier to see in
retrospect than during their formation, that stocks move in perfect channels
only occasionally, and that all channels come to an end, frequently without
warning. In this case, the long trend channel does give a warning of
Reversal.
In 1946, “FJ” had declined from 48 to a Support Level of 30. From here it
rallied for three months in a Trend Channel that brought us to the February
Top at 37. The next decline broke the previous trend, and volume developed
at the bottom of this break. If you will follow the entire chart, you will
notice volume nearly always shows an increase at the points of Reversal,
which are also usually points of contact with the Trend Channel. Notice also
the way the Corrective Rallies tend to stop at or near the previous Minor
Bottoms in the downward trend, and how reactions tend to stop at the
previous Minor Tops in the upward trend.
Trading on this situation would have been profitable. The Secondary
Intermediate Rally up to February approached the Resistance Level marked
by a 1946 Bottom around 40, and a correction of the drop from 48 to 30
would indicate short sales around 37 (which objective was just barely
reached). Such sales, if made, would have been covered after the first drop
(week of March 1) around 33 1/4. New shorts at 34 1/2 would have been
closed in the week of March 15 at about 31 1/2. Shorts made on the rally of
the March 22 week around 33 would be covered in the week of April 19 at
30. If shorted again, the same week at 31, the sale would have been covered
after the Climactic Bottom in the week of May 24. The combination, here,
of great volume and a One-Day Reversal would have warned against further
shorts.
The Rising Channel, being a Secondary, presumably of limited extent,
would not offer any great inducement to long-side trading in the absence of
other good reasons.
Support and Resistance
When you are long a stock, you do not want to see it violate any Minor
Bottoms previously made. Neither do you want to see it violate any of the
preceding Minor Tops that it has surpassed. Therefore, your stop orders will
be placed at a computed distance, as explained in Chapter 27 on stop orders,
using both the Minor Bottoms and the Minor Tops as Basing Points.
Normally, the Minor Bottom most recently formed will be at the
approximate level of the preceding Minor Top, so that these Basing Points
often will coincide. Ordinarily, therefore, in a rising trend, we look to the
most recently formed Minor Bottom. When the stock has, for three days,
made a price range that is entirely above the entire range of the day marking
this Bottom, you may move up your stop protection to a place indicated by
this new Basing Point.
The same procedure will apply in Bear Markets; the “three-days-away” rule
being used to confirm Basing Points established by Minor Peaks and also
by the preceding Minor Bottoms. Ordinarily, it will be sufficient to use the
Minor Peaks as Basing Points.
Intermediate Tops and Bottoms are used in determining the probable
objectives of Intermediate Moves because previous Tops constitute Support
under Intermediate Reactions, and previous Bottoms indicate Resistance
over Intermediate Rallies.
Multiple Tops are Support Levels. Multiple Bottoms are Resistance Levels.
The neckline of a Head-and-Shoulders Pattern is a Support or Resistance
Level, as the case may be. The apex of a Symmetrical Triangle is a strong
Support and Resistance point that may show its effect again on a subsequent
move. Any congestion or area at a certain price level or within narrow price
limits may provide Support or Resistance when a stock moves again to that
price or range.
Trendlines
We have already gone into the methods of following trends in stocks, and
the use of the Top and Bottom Trendlines (Basic an


l Triangle is a strong
Support and Resistance point that may show its effect again on a subsequent
move. Any congestion or area at a certain price level or within narrow price
limits may provide Support or Resistance when a stock moves again to that
price or range.
Trendlines
We have already gone into the methods of following trends in stocks, and
the use of the Top and Bottom Trendlines (Basic and Return Lines) as
indicators of Bullish and Bearish opportunities, and as price determinants
for executing purchases or short sales.
There remains the tactical problem of the stock in which you are
committed, which is acting badly, but which has neither broken out of a
recognized pattern nor violated an established Minor Peak. This is not a
common situation, but it can present a very difficult problem when it does
come up. Let us say the Major Trend is Bullish, and a certain stock that has
been moving up irregularly in a Parallel Trend Channel confirms its uptrend
by a long, more or less continuous advance and calls for repurchase on the
next reaction. You buy on the reaction, and the stock continues down;
namely, the reaction continues with prices sagging for days and weeks,
without any rallies, Consolidations, or Corrections that are sufficiently well-
defined to serve as Basing Points for stop orders.
In the absence of clear indications during the reaction, and also during the
preceding large upward move, your stop would be placed at a computed
distance below the top of the preceding rise. Plus, if the reaction continues
down until that level is reached, you will have sustained an abnormally
large loss.
In a case like this, you should examine the trendlines making up the long
advance in the Trend Channel. The points of contact with the Basic
Trendline can serve as a fair emergency substitute for Minor Bottoms. Your
stop level, therefore (in the absence of more definite Basing Points), should
be placed at the computed distance below the last point at which the stock
made contact with the bottom trendline and moved decisively up away from
it. If a penetration and close below this point occurs without catching the
stop, sell on tight progressive stops. (EN: The editor feels that such
situations should occur only in positionbuilding or pyramiding cases. Every
effort should be made to join trends on breakout or origination, whatever
the source. There is no excuse for “chasing stocks” in the modern
environment in which literally monitoring all stocks and instructing the
system to alert one to the conditions attending breakouts is possible with a
computer. EN9: On the other hand, human frailty being what it is, we will
all find ourselves chasing a train at some time or other.)
The reverse of this rule would apply to the same type of situation in a Bear
Market, where stops for short sales would be placed at the computed
distance above the point at which the stock made contact with and fell away
from the upper trendline.
The changes of angularity and direction in Intermediate trendlines are
helpful in showing the gradual turning of a Major Trend.
Taylor & Francis
Taylor & Francis Group
http://taylorandfrancis.com
chapter thirty-four
A quick summation of tactical methods
There are three types of tactical operations: (1) getting into new
commitments; (2) getting out of commitments that have moved as expected
and show a profit; and (3) getting out of commitments that have not moved
as expected, whether the transaction shows a profit or a loss.
The principles of taking profits based on trends, Resistance and Support
Levels, measuring implications of patterns, and most especially, on the
daily technical and volume action of the stock, already have been covered.
These profit-taking operations seldom present very difficult problems
because the picture has developed normally and in the way you hoped and
expected it would. The “stepping off” point is usually easy to determine.
The more difficult problems arise in making new commitments correctly,
and in the very important defensive operations of getting out of losing
commitments with the least possible loss.
It should be emphasized that a stock ceasing to act in a Bullish manner
should, therefore, be sold and is not necessarily a short sale on the next
rally. In other words, the signal that shows weakness or failure of a move in
one trend is not always a signal to make new commitments on the opposite
side of the market. More often than not, in fact, it is nothing of the kind.
We know certain moves, such as adverse breakouts from Symmetrical
Triangles or Rectangles, advise us simultaneously to get out of
commitments in what is now clearly the “wrong” direction and to make
new commitments in the “right” direction. The simple failure of a trendline,
however, where the stock merely penetrates an old Minor Bottom without
completing a Head-and-Shoulders or other Reversal Pattern, although
reason enough to get out of commitments that are showing losses, is not
sufficiently conclusive by itself to justify reversing policy and making new
commitments in the opposite direction. Therefore we separate the two types
of signals as follows:
Get out of present commitments
• On adverse breakout from Head-and-Shoulders Formation.
• On adverse breakout from Symmetrical Triangle.
• On adverse breakout from Rectangle.
• On establishment of new Minor low or new Minor high in adverse
direction.
• On adverse breakout from Diamond.
• On adverse breakout from Wedge.
• On One-Day Reversal if marked by heavy volume or a gap.
• On adverse breakout from Flag or Pennant.
• On clear penetration of any Resistance or Support Level in the adverse
direction.
• On an adverse Breakaway Gap.
• On the appearance of an Island after a move in the favorable direction.
• On penetration of basic trendline in the absence of pattern or other
favorable criteria.
Note: It is understood all breakouts must close in the breakout area. A
closing 3% beyond the Support, trend, or pattern is sufficient to give the


ny Resistance or Support Level in the adverse
direction.
• On an adverse Breakaway Gap.
• On the appearance of an Island after a move in the favorable direction.
• On penetration of basic trendline in the absence of pattern or other
favorable criteria.
Note: It is understood all breakouts must close in the breakout area. A
closing 3% beyond the Support, trend, or pattern is sufficient to give the
danger signal. All takeouts are performed by the use of 1/8-point
progressive stops.
Make new commitments
• In line with the Major Dow Trend, or to a limited extent in countertrend,
moves as insurance to reduce overall risk.
• On breakout from Head-and-Shoulders Pattern.
• On breakout from Symmetrical Triangle, provided it is not working into
the final third of its length toward the apex.
• On breakout from Right-Angle Triangle.
• On breakout from Rectangle, or (possibly) on points of contact, beginning
with the sixth Reversal.
• On breakout from a Broadening Top.
• On breakout from Double or Multiple Top or Bottom. (Namely breakout
through the Bottom of the valley between Tops, or upside penetration of the
“dome” between Bottoms.)
• On breakout from Wedge, or (possibly) commitments within the Wedge in
the last third of its length as it approaches its apex.
• On Flags and Pennants, after sufficient Secondary or Corrective Move by
the pattern, or (possibly) within the pattern, provided volume and all other
indications tend strongly to confirm the pattern.
• On clear penetration of a well-defined Support or Resistance Area.
• On Breakaway Gap (possibly).
• After formation of an important and well-defined Island following a
considerable move.
• On contact with, or penetration of, the “favorable” trendline if both
trendlines are moving in the Major Trend direction. (Blue Top Trendline in
a Bull Market, Red Bottom Trendline in a Bear Market.) Note: Breakouts
and penetrations must show a closing in the breakout area and must
conform to volume requirements. Breakout closings should conform to the
3% rule.
New commitments (marked “possibly”) may be made in certain cases
within some patterns: Rectangles, Wedges, Flags, and Pennants.
Exceptional care should be used in such cases.
It is extremely difficult to catch Breakaway Gaps; we would not
recommend this as a general practice. (EN: This is not so difficult as it was
in Magee's time thanks to modern communications, computers, and access
to the internet.)
All commitments, except those just noted, are made on the next following
reaction or rally, to rules previously stated.
All commitments are protected by stops from the moment they are made.
Stops are moved, as conditions justify moving them, but always in the
favorable direction, never in the adverse direction.
chapter thirty-five
Effect of technical trading on market action
The question often is asked whether the very fact that traders are studying
methods and patterns tends to create those very patterns and trends—in
other words, whether the technical method sets up, to some extent, an
artificial market in which the market action is merely the reflection of chart
action instead of the reverse.
This does not seem to be true. The charts we make today seem to follow the
old patterns; the presumption is very strong that markets have followed
these patterns long before there were any technicians to chart them. The
differences mentioned briefly in Section I, due to changed margin
requirements, restraining of manipulative practices, and so on, seem to have
changed these habits, if at all, only in degree and not in their fundamental
nature.
The market is big, too big for any person, corporation, or combine to
control as a speculative unit. (EN9: And even beyond big in the twenty-first
century. Gargantuan.) Its operation is extremely free and extremely
democratic in the sense it represents the integration of the hopes and fears
of many kinds of buyers and sellers. Not all are shortterm traders; there are
investors, industrialists, employees of corporations, those who buy to keep,
those who buy to sell years later—all grades and types of buyers and
sellers.
What is more, not all short-term traders are technicians by any manner of
means. There are those who trade on fundamentals for the short term, and
those who rely on tips, hunches, on reading the stars, or on personal
knowledge of the company. They are all part of the competitive market and
all use methods different from yours—and sometimes they will be right and
you will be wrong.
The technician using the various tools of technical analysis, Dow Theory,
Point-and-Figure charts, oscillators, scale order systems, and monthly,
weekly, and daily charts is in the minority. The cold attempt to analyze a
situation on the basis of the market record alone does not appeal to many
people. Technical analysis leaves out the warmth and human interest of the
boardroom, the trading room, the fascinating rumors of fat extra dividends
to come, the whispered information on new patents, and the thrilling study
of the quarterly earnings reports. (EN9: Unless I am mistaken the only
appearance of irony in Magee's work.)
It is the influence of all these rumors, facts, and statistics that causes people
to buy and sell their stocks. It is their actions that build the familiar chart
patterns. You are not interested in why they are doing what they are doing.
So far as your trading is concerned, you are interested only in the results of
their actions.
The habits and evaluative methods of people are deeply ingrained. The
same kinds of events produce the same kinds of emotional responses,
hence, the same kinds of market action. These characteristic approaches are
extremely durable. It is not quite true that “you can't change human nature,”
but it is true it is very difficult to change the perceptive habits of a lifetime.
Considering the “orthodox” investors greatly outnumber the technicians, we
may confidently assume technical trading will have little or no effect on the
typical behavior


the same kinds of market action. These characteristic approaches are
extremely durable. It is not quite true that “you can't change human nature,”
but it is true it is very difficult to change the perceptive habits of a lifetime.
Considering the “orthodox” investors greatly outnumber the technicians, we
may confidently assume technical trading will have little or no effect on the
typical behavior of free markets.
(EN: This statement by Magee is still true in principle and it should be
noted in modern markets professional investors attempt to learn (or
perhaps it is “the mysterious and anomalous market”) what makes systems
and other investors successful. They then take action to frustrate those
methods, which are inimical to their self-interest. For example, locals and
professionals will search for stops above a congestion zone in an attempt to
cause the market to break away. This might be in an attempt to create a
trend or it might be in an attempt to create a Bull trap.
The proliferation of systems trend traders in the futures markets has, some
of those traders feel, created conditions hostile to systems traders as a
group. The moral of the story is the trader-investor must be ever alert for
the false move and the changing rhythm of the markets.
No one has been able to quantify chart analysis or to disguise his own
activities from the x-ray of the charts. Nor has anyone changed human
nature to eliminate treachery and perfidy and truculent defense of self-
interest.)
(EN9: And—dramatic drum roll—in 2005, Smith-Barney fires its entire
technical analysis staff. What to make of this is left to the imagination of the
reader. Some commentators attribute it to the Bearish outlook of the
technical staff as opposed to the need of the firm to sell long positions to its
customers. In my view, an unintended validation of the craft. When you
have to shoot the messenger, it says something about the state of the market,
as well as something about the industry.
Also, in conversation at a meeting of the Technical Securities Analysts
Association of San Francisco (http://www.tsaasf.org), Larry Williams said,
“I hate technical analysis.” I am reasonably certain the “technical
analysis” referred to is number-driven analysis.)
chapter thirty-six
Automated trendline: the
Moving Average
In 1941, we were still filled with starry-eyed ignorance and felt if only we worked hard enough and lookedshrewdly enough, we would discover the sure, unbeatable formula or system that would solve all our problems inthe stock market, and all we would have to do for the rest of life was apply the magic and telegraph our brokerperiodically from Nassau, or Tahiti, or Switzerland, or wherever we happened to be enjoying life at the time.
We have learned (we hope) quite a bit since then. We have learned most particularly a number of things not to doand by not repeating the same errors over and over, we have been able to improve our performance substantially.We have also learned (to date) (EN: still true in the twenty-first century) there are no sure, unbeatable formulas orsystems in the market, even the most useful and generally dependable forecasting methods must be regarded asstatements of probability only, subject to revision and vulnerable to failure at all times.
One of the useful tools, and one of the first many students of market action adopt, is the trendline. Whether a stockis moving generally up or down or sideways, there seems to be a tendency for the Major Trend to persist. It is trueevery trend is broken sooner or later, and the fact that it has been broken is often significant. But given a well-established trend, the probabilities certainly appear to favor its continuance rather than its Reversal.
As with all other market studies, however, there are times and conditions in which the simple trendline actionseems “not quite good enough.” One feels there should be some mechanical or mathematical way of determiningthe trend that might avoid some of the perplexities of choosing the right point through which to draw a trendline. Itwas back in 1941 when we delightedly made the discovery (although many others had made it before) that byaveraging the data for a stated number of days, weeks, or months, one could derive a sort of Automated Trendlinethat would definitely interpret the changes of trend over the past 30 days, or 200 days, or 12 months, or whateverperiod was chosen. It seemed almost too good to be true. As a matter of fact, it was too good to be true.
The Moving Average is a fascinating tool and has real value in showing the trend of an irregular series of figures(like a fluctuating market) more clearly. It also has value in the fact it can be used to cancel out the effect of anyregular cyclical variation, such as a normal seasonal range of temperatures, to get a better picture of the truesecular trend.
The trouble with a Moving Average (which we discovered long since but keep bumping into from time to time) isit cannot entirely escape from its past. The smoother the curve (longer cycle) one has, the more “inhibited” it is inresponding to recent important changes of trend. Plus, there is a very bad fault of Moving Averages in that “the tailtends to wag the dog”; the figures back to the first date of the current tabulation, perhaps six months ago, or a yearago, if they are large, may unduly affect the present average, and may conceal or mask some important feature bydistorting the curve. We feel the Moving Averages trendlines are useful, but they should be understood and usedwith discretion and with a full perception of their limitations.
After going through some of the caveats of Moving Averages, let us give you some of the ways to construct them.Moving Averages can be classified as Simple Moving Averages, Weighted or Exponential Moving Averages, andLinear Moving Averages. We have found over the years, and prefer, the simple methods that work just as well andsometimes better than the more complicated Moving Averages,


limitations.
After going through some of the caveats of Moving Averages, let us give you some of the ways to construct them.Moving Averages can be classified as Simple Moving Averages, Weighted or Exponential Moving Averages, andLinear Moving Averages. We have found over the years, and prefer, the simple methods that work just as well andsometimes better than the more complicated Moving Averages, while the others are more useful when usingcomputers.
For this reason, we will concentrate on Simple Moving Averages. The most common are the 50-day and the 200-day Moving Averages. If you want to increase the sensitivity of a Moving Average, shorten the Moving Average byusing 10 or 20 days. Another way is to increase the lead time by starting on the third day for the 10-day MovingAverage, or on the 20th day for a 50-day Moving Average, and so on.
To construct a Simple Moving Average, whether it is 5 days, 10 days, 50 days, or 200 days, add the price of 5 daysand divide by 5, or the 10 days and divide by 10, or the 50 days and divide by 50, or 200 days and divide by 200. Asimple way of doing the five-day Moving Average, instead of adding all five prices each time, is to drop day one
and add day six. A similar method can be used in calculating the 50-day Moving Average or the 200-day MovingAverage. Instead of adding the 50-day Moving Average each time, just drop the first day of the previous averageand add the 51st day. The same with the 200-day Moving Average; drop the first day of the previous 200 and addthe 201st day. Another way of calculating the 200-day Moving Average is to take one day of the week of 30 weeks,such as Wednesday or Thursday, add them, and divide by 30. This will give you the same Moving Averages as youwould have doing 200. Another way to put it is, on the second day, take the total, add the new day's price, andsubtract the oldest day's price from your 5-day, 10-day, 50-day, or 200-day Moving Average, whichever way youare doing it. Repeat the process on a daily basis and divide by the representative day—for the 5 day, you woulddivide by 5; for the 10 day, you would divide by 10; for the 50 day, divide by 50; and for the 200 day, you woulddivide by 200.
Sensitizing Moving Averages
The shorter the time period, the greater the sensitivity you will develop in your Moving Average. The 5-dayMoving Average will be much more sensitive than a 10-day. The problem with short-term Moving Averages is youcan have a greater number of false moves. Shorter Moving Averages are more suitable for commodities. Oncommodities, we would even advise using a 30-hour, a three-day, and a six-day Moving Average.
It is often better to use two Moving Averages, one of shorter duration and one of longer duration. In addition, youcan use channels, a Moving Average of lows and a Moving Average of highs. (EN10: In the markets of the 2000s,the most watched Moving Averages are the 50-day and the 200-day. In fact, these two have gained almost iconicstatus.)
Crossovers and penetrations
As a general rule, consider the crossing of two lines (EN10: as 50 and 200) by the price line as a sell or buy signalin the direction of the crossover or penetration.
1. Uptrends—Long positions are retained as long as the price trend remains above the Moving Average Line.
a. When the price line intersects or penetrates the Moving Average Line on the upside, it activates a buysignal.
b. When the price line goes above the 200-day Moving Average, but falls sharply toward it withoutpenetration, it is a possible buy signal. Additionally, conditions at the time must be closely observed.
c. When the price line falls below the Moving Average Line while the line is still rising, it could be a buysignal.
d. When the price line spikes down too fast and far below a declining Moving Average Line, a short-termrebound toward the line may be expected: a possible whipsaw trap.
2. Downtrends—Short positions are held as long as the price trend remains below the Moving Average. Whenthe price trend reaches a bottom and turns upward, a penetration of the Moving Average is a possible buysignal.
a. When the price line moves above the average line while the average line is still falling, it is a sell signal.
b. When the stock price line moves below the average line and rises toward it, but fails to penetrate andbreaks down again, it is a possible sell signal.
c. If the price line rises too fast above the rising average line, a short-term reaction may be expected: could bea whipsaw.
d. Occasionally, penetration of the Moving Average Line will occur in close conjunction with the penetrationof a trendline, and then according to its direction, it is a buy or sell signal.
3. Horizontal, Diagonal, or Sideways Movements—If the fluctuations are broad in comparison to the lengthof the Moving Averages being used, the price trend will fluctuate back and forth as the Moving Average, trueto its character or purpose, moves horizontally. The trader must be alert to the need to change tactics.
4. Gaps—Moving Averages, depending on their length, may have a tendency to be penetrated in proximity toa Breakaway Gap, particularly at the beginning of a Major Phase of an Intermediate cycle, and also in suchcases in which Breakaway Gaps occur at the beginning of correction phases.
Area Patterns can be a pitfall for the Moving Averages. Normally, the Moving Average oscillates through thecenter of these areas, producing buy and sell signals in rapid succession. In Area Patterns, the Moving Average is aheadache to the trader because he never knows which penetration is the one preceding either the renewal of thetrend or the Confirmation of a Reversal.
When trading areas develop in the form of Triangles—Descending, Declining, or Symmetrical—the MovingAverage will trend through the center of the Triangle. The technician has some small advantage in judging whichof the series of penetrations of a Moving Average is the important one. When the Triangle reaches its apex and thestock breaks ou


the renewal of thetrend or the Confirmation of a Reversal.
When trading areas develop in the form of Triangles—Descending, Declining, or Symmetrical—the MovingAverage will trend through the center of the Triangle. The technician has some small advantage in judging whichof the series of penetrations of a Moving Average is the important one. When the Triangle reaches its apex and thestock breaks out in one direction or another and penetrates the Moving Average, the penetration is likely to be themost important one during the sideways movement of the Triangle's development. Penetrations occur many timesin close conjunction with the penetration of a trendline.
As a price derivative product, the Moving Average can be a trend indicator by the way it fits a trendline.Nevertheless, it should be considered an adjunctive tool to everything else you have learned in relation to technicalanalysis.
(EN10: Magee had, and I have, an instinctive aversion to mechanical systems. We want to see and feel the analysisand the moment and consider the context and the subtle variables. A mechanical system of any type—and aMoving Average system is not bad in broadly trending markets—is blind. It will throw your capital in front of anon-rushing train and merrily hum along while the
Figure 36.1 150-day Moving Average (dotted line). Up to the 1980s (the period during which Ronald Reagantripled the national debt) trading the 150-day Moving Average (buying on an up crossover and selling on a downcrossover) gave a trader somewhat the same advantage that trading the Dow Theory afforded. In the 1980s, thesystem stopped working. Here in 1929 it would have been a lifesaver, as can be seen. Not illustrated here is whatthe Moving Average does in a Dow Line, or rectangle or congestion pattern. If taking signals on crossovers onecould find his capital ground to hamburger meat.
market is eating your lunch. I have called these “unnatural” systems—they interpose an algorithm between thetrader and the facts. This reduces decision-making stress but can go badly awry in some types of markets.)
A 150-day Moving Average is charted in Figure 36.1.
The PENTAD Moving Average system from Formula Research
One of the solid and prestigious technical research firms in the country is Ned Davis Research, Inc. (NDR). NelsonFreeburg of Formula Research has taken one of NDR's systems and tweaked it to yield what may be an effectivelong-range approach to the market. It is presented here because Magee was interested in Moving Average systems,as well as investors who are graphically challenged, meaning they can relate to numbers but not to pictures.
Freeburg took an NDR Moving Average system and a 20-week Moving Average, added a filter, and produced asystem that reportedly has an 80% profitability on signals and generated returns in the 15% range going back to1942. Since 1980, returns averaged 19%. We all know (or the reader can quickly demonstrate to himself with asoftware package) that a Moving Average tends to create whipsaws in a sideways market. As the market movessideways, the Moving Average moves through the pattern creating buy and sell
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(Nov| Dec | 94 [Feb |Mar|Apr |May| Jun | Ju. ’Aug | Sep (Oct ]Nov| Dec ] 95 | Feb ] Mar
Figure 36.2 Looking at the top chart, we can see the deleterious effects of using a Moving Average system in asideways market. Of course, at the end in January 1995, the system gets ready to cash in big time. You will nevermiss a big market with a Moving Average system—if you have any capital left after the whipsaws. Yet when a 1%filter is added, the number of trades is dramatically reduced and the accuracy improved. Something systems tradersnever think of is a qualitative filter—looking at the context when price crosses the average. What is the volumeand what is the price action? Also, the trader can experiment with different-size filters and filtering conditions.
signals as price oscillates about it. In a common-sense move, Freeburg added a filter to the system thatimmeasurably improved it. Readers should be aware we include this method because experience tells us this kindof system can be effective, but we have not validated the research. Also, any system including the 1990s isguaranteed to have good, if not spectacular, results. Diagrams illustrating the idea are shown in Figure 36.2.
Taylor & Francis
Taylor & Francis Group
http://taylorandfrancis.com
chapter thirty-seven
The same old patterns
To the newcomer, the market appears filled with wonders and mysteries as the landscape of Mars will appear to thefirst space travelers to land there. There are strange rumblings, apparently unexplainable upheavals, weird growths.An unknown stock will suddenly emerge from a morass of debt and deficit and proceed to soar to great heights. Anold and trusted issue will paradoxically sag and droop, although apparently rooted in the soil of economic stability.All will seem peaceful and secure, and, suddenly, the ground opens up and swallows values in a sensational marketbreak. (For illustrations in this chapter, see Figures 37.1 through 37.54.)
Such a newcomer, perhaps not realizing what appears unusual and alarming is only the normal fluctuation andadjustment that goes on continually in the market according to the changing evaluations of millions of investors,will feel frightened, insecure, and indecisive. He may scur


p and swallows values in a sensational marketbreak. (For illustrations in this chapter, see Figures 37.1 through 37.54.)
Such a newcomer, perhaps not realizing what appears unusual and alarming is only the normal fluctuation andadjustment that goes on continually in the market according to the changing evaluations of millions of investors,will feel frightened, insecure, and indecisive. He may scurry from boardroom to boardroom, personally or on thetelephone, scan the financial pages, talk with friends, accumulate a mass of conflicting information, and end upshutting his eyes and making a blind stab in the hope he may come up with the right answer.
Some never, even after years of contact with the market, achieve a tranquil and assured approach.
However, it is possible to learn something about the basic nature of stock trends. It is possible to know, withinreasonable limits, about what might be expected in certain situations. It is also possible to find ways of coping withthese situations, including the exceptional cases that persist in doing the unexpected. To repeat: it is possible todeal successfully with the unexpected and with what cannot be precisely predicted.
To put it another way, it is possible to be wrong part of the time and still to be successful on the balance. To dothis, it is only necessary to have a background of experience sufficient to know what will usually happen underparticular conditions, about how often the unexpected will occur, and how to deal with the unexpected when itdoes happen. These are the same general problems that would confront the space traveler, the chemist, thephysician, or almost anyone else in his daily affairs.
There are men who have observed the market long enough and carefully enough to discover there are not quite somany unexpected events as the newcomer might be led to believe.
The charts in this book are, in the main, the same as those used for examples in the first edition in 1947. Some ofthem show situations from 1928 and 1929, others from the 1930s and 1940s. (EN: And still others from the 1980s,1990s, and 2000s.) The reader can hardly overlook the similarities that occur in various stocks at different timesduring corresponding phases of their trends or turning points.
We have said that these same patterns, trends, and Support/Resistance phenomena repeat themselves over and overagain, and that they may be observed by anyone in his own current charts for any period of time, in any normallyactive stocks, and on any exchange or market.
By way of demonstration, there were included in this chapter of the fifth edition a number of typical technicalexamples, similar to those already discussed, but taken from
Figure 37.1 A 1952 Major Head-and-Shoulders Top in U.S. Smelting, Refining and Mining. This stock had movedup from a bottom at 33 in 1950 to the peak at nearly 88 shown here. The decline carried down to 37. This chartshows the typical high volume on the left shoulder. The volume at the head is a little higher than in the “ideal”pattern. Light volume on the right shoulder is a definite warning. Notice the Pullback Rally to the neckline in thelast week of August. Also, the Secondary Recovery in November and December. There also appears, at the left sideof this chart in 1951, a beautiful example of an Ascending Triangle, indicating the resumption of the previousinterrupted advance.
the period 1947-1966. (EN: The eighth edition includes examples taken up through the turn of the millennium.) Itwould be possible to include ten times the number of good examples, for almost every situation that has beenpreviously illustrated has appeared again and again in recent years.
Not all the same
Although a majority of stocks will participate in a big market trend, they will not all move at the same time or tothe same degree. Some will move quite independently and contrary to the Averages. There was a “boom” in the1920s and there was a Panic in October 1929, but these are inadequate statements, half-truths if you will, and canbe very misleading if they are swallowed whole. A technician, following the individual behavior of stocks, wouldhave been able, through a balanced and diversified portfolio, to protect himself against irreparable loss.
The facts are that of 676 stocks we have studied through the period 1924-1935, only 184 made a Bull Market Topin August-September-October 1929 and suffered Major Declines in October and November of that year. Therewere 262 stocks actually in Major Downtrends before the year 1929. Another 181 stocks made their Bull MarketTops in the first nine months of the year and were already moving down before the end of the summer. Five stocksdid not start their decline until after 1929 and 44 stocks continued to make new highs after 1929. In Figures 37.9through 37.11, there are three stocks showing very different trends during the years 1927-1930.
Figure 37.2 Downtrends seldom show the perfect and regular trendlines we often see in uptrends, but in spite ofthe irregular, ragged rallies and spotty volume action, the basic principles are about the same as for advances.Notice in this six-month period, Inspiration Copper had no rally that carried above the Top of a preceding rally. Awell-marked downtrend of this sort must be presumed to continue until there is a marked change in the pattern andvolume action. Notice the volume on the day “IC” broke the historically important 52 level, and subsequent action.

Figure 37.3 Part of the Major Advance in Granite City Steel. Here we see the familiar phenomenon of Support andResistance in almost every move through the period shown.
The August-September Rectangle held for six weeks between the top limit of 47, which was reached on threeoccasions, and the bottom at 44. Like most Rectangles, it was marked by heavy volume at the start on July 19, andgradually declining volume as the pattern progressed. The breakout move on August 29 was on enormous volume.
After this breakout, there was a typical Flag-l


through the period shown.
The August-September Rectangle held for six weeks between the top limit of 47, which was reached on threeoccasions, and the bottom at 44. Like most Rectangles, it was marked by heavy volume at the start on July 19, andgradually declining volume as the pattern progressed. The breakout move on August 29 was on enormous volume.
After this breakout, there was a typical Flag-like reaction on sharply diminished volume, and although this movepenetrated the top border of the Rectangle, the penetration was not decisive or significant, and the lower borderwas never violated. Now, see how volume appears on October 15 as the old high is reached, and again at the top ofthe move on November 14. The decline returns to the level of the September high on a low-volume reaction. It isinteresting how, on five occasions in this chart, the 52 level served as a Support or Resistance point: twice asResistance on the way up, and three times after the new October high, as Support.
On the next rise, we see almost the same type of advance. In this case, the Support-Resistance Level is about 57.Notice the approach to the critical level, the backing away, the aggressive move into new high ground (in mid-December), and the recession to the Support at 57.
Advances of this sort seem to represent the ebb and flow of the Minor Moves during a Major Trend when there areno great “news developments” to change the normal progress of the trend. Where there are frequent and importantchanges in the market or in news affecting the industry, we may see long Consolidations or Secondary Reactions,but the Major Trend is durable. We must not assume a Major Reversal prematurely.
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Figure 37.4 During the same period that Granite City Steel was making the series of steps upward, as shown inFigure 37.3, Masonite was doing almost the same thing in reverse.
To have continued to hope for a change in trend with a stock that was acting as “MNC” did through the latter partof 1956 would have required an unusual amount of optimism or innocence about the habits of stocks. Actually,there would be good reason for optimism if the stock had been sold short early in the trend.
This is almost a perfect counterpart to the “GRC” chart. We have not only a series of declines with rallies that failto establish even Minor highs above the previous Tops, but we are also able to draw a trendline with a number ofpoints of contact on the way down, which is somewhat unusual in a downtrending situation. Notice the tendency ofthe rallies to stop short at the level of previous bottoms in a series of Support-Resistance Levels. We see suchaction at 44, at 41, at 38, and at 36.
We would certainly not consider the breaking of the trendline on the upside in late December as evidence of aReversal. Such a break after a trend of this sort probably means no more than a Secondary Recovery. To be ofgreater significance, it would certainly call for some volume showing, which was utterly lacking here, and beforewe would consider the stock again strong enough to buy, there would have to be some sort of Reversal Pattern. Afaltering rally back to around 40 would, in fact, suggest the advisability of further short sales.
DELAWARE, LACKAWANNA AND WESTERN
11
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100's
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SEPTEMBER OCTOBER
NOVEMBER DECEMBER
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Figure 37.5 Very often you will hear the question, “But how can you tell whether a technical formation or abreakout is valid?” In many cases, and in a great majority of upside patterns, the volume gives such a decisiveanswer that all doubts are removed. Not always is the volume confirmation as clear as in this chart of Delaware,
Lackawanna and Western, but this is typical of a good many breakouts in uptrends. You will see the volume wasgenerally light during the Rectangle, in which we see five plainly marked Tops and Bottoms.
On Thursday, November 4, the volume increased sharply as the price moved up to the top of the Rectangle andclosed at that point. The following day, Friday, we see good volume again with a close beyond the top border.From this point on, the move is obviously upward.
There was no indication of Reversal at any time after the breakout. A Top was reached in March at 25 1/2.
This was an especially vigorous move as it came out of the Rectangle. Normally, we would look for MinorSetbacks such as the series of reactions in “GRC,” Figure 37.3. If these had occurred, it would in no way haveweakened the Bullish Pattern.
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11 Sales 100's
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Figure 37.6 The situation, somewhat similar to “DL” in Figure 37.5, presents a little complication. The problemwould have been whether to sell or continue to hold “LA” after the late October break down through the Bottom ofthe Rectangle. There was no important volume on this drift move, and on only one day did the price close barely3% below the bottom of the pattern. A holder of the stock might well have sold it, might even have executed ashort sale.
Suppose now, you had actually sold the stock short; observe the volume and the price action on Thursday,November 4, and Friday, No


tober break down through the Bottom ofthe Rectangle. There was no important volume on this drift move, and on only one day did the price close barely3% below the bottom of the pattern. A holder of the stock might well have sold it, might even have executed ashort sale.
Suppose now, you had actually sold the stock short; observe the volume and the price action on Thursday,November 4, and Friday, November 5. Notice the volume and the price on the following Monday and Tuesday as itreacted slightly. Then see the quick pick up in volume as the price advanced on Wednesday, the week and a half ofdull Consolidation, and the larger volume on the move up on Friday. Surely by the middle of the first week ofDecember, if not before, you would have seen the danger signals and closed out your short.
Such a turnabout does not need to be a tragedy nor even a discouragement. Some easily discouraged traders wouldbe so concerned about the small loss realized on their unsuccessful short sale they would not be ready to seize theopportunity to reverse position and buy the stock after the strong up signals. This move carried to 26 3/4 in March1955.
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Figure 37.7 Bottoms normally take longer to complete than Tops. That is one reason we have this chart of Fansteelon a weekly basis, so that a year and a half of the action can be shown. The pattern shown at the left is aConsolidation formed after a rise from the 1953-1954 Multiple Bottoms around 21. The top of the AscendingTriangle corresponds roughly with the April 1953 peak.
At the time this Triangle started, in early 1955, it was not possible to identify it as such—particularly since theFebruary high ran a little higher than the horizontal Tops that eventually formed. However, during the sevenmonths preceding the first breakout move, it became increasingly clear each rally to the neighborhood of 32 1/2was followed by a reaction on low volume, and these reactions were forming a series of Rising Bottoms.
In the first week of September we see a clean penetration upside, and from here on, the advances and declines fitinto the typical pattern of a Major Advance. Notice the Breakaway Gap in November and the low volumethroughout the December-January-February reaction.
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Figure 37.8 Here, in a daily chart, we see once again the dramatic sequel to a Descending Triangle. Here is thetypical series of declining Tops on rather low volume with retreats between the rallies to a horizontal line.
Notice the important Support here was violated with heavy volume on Friday, January 25. Although the degree ofpenetration was not great, in view of the generally Bearish reaction to this point we would sell at once. ADescending Triangle has Bearish implications even before the breakout. There was no substantial Pullback afterthe breakout. Since it is not possible to count on such a recovery after a break through Support, it is safest to selllong holdings immediately or to place a very near stop on them as soon as a close outside pattern occurs (in thiscase, outside the pattern as adjusted for ex-dividend).
Notice the pickup of volume as the price drops into a tailspin at the end of January. Heavy volume is notnecessarily a feature of important downside moves, but it may, and often does, accompany them, and when it does,it simply underscores the significance of the


place a very near stop on them as soon as a close outside pattern occurs (in thiscase, outside the pattern as adjusted for ex-dividend).
Notice the pickup of volume as the price drops into a tailspin at the end of January. Heavy volume is notnecessarily a feature of important downside moves, but it may, and often does, accompany them, and when it does,it simply underscores the significance of the move.
Question: does Textron look like a “bargain” to you at the end of January on this chart? Would you be tempted tobuy this stock because “it can't go down any more,” or because it is “due for a rally,” or because it is “sellingbelow its true value”?
Suppose “TXT” did have a technical rally, which seems quite likely after the move shown. How far would youlook for it to go? Would you expect it to penetrate the 20 level in the near future? Would you call this a BullishSituation at the end of January 1957?
LIBBY, McNEILL
AND LIBBY
1927 1928 1929 1930

Figure 37.9 (a) Libby, McNeill and Libby showed no serious effects at the time of the October 1929 panic, andwent on to new highs in March and April 1930. (b) Chrysler, one of the great market leaders, made its Bull MarketTop in 1928, more than a year before the Panic, and had already lost 60% of its value before October 1929. (c)Eagle-Picher Lead never enjoyed any Bull Market at all. Aside from an unimpressive rally in 1928, it was in adowntrend all the way.
The examples given are not rare exceptions; there are many others involving important stocks that did not followthe pattern set by the Averages. This variety of behavior is typical of the market. It is to be seen today. They are not“all the same,” and each stock must be studied individually. In Figure 37.10, there are a few examples showingdisparate action during the years 1953-1956. There are hundreds of others that would illustrate the point equallywell.
(a)
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Figure 37.10 (a) West Indies Sugar broke out of its “Scalloping” Pattern in late 1956 to make its own Bull Marketat a time when action in the Averages was apathetic and generally weak. (b) Although the Averages continued tomake new highs through the spring of 1956, Westinghouse Electric made its top and went into a Major Declinemore than a year earlier. (c) Here is a companion piece to Eagle-Picher's chart of more than 25 years ago, shownabove it. Kresge, like a number of other “blue chips,” did not participate in the Bull Market Moves of 1953-1956.
These six charts were adapted from “Graphic Stocks” (F.W. Stephens, New York). The 1927-1930 charts are froma Special Edition covering nearly 700 stocks through the period 1924-1935. The 1953-1956 charts are from a lateredition of “Graphic Stocks.”
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NORTHROP AIRCRAFT
NOC
DECEMBER
' 4 ;11 18 25
J ANUARY FEB R UARY MAR CH
4 41 18 2^ 1 8 45 22 2^ 5 12 19 26 5 12 19 26 2 9 16 23 30 7 14 21 28 ’
Figure 37.11 A beautiful Top Formation in Northrop Aircraft, 1954-1955. The move, which ended here at 39 3/4 inJanuary 1955, emerged from a Bottom in 1953 at 6 1/4.
The Descending Triangle is marked by rather unusual volume at the peaks of rallies in February and March.Otherwise it is typical of this sort of Reversal Pattern. As so frequently happens, there was a Pullback effort afterthe March 14 breakout, but this rally lasted only two days.
You will notice the volume on the breakout and throughout the downside move was not so spectacularly heavy, notnearly as heavy, in fact, as on the Minor Rallies within the Triangle. As pointed out previously, however, we do notneed or expect so much volume on a decline as we look for in an advance.
Volume did not develop until the end of the first stage of the decline. It is quite usual for heavy volume to show upat the end of a Minor Move whether on the upside or the downside.
Notice the Flag formed on the subsequent rally in mid-April. The measuring implications of this Flag wereapproximately carried out a month later.
During the following year and a half, “NOC” never reached 31 again.
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Figure 37.12 Bearing in mind the 1954-1955 chart of Northrop in Figure 37.11, we now turn to the action in thissame stock in the latter part of 1956 and the beginning of 1957. The question is whether the Major Downtrend isstill in effect or whether an important upturn has taken place.
As usual, it is the volume that must be watched and studied. Notice the Minor Peak on August 14, then the veryheavy volume on August 24. See how the activity dries up during September but resumes briskly as a new MinorTop is established in October. Observe the drying-up of volume on declines and the activity on rallies to the 25 1/2level, which, by the middle of December, has become the horizontal Top of an Ascending Triangle.
There was no question about the validity of the breakout move on December 10, and the subsequent reaction in thenext two weeks confirmed this by the lack of activity on the decline. Again, in early February, we see volume pickup notably as a new high is registered.
At the time this is written (EN: 1957), it is not possible to say whether or not “NOC” will continue this upwardcourse and eventually smash the “31 barrier.” We feel there will be no doubt in the reader's mind at the beginning
of February, Northrop was presumably moving in an uptrend and must be presumed to be in that trend until adefinite change in its market action has taken place. It seems quite probable if “NOC” should advance to the 30-31level, there is likely to be a period of Consolidation with the formation of an Area Pattern before a successfuladvance above 31 is accomplished.
As a sidelight on this chart, it might be mentioned that during the period of advance shown above, many aircraftstocks were moving lower.
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’EMBER OCTOBER.
APRIL
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CHICAGO, MILWAUKIE, ST PAUL AND PACIFIC ST
JOVEMBER DECEMBER JANUARY FEBRUARY MA


formation of an Area Pattern before a successfuladvance above 31 is accomplished.
As a sidelight on this chart, it might be mentioned that during the period of advance shown above, many aircraftstocks were moving lower.
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JOVEMBER DECEMBER JANUARY FEBRUARY MARCH
B.;
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Figure 37.13 The 1954-1955 advance in Chicago, Milwaukee, St. Paul and Pacific is an object lesson in BullMarket techniques. Where would such a trend (of which there are many similar cases) leave the man who sells just“because he has a good profit,” say at 15, or who feels “17 is too high a price”?
Here is a chart worth considerable study because it exemplifies a great many features of the “ideal” uptrend. In thisfull year of advance, there is no point at which even a tyro technician could find reasonable cause for anxiety orjustification for selling the stock. What is more, we should not overlook the tax advantages of long-term gains.
In August and September, we have a perfect example of the Symmetrical Triangle as a Consolidation. The volumeis typically heavy at the start of the pattern and shrinks to almost nothing as it progresses. The breakout volume isdecisive. The reaction after the breakout, also on lower volume, as it should be, runs right back to the apex, the“cradle point” that is nearly always a strong Support on such a reaction.
Now follow the action from here; the two days of higher volume in the early November rally represent thepenetration of the previous Minor Top, and the end of the rally, respectively. The reaction comes back to theprevious top.
The December rally is marked by heavier volume when the November top is exceeded, and again, to a lesserdegree, at the end of the move. Once more there is a reaction, this time to the November top.
A fast move near the end of December repeats the same price and volume action, and it is followed by a typicallow-volume reaction to the early December top. (This is becoming monotonous, but it is important. You are seeinghere a long-term demonstration of Bullish technical action.)
Next, we have the January breakout. How far would you expect its Minor Reaction to go? Would you be surprisedif it found Support at the level of the three little Tops formed early in the month at 17 1/2?
The following advance drives through the 20 level, and, in a series of small fluctuations, forms an AscendingTriangle. By the end of February, another new high has been established. Can you estimate where to look forsupport on the reaction?
Figure 37.13 (Continued) Now we see the formation of the second Ascending Triangle (notice the relatively lowvolume), which is broken on the upside in a burst of trading activity toward the end of April. The next reactioncomes back to the support of the former Tops as you would expect. Once again, an Ascending Triangle is formed,and you will see how the volume dries up throughout this pattern, coming to life emphatically on the breakout onWednesday, June 8.
Many students, on first seeing this chart, remark, “Well, the trend wasn't broken until Tuesday, June 21.” Actually,no break occurred on that day. The stock simply went ex-dividend $1.50, which, as you will see if you adjust theprice by that amount, merely brings it back to the Support at the top level of the April-May Ascending Triangle.
It is inconceivable that any such regular series of Bullish Patterns could appear throughout a full year of trading ina stock “by accident.” This is part of the normal mechanism of the market, representing the judgments, opinions,fears, hopes, and trading tactics of thousands of traders and investors. It should be added, however, that it is notoften that one sees such a long and “perfect” Major Advance as this. Normally, there are interruptions, distortions,or Secondary Reactions from time to time.
80
76
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68
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56
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48
44 Sales 100's
250
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50
WESTINGHOUSE ELECTRIC AND MANUFACTURING CO.
1955
FEBRUARY MARCH i . ApR1^ , , MAY . , JUNE JULY. ,
5 12 19 26 5 12 19 26 2 9 16'23 30 7 14 21 28 4 11 18 25 29 16 23 30'
Figure 37.14 Does it require second sight to perceive this is a Bearish stock? If you were keeping a chart onWestinghouse Electric and Manufacturing, wouldn't you have recognized, long before the end of the period shownabove, that the trend was down, not up?
It is one of the great delusions of the market that the stock we own must be “good.” As prices decline, the price-dividend ratio, based on past history, will improve. Additionally, the priceearnings ratio likewise will lookcontinually better. Investors will begin to speak of “averaging their cost” by putting more money into a tumblingstock (instead of looking for something going their way). They will talk endlessly about improved outlook, newproducts, and a forward-looking management; they will prove to you it is selling “below its true value,” whateverthat may mean. They will bend every effort to establish what is going on before their eyes is not true; that the veryweak-looking stock is actually strong; that the American public is making a great mistake and is misjudging thisstock; that the tape is wrong because they must be right.
Nevertheless, values in the market are determined democratically and, by and large, probably represent the bestcomposite appraisal you can find. A move like this is not meaningless, and it is not possible today to attribute it tothe machinations of a few manipulators. In the chart, we are seeing the reflection of a collective evaluation thatcannot be lightly disregarded. Westinghouse reached 50 7/8 in November 1956.
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Chapter thirty-seven: The same old patterns
Figure 37.15 A typical stock chart on TEKNIPLAT™ charting paper. Allowing for ex-dividends, "OT" neversignificantly violated the apex of the Triangle. The advance ultimately added 60% to the value of the stock. Thischart, in its long, mostly sideways mov