uation 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 movement, is a good example of the importance of making allowance for theex-dividend drop in the price. During the first five months shown, we see an almost perfect Symmetrical Triangle.The first critical point would be on the slight breakdown in the middle of May. The lower border of the Trianglewas violated just a trifle, even if we had allowed for the 62 1/2(2 March dividend. If one had sold the stock here,who could blame him? No great or immediate harm would have been done. However, an experienced technicianmight have taken into account the insignificant volume at this point and waited a bit, with a stop at, say, 60. (Seethe somewhatsimilar situation in the chart of "LA," Figure 37.6.) If "OT" had been held, the volume pickup on therally would have shown the trend had not yet reversed itself. The second critical point came in late September andearly October, at the time of President Eisenhower's illness. However, if we allow for the two dividends that wentex in July and October, the break did not violate the May Bottom. Furthermore, it was on relatively light volume.If the stock was still held, there was no valid reason for selling on this decline. From here on, breaking upwardsharply from the October-November Island, "OT" resumed the Major Advance interrupted by this long period ofConsolidation, and advanced to the equivalent of over 100 (adjusted for two-for-one split) in 1956.
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Figure 37.16 The Broadening Top in the Dow-Jones Industrial Average that formed in May, June, July, and August1957. Although Broadening Tops have appeared many times in individual stocks, and, as a rule, have carried outtheir Bearish implications, such a chart pattern has never before been completed in the Industrial Average. In 1929,on two occasions, there were patterns that began to show Broadening tendencies, but because these wereinterrupted by continuation moves, about all one can say of them is they may have indicated a growing technicalweakness in the market.
The 1957 situation, on the other hand, was very definite and was fully completed. During the early stages of thepattern, several of our friends wrote, calling attention to the possible Broadening Top, among them Charles E.Carden of Fort Worth, TX, who has handled Dow Theory comment and analysis for the Fort Worth Star Telegram.The chart shown in Figure 37.16 is adapted from one of Mr. Carden's charts and is reproduced with his permission.
The first significant point after the February 12 Bottom was the Minor Peak of Tuesday May 21, marked (1). TheMinor Decline from this point on Tuesday, May 28 (2), was quite normal, as was the renewed advance to Monday,June 17 (3).
The first sign of a broadening tendency was when the Average closed on Monday, June 24 (4), below the May 28bottom. However, this by itself did not indicate a Reversal. The advance was resumed, and surmounted the May 21and June 17 Minor Tops, reaching a high closing figure of 520.77 on Friday, July 12 (5). The Broadening picturewas now quite evident, and the completion of a Broadening Top required only a close below the June 24 Bottom.
On Tuesday, August 6, the Industrial Average closed decisively below the June 24 Bottom, signaling thecompletion of the Broadening Top. This was an indication of Major weakness, a warning not to be taken lightly.
The Broadening Top, as we have pointed out previously, is an indication of a wildly gyrating market, a marketwithout leadership or definite trend. The presumption is that heavy distribution is going on under cover of therallies and the breakout move is seldom a false one.
Figure 37.16 (Continued) Since we are dealing with an Average rather than a single stock, we would consider anyclosing below point (4) after the peak at (5), regardless of how slight the margin might be, would constitute a validbreakout, because Averages are less sensitive than individual stocks, and it is customary to consider even slightpenetrations at signal points (as in Dow Theory) as perfectly satisfactory. You will notice also that, although itwould be possible to draw the Broadening Top through the extreme ranges of the price, as we have done with thewide-dashed line, we have used the closing prices as marked by the narrow-dashed line. This, too, is in line withDow Theory practice, where only closing prices are considered.
The implication of the pattern here was Bearish for the “market-as-a-whole.” As might be expected, a majority ofstocks showed weak patterns of trends at this time. As always, however, it was necessary to examine each stockseparately on its merits, because, as we will show in the following pages, not all stocks behaved alike even in thisextremely weak market situation. Compare the broadening top from 1999 to 2000 (Figure 37.17).
Figure 37.17 The Broadening Top in the Dow in 1999-2000. If repetition is the heart of pedagogy, the reader maydie of heart disease with looking at the Dow Broadening Top, especially if he was long at the time and eitherdisregarded the signs or was not educated as to their significance. The lesson is always the same: bad news is on
the way. The numerous technical aspects of this historic market top are discussed at length in other views of theDow taken at this time. Remember, this time it is different. The market paradigm has changed, and so on and soon. ... Those who listen to fools will be fooled.
Figure 37.18 1957 Bearish Trend in Industrial Rayon. At no time did this stock show significant strength.
Averages do not tell the whole story. Each stock has to be considered on its own


rket top are discussed at length in other views of theDow taken at this time. Remember, this time it is different. The market paradigm has changed, and so on and soon. ... Those who listen to fools will be fooled.
Figure 37.18 1957 Bearish Trend in Industrial Rayon. At no time did this stock show significant strength.
Averages do not tell the whole story. Each stock has to be considered on its own merits. Long before the formationof the 1957 Broadening Top in the Industrial Average, Industrial Rayon was moving down in a Major Decline. Youwill find many cases in which it is difficult to "see" what a stock is doing or to determine its Major Trend, but insuch a situation as this (and this is not a rare case), it is perfectly obvious that the trend is down. Although therewere a number of Minor Rallies and Consolidations during the decline, the entire pattern was so obviously part andparcel of the same big decline that no one who was even slightly familiar with typical stock behavior would havebeen tempted to buy the stock, even to cover shorts.
On Monday, July 29, there was a sharp downward break with a gap on climactic volume. This would havesuggested the probability of a Minor Bottom, and for three and a half weeks, the stock did stabilize at around 24.But even during this Consolidation, the continuing weakness showed up on the small Descending Triangle that wasformed, and ultimately on Wednesday, August 21, the price broke sharply to continue the Major Decline.
446 Technical Analysis of Stock Trends
Figure 37.19 1957 Bullish Trend in Lorillard. Although most stocks declined in 1957, there were a number ofstrong issues like this one that appeared to be totally unaffected by the general pessimism.
Averages do not tell the whole story. It will come as a shock to many readers, who rightly regard the latter half of1957 as a Major Bear Market, to see Lorillard making a typical Bull Market Advance. Lorillard moved up from15L to 34 during the year—and reached 54J during the first three months of 1958. It is hard to believe this chartand the Industrial Rayon chart we just looked at cover the same period, the year 1957.
The majority of stocks did suffer severe depreciation, but there were a good many issues, like Lorillard, whichenjoyed a generally Bullish Trend all year. Among the important stocks that moved up consistently in 1957 wereAmerican Chicle, Anchor Hocking Glass, Colgate-Palmolive, General Foods, General Cigar, Grand Union,National Biscuit, Parke Davis, Penick and Ford, Plough, Inc., Proctor and Gamble, Ruberoid, Vick Chemical,Winn-Dixie Stores, and Zenith Radio.
Whatever theories we may have as to the condition of the "market-as-a-whole," we must always realize we arebuying and selling individual stocks. (EN: Unless we are trading Index Shares.) We may get a picture of extremeBullishness or extreme Bearishness in the "general market," but if this picture conflicts with the clear evidence in aparticular stock, we must recognize it is the stock, not the Average, with which we have to deal. We cannot assumea stock "must" follow the Average. Often, it is possible to obtain greater stability and safety by buying a few strongstocks in a Bear Market or by selling short a few weak stocks in a Bull Market, than by attempting to maximizeprofits with an "all-out" position one way or the other.
Chapter thirty-seven: The same old patterns 447
448
Technical Analysis of Stock Trends
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Figure 37.20 During the latter nine months of 1961, some well-known market Averages continued to show newall-time highs. However, the Evaluative Index (see Chapter 38), in this period did not indicate any such overallstrength; many stocks were in almost continuous decline for the nine months. These included such important issuesas Air Reduction, Allied Chemical, Allis-Chalmers, Aluminum, Ltd., Fansteel Metallurgical, Flintkote, HeydenNewport Chemical, Sperry Rand, Texas Instruments, Trans World Airlines, Universal Match, and many others. Atsuch times, it is best to choose stocks selectively and maintain adequate liquid reserves.
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Figure 37.21 A familiar Top Pattern. From the end of 1957 to the spring of 1961, Burndy Corporation moved frombelow 10 to 37 in a generally Bullish Trend. The advance accelerated sharply on the postelection rally of late 1960and early 1961. However, with Burndy, as with many other stocks, the rally ended in the early months of 1961.Here, we have not only a perfect example of the Head-and-Shoulders Top in the price action, but we also have thetypical volume confirmation. The early April rally was on heavy volume. The rally in the last week of April was onsomewhat-disappointing volume

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


the postelection rally of late 1960and early 1961. However, with Burndy, as with many other stocks, the rally ended in the early months of 1961.Here, we have not only a perfect example of the Head-and-Shoulders Top in the price action, but we also have thetypical volume confirmation. The early April rally was on heavy volume. The rally in the last week of April was onsomewhat-disappointing volume, although a new high was made at that time. We have a definite increase ofvolume on the retreat from this peak, and practically no enthusiasm in the final rally of the first week of June. Thebreakdown on Monday, June 19, accompanied by heavier volume and a definite gap in the price track, confirmedthe Top Formation. Although Burndy held around the 30 level for a time, and after a further drop recovered to 31,the Major Trend had definitely been reversed. By June 1962, Burndy was selling at 11 3/4.
Figure 37.22 Weekly chart of Brunswick Corporation showing the final stages of the long Bull Market in "BC,"the Climactic Top in March 1961, the distributive phase through December 1961, and the ultimate breakdown.
For five years, from 1956 into early 1961, Brunswick advanced in a great Bull Market surge. During this period,the stock was split four times. In the first week of March 1961, terminating the postelection rally, "BC" made anew high on extraordinary volume, but closed the week nearly at the bottom of the weekly range. The One-WeekReversal might well have served as a warning to the market trader.
Assuming, however, the owner of shares in Brunswick was not a trader and was interested in the stock from along-term point of view, he might have held the stock through the breakdown from the Symmetrical Triangle
formed in March and early April. He might have continued to keep his shares through the summer and fall of 1961and the rally of September and October. If so, and if he had been watching the action of the stock, he would realizethe 50-52 level was a critical area. A break through this previous Bottom would represent a serious failure ofSupport and, certainly, the decisive violation of the 50 level in the first week of January 1962 (with heavy volume)could be recognized as a very dangerous Reversal Signal, calling for immediate sale of the stock regardless ofcapital gains tax or anything else. Although this move preceded the general collapse of the market by severalmonths, it was a clear technical indication of extreme weakness and extreme danger in Brunswick, regardless ofthe action of other stocks at that time. If an investor had noted the break but decided to "wait for a rally" to sell hisstock, he would have had no chance to get out. Brunswick never recovered, never rallied, and by October 1962 itwas selling at 17.
Technical Analysis of Stock Trends
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Figure 37.23 A beautiful example of a Rectangle in Polaroid. Notice the low-volume fluctuations between(approximately) 178 and 202. On Thursday, May 10, on the highest volume of that year to date, Polaroid brokeSupport and plunged to 168. This was a clearly Bearish Move. It would have been fatal to “hold for a rally,” forthere was no rally. It can be very expensive to hold onto a stock wishfully when the situation has changed radically,no matter how good it may have looked previously. Note this break came more than two weeks before the “near-panic” of May 28. By that time, “PRD” had dropped 50 points and was headed for still lower levels.
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Figure 37.24 At a time when a majority of stocks were already showing signs of serious weakness, early in 1962,Copper Range was making vigorous new highs. Actually, the move did not get far; it never substantially brokeabove the 1961 Top.
The evidence of weakness in “CPX” did not become apparent until, after the relatively weak April rally, the stockbroke through 19 on Monday, April 30, and closed at 17. This was the completion of a well-marked Head-and-Shoulders Top. In this case, there were three days of rally before the downward move really got under way, but itmight have been dangerous to count on a rally after the clearly Bearish signal.
Incidentally, this Top Formation was completed well before the precipitous drop of May and June.
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Figure 37.25 Like practically all stocks, “UV” went into a tailspin in the spring of 1962. After the “bad day,” May28, it continued to slide throughout the month of June. At this point, there started what could be considered nomore than a technical rally in a Bear Market. This rally stopped at 29 and was followed by a dull decline lastingabout two weeks.
The next move, in the second week of August, was marked by considerable volume, and although there was noobvious, clear-cut pattern, it seemed significant that the 29 level, briefly touched on May 23, May 28, and July 12,was penetrated on August 6.
Whether to regard this August 6 closing as a


ally in a Bear Market. This rally stopped at 29 and was followed by a dull decline lastingabout two weeks.
The next move, in the second week of August, was marked by considerable volume, and although there was noobvious, clear-cut pattern, it seemed significant that the 29 level, briefly touched on May 23, May 28, and July 12,was penetrated on August 6.
Whether to regard this August 6 closing as an immediate buy signal, or to wait for the completion of the breakoutmove and look for an opportunity to buy on a reaction, would be a problem. In this case, it would have paid towait. Notice the late August reaction came back to the 29 level, where it found Support, and then continued itsupward move.
Considering the weakness of most stocks in this period, the action of “UV” is remarkable. The important thing torecognize is individual stocks do not necessarily follow “the main trend” of the Averages.

Figure 37.26 Weekly, July 1961 through June 1962. This chart shows the Head-and-Shoulders Top Formation inthe Industrial Average that preceded the collapse of April, May, and June 1962. Normally, especially in the chartsof individual stocks, there would tend to be heavier volume on the left shoulder. The price pattern alone issufficient to mark the pattern as a dangerously toppy situation. During the entire period in which this formationtook shape, many individual stocks representing important companies were showing Top Reversal symptoms, asmight be expected. Note, so far as this Head-and-Shoulders Pattern is concerned, the Reversal Signal is notdefinite until the neckline has been penetrated.

Figure 37.27 Daily, April through September 1961. Here is a rather confusing and complicated chart, but one thatcontains several points of interest worth a bit of analysis. Notice the beautiful little Head-and-Shoulders Top inApril and May, especially the volume weakness on the final rally before the downside breakout. Notice also thisstock was split two-for-one in June, but such a split does not materially affect the technical action of the stock,except because there are now two shares of stock (at half the market value) for each share of old stock, there maybe some increase in the average number of shares traded per day. Notice also that once the downtrend wasestablished, the rallies (especially the mid-July rally) do not penetrate the trendline drawn through the April andMay peaks. This trend continued down for more than a year after this, reaching a low of 11 1/4 in October 1962.
Figure 37.28 Daily, January through June 1963. Here is a good example of a Symmetrical Triangle as aContinuation Pattern. Triangles of this (Symmetrical) type may mark Consolidations in a Major Trend, or they mayconstitute a Reversal Formation. The characteristics in either case are an active move to the first turning point ofthe Triangle, and then, generally diminishing volume as the price fluctuates in a narrowing pattern. During thisperiod, it could be said the stock was in both an uptrend, marked by the lower boundary of the formation, and adowntrend, indicated by the upper boundary. Notice the increase of volume on the breakout, which, in this case,was on the upside. Also, notice the reaction to the “cradle point” defined by the intersection of the two boundarytrends of the Triangle. The advance of the stock from April to June measures just a little more than the height ofthe open side of the Triangle. The attainment of this “objective” does not necessarily mean the termination of theMajor Trend, however, and by August 1963, Cerro had reached 33 1/4.
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Figure 37.29 XA. Daily, March through August 1963. Here is a good example of an Ascending Triangle, in whichthe rallies advance repeatedly to a given level; the reactions find Support at gradually higher points. Such a patternnormally indicates a potentially Bullish situation in the making, just as the reverse (Descending Triangle) implies aBearish tendency. Notice the higher volume on the various peaks near 22, and the very high volume on thebreakout move in August. If any further evidence of the strength of this move was needed, the Breakaway Gap atthe opening, Monday, August 12, would supply it. After a breakout of this sort, it would be quite normal for thestock to suffer some


g, just as the reverse (Descending Triangle) implies aBearish tendency. Notice the higher volume on the various peaks near 22, and the very high volume on thebreakout move in August. If any further evidence of the strength of this move was needed, the Breakaway Gap atthe opening, Monday, August 12, would supply it. After a breakout of this sort, it would be quite normal for thestock to suffer some profit-taking reaction, usually on light volume, and such a reaction might run back to 22 oreven a little below this without altering the essentially Bullish nature of this picture.
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Figure 37.30 SOC. Daily, June through November 1962. Before commenting on the November breakout here, weshould call attention to the fact “SOC” was one of the stocks that held up fairly well during the Cuban crisis inOctober 1961 and did not make a new low under the June bottoms. This chart picture is an excellent example of aDouble Bottom. It is not necessary for the two Bottoms to be at exactly the same level if they are reasonably close.The important thing is the stock has found Support once, has rallied, then declined again, and has found Support atnearly the same point. The Bottoms should be some distance apart; there should be at least six weeks betweenthem, preferably more. Also, the rally between them should be definite and should amount to at least a 15% gain atits peak. The formation does not acquire significance as a Major Bottom Pattern until the level of the top of therally is penetrated on substantial volume. This penetration took place on Tuesday, November 13, and from thattime continued in a Major Bullish Trend, reaching 1559 in May 1963, an advance of more than 500 points from theclose on the day of breakout.
Double Tops have an opposite significance; they are similar to the Double Bottoms, but they consist of two tops atapproximately the same level, separated by some weeks or months, and with a decline between them, which mustbe penetrated to validate the Top Formation.
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Figure 37.31 Daily, November 1962 to April 1963. To the average person unfamiliar with the usual behavior ofstocks in the market, the price fluctuations appear meaningless and entirely fortuitous. If they are aware of generaltrends lasting months or years, they are often inclined to consider only the trend of “the Averages,” and are notconscious of the fact many stocks may be making large advances at the very same time that others are slidinglower and lower. It is not always possible to lay a straight-edge ruler along the trend and show \ it makes a perfectstraight line (although this does sometimes happen); however, as in the case of General Steel Industries, there is noquestion the advance is fairly consistent over a long period of time, barring the relatively unimportant reactions,Consolidations, and so on, along the way. You will notice, too, the two-for-one split in early March did notmaterially affect the upward trend except to show somewhat more volume, as might be expected with a greaternumber of (new) shares. For a contrasting (downside) trend, see the chart of Avnet Electronics, Figure 37.20.
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Figure 37.32 Daily, February to August 1963. This is an interesting study of Support and Resistance phenomena.Incidentally, it is also an example of a Bearish Stock (and not the only one by any means) in what was generallyconsidered a Bullish Market, during the spring and summer of 1963. We would point out several rallies to 31 inMarch and April, and the breakdown in early May. In May and June, the stock rallied, but it stalled at about the
level of the March low. Then there was another drop, and in the rally, this time came back to the late April low. Thenext drop, in July, was followed by a little rally to the June Bottom at 25. This is fairly typical Support-Resistancebehavior. The price level that has been a Support tends to become a Resistance once the Support has beensubstantially broken. Vice versa, as regards overhead Resistance; after it has been broken, it tends to serve as aSupport level.
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Figure 37.33 January through June 1963. Sometimes a move happens all of a sudden and does not result in acontinuing long trend. In this case, it is not possible to say whether the long-term trend will be up or not. Thepurpose of showing this chart is to point up the remarkable action that can follow a break through an importantSupport or Resistance Level. You will notice that the entire period from mid-January to Tuesday, May 14, can beregarded as a Rectangle on the chart with Bottoms at about 10 1/8 or 10 1/4, and Tops at about 11 3/4. Notice theincrease of activity on the several rallies during the formation. The move, which was a “situational” thing insugars, affected all sugars in May, and turned out to be somewhat of a flash in the pan. Nevertheless, it was aspectacular one, and a trader with courage and acuity might have picked up this stock as a speculation after theclose of Tuesday, May 14. The next five trading days advanced the price from Wednesday's opening at 12 to theTuesday, May 21, close at 17 1/2, an advance of 46%. This is a type of market trading we would not recommendgenerally; it calls for courage, experience, and the willingness to take a number of small losses to secure onesubstantial gain. However, the in-and-out trader who observed the action on May 21 and noticed the One-DayReversal with abnormal volume and a gap could have secured maximum quick profits either by selling his stock atthe opening of the next day or by placing a stoploss order just under the close, say, at 17 3/8.
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to secure onesubstantial gain. However, the in-and-out trader who observed the action on May 21 and noticed the One-DayReversal with abnormal volume and a gap could have secured maximum quick profits either by selling his stock atthe opening of the next day or by placing a stoploss order just under the close, say, at 17 3/8.
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::::::::::::::
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Figure 37.34 There are some warning signs in “CDA” in the Minor Breakdowns of late March and early May.What seems especially significant, however, is the nature of the recovery move in May and early June 1965. Thetwo convergent boundaries of the Recovery Trend form an up-sloping Wedge, which has rather definite Bearishimplications. If the Wedge had been pointed down, it would strongly suggest the possibility of a decisive upwardbreakout. Notice on the two days during which the highest prices were attained during this Wedge Pattern, thestock closed near the Bottom of the day's range. The subsequent history here, the collapse on heavy volume, showsclearly how dramatic a break from this not-too-common formation can be.
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Figure 37.35 Here is a chart that shows several interesting technical features. In July, August, and most ofSeptember, “W” was in a period of dormancy. The breakout of September 27 was followed by a week of inactionand then a strong continuation of the move on big volume. Notice the October-November Consolidation, whichtook the form of a large Symmetrical Triangle. If we draw the upper boundary of this Triangle, and the lower, wesee the breakout signaling a continuation of the move, on Wednesday, December 1, was decisive both in price andvolume action. At no time during the advance from 28 1/2 to more than 62 was there any indication of potentialweakness.
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Figure 37.36 The weekly chart of Livingston Oil from January 1965 into January 1966 is a good example of aMajor Bottom. Just how weak the stock was during the early months of 1965 can be judged by the clear DownsideGap during the month of May. Also, you will notice the volume on this whole headlong collapse was rather heavy.From July to the middle of October, however, the trading activity “dried up,” and the stock fluctuated in narrowerand narrower swings, forming a Symmetrical Triangle. The pickup of volume on the October breakout wasspectacular, and an observant investor would have had a “second chance” to buy on the reaction in the first weekof November when the stock drifted back to the top of the Triangle.

Figure 37.37 Here is a beautiful picture of technical market action in Packard-Bell Electronics from August 1965into January 1966. The first point of interest is the Flag Consolidation in September and October, a classic example(“The Flag flies at half-mast”) and on the resumption of the up-move, the stock did duplicate the earlier move, anda bit more. (Compare with the 1945 chart of Martin-Parry, Figure 33.13.) Notice the nearly flat Tops and the risingBottoms from October to January, with generally declining volume (Ascending Triangle), and the magnificentbreakout move in the second week of January 1966. In


ssic example(“The Flag flies at half-mast”) and on the resumption of the up-move, the stock did duplicate the earlier move, anda bit more. (Compare with the 1945 chart of Martin-Parry, Figure 33.13.) Notice the nearly flat Tops and the risingBottoms from October to January, with generally declining volume (Ascending Triangle), and the magnificentbreakout move in the second week of January 1966. In this case, we can see no evidence calling for selling thestock all the way from September into January.
1969 197
N OVEMBER . D ECEMBER J ANUARY
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Figure 37.38 This could be regarded as a very flat Head-and-Shoulders Top or as a long Rounding Top. Thebreakdown through 66 was a warning, and certainly the sharp break below 60 in February was a definitely Bearishsignal.
ASTRODATA INC.
ADA
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OCTOBER NOVEMBER DECEMBER JANUARY FEBRUARY
4 11118 25 1 8 15 22 29 6 13 20 27 I 3 10 17 24 31 7 14 21 28 >
Figure 37.39 A complete collapse in one day, Astrodata in January 1970. Not the sort of action you see every day,or even every month, but it is “normal” in the sense it is a phenomenon we have seen many times in the past andundoubtedly will be seen many times in years to come. When it does happen, it should be heeded—it meanstrouble. “ADA” was doing well in what appeared to be a typical and perfectly healthy uptrend. After a one-daysuspension on January 15, it reopened many points lower and never recovered. Trading was halted in lateSeptember. Some readers may remember other downside moves of this nature in the past. In Mack Trucks, in FifthAvenue Coach, and some may even recall, many years ago, a break like this in American Woolen. Such a break isdue to some sudden development or change in company affairs, but it is not necessary “to know the reasons”: thechart speaks for itself. As Lady Macbeth put it (in another connection), “Stand not upon the order of your going,but go at once.” There was a good example of this type of a “Gap Move” in Villager Industries on April 30, 1971,when the stock dropped 42%, from 7 3/8 to 4 1/4 in one day. Such moves as we are discussing here are nearlyalways on the downside; we do not often see comparable upside gap moves. After this type of break, althoughthere may be brief rallies, the stock nearly always resumes the downtrend, and in many cases, is delisted from theExchange. Anyone caught holding such a stock should not feel he had made a mistake in buying it, nor should helook for evidence of weakness before the big breakdown, for ordinarily, there is none, however, he should get outimmediately to avoid further loss. By way of reassurance, it can be repeated though this kind of collapse is a ratherrare occurrence.

Figure 37.40 Oracle Corporation. Lest one think the air pocket gap does not still exist, here is an example from theturn of the century (third millennium). These gaps, caused by disappointing earnings, were so prevalent at the endof the century at the top of that Bull Market that one could short vulnerable stocks before earnings reports withlittle upside risk and often collect nice scalps like this one.
EARN.
DIV.
. SHARE S
PUBLIC SERVICE ELECTRIC AND G A S PE G
THOUSANDS OF
, 1
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Figure 37.41 A typical electric and gas utility stock. There are a great many stocks in this group, serving variousmunicipalities or regions. They tend to show similar market behavior because they are basically similar in nature.
There is a relation between the earnings of a company and the dividends paid, and the market price of the shares.Neither earnings nor dividends alone, however, are sufficient to constitute a complete determination of “value”because there are many other factors that can affect the “value” considered from different angles, such asdependability of earnings, future prospects, taxability, research and development investment by the company, andso forth.
The electric and gas companies, enjoying a regulated monopoly position in most communities, have a sure andsteady income. They are also in a definite “growth” situation because of the constantly increasing demands forpower by users. Most utilities will show a record and pattern of trading over a period of years very similar to thatof “PEG.” You will notice reported earnings have been larger each year from 1959 through 1970. Also, thedividend rate has been increased each year except in 1970, when it was unchanged from the year before. Anyonebasing his estimate of “value” on a simple index such as “price-earnings ratio” would conclude the stock was 2 1/2times as good a buy in 1970 as it had been in early 1965.
Obviously, there is more to it; the big funds and other large holders of stock are not giving up “bargains” of thatsort lightly and for no reason. The depressed chart is undoubtedly reflecting the whole thorny outlook facing theutility industry, including costly new facilities, anti-pollution devices, and other problems including deregulation.
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JANUARY
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[ARCH APRIL MAY
MEMOREX CORP. MRX
SEPTEMBER OCTOBER NOVEMBER DECEMB
FEBRUARY
Figure 37.42 Although 1969 was Bearish for most stocks, “MRX” was enjoying the final fling of a dramatic four-year advance. Notice the Island-like Top in November, December, and January, and the low volume all throughthis period. The Breakaway Gap in early February speaks for itself. See also Figure 37.39.
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Figure 37.44 Here is a familiar pattern you have seen many times before in the pages of this book or in your owncharts—a large Ascending Triangle in the daily chart of Action Industries, formed in December of 1971 andJanuary of 1972. Notice the typical breakout and reaction moves and the continued uptrend into April of 1972.
Figure 37.45 Two things are remarkable here: (1) the amazing story of a business emerging from a college dormroom—a computer business, of course—and (2) the regular occurrence of air pockets, which will be seen better onthe next chart. Not a stock for those who dislike carnival rides and surprises. One should fit his portfolio to hisdigestion. Dell broke its long-term trendline, which the reader may easily draw here with a ruler, and after setting abull trap, went to 20, displaying several major warning downside gaps (see next chart). The out-of-proportionvolume at the chart end is a forewarning.
Figure 37.46 DELL. The breakaway or air pocket gap continues to astound, so frequently choosing to occur athorizontal lines. An exceptionally alert trader might have avoided the air pocket, observing the broken trendlines.
The average technician would have got out and shorted the breakaway gap. Seen one tulip, seen them all.
Figure 37.47 The benefits of the “Wintel” partnership are reflected in Intel's chart. The trader might have been inand out of Intel several times based on tightening trendlines, whereas the long-term investor would have patientlywaited out the—call it a “rectangular wedge”—that never was violated on the downside. The steeper the trendlinethe more likely—even the more certainly—it will be broken.
Figure 37.48 NOKIA (NOK). Not enough is made of the marking of zones of Support and Resistance (highs andlows) with horizontal trendlines. These benchmarks help the technician to mark the running of the tide, just likeDow's stakes on the beach. Notice how the high of 1999 influences the high of 2004. The breaking of horizontallines here after the breaking of the steepest trendline once again tells the tale for the technician.
Figure 37.49 AMD. Reflecting the vagaries of the semiconductor business, including the felicity (or infelicity) ofbeing a competitor of Intel, AMD shows trading opportunities both up and down. Here the intermediate-termtrader would respond to the vigorous breaking of short-term downtrend lines to get long.
JulOct 97 Apr Jul Oct 98 Apr Jul Oct 99 Apr Jul Oct 00 Apr JulOct 01 Apr
Figure 37.50 Yahoo! (YHOO). A superb trendline that should have kept the technician long until April of 2000—and then got him out, especially when combined with the top horizontal trendline. The extravagant volume at the
v


ntermediate-termtrader would respond to the vigorous breaking of short-term downtrend lines to get long.
JulOct 97 Apr Jul Oct 98 Apr Jul Oct 99 Apr Jul Oct 00 Apr JulOct 01 Apr
Figure 37.50 Yahoo! (YHOO). A superb trendline that should have kept the technician long until April of 2000—and then got him out, especially when combined with the top horizontal trendline. The extravagant volume at the
very top is the exclamation point on the warning.
Figure 37.51 Any resemblance between this chart and Amazon (see Figure 23.13) is not strictly coincidental.Readers will remember Magee's principle that birds of a feather flock together. Internet goony birds certainly do—or did. Yahoo! looks in this guise somewhat stronger than Amazon, but then selling books and mortar is a harderrow to hoe than selling electronic images (best business in the world). Again, such an attractive fundamental story.Gooks (or geeks) on skates helping revolutionize the wild frontier—we love these stories, but not enough to stopdrawing lines on the chart and selling them when they violate our lines. Even love must obey the rule of the ruler.
Figure 37.52 Apple (APPL). Apple is a remarkable delight because it illustrates vividly one of the centralprinciples of technical analysis: ignore (or take with a cellar of salt) the news. Any time the media swarms on acompany, be skeptical. If we believed the media, Apple would have more lives than a cat, considering how manytimes the media has written it off as dead. It is also a chartist's delight as illustrated in my Basing Point studies(Chapter 28), and here, by trendlines (horizontal and sloped) and a large fan. Readers years from now will want toobserve how the trendlines here forecast Apple's future. Figure 37.53 vividly illustrates the technical signal thatkicked off Apple's run, complete with Triangle and run day, and wake up volume. We constantly deprecated thepress disrespect of Apple—hounds of the press are appropriate—and they paid the price for their disrespect asApple went to 425 in 2011. It is satisfying to see the know-nothings of the financial press exposed for how littlethey know.
Figure 37.53 The file of press clippings predicting the death of Apple weighs as much as the daily output of theAugean Stables, and it is worth as much. One wonders why the press likes to beat on Apple so, especially when thewizard was up to his never-ending tricks; the wizard (Steve Jobs) had millions of fanatics ready to support his nexttrick. Although the Beatles are mad at Jobs and Apple, Apple is now a music company as well as a computercompany. The smooth-as-silicon lubricant iPod made music to investor's ears and Apple took off on another run.The start of the latest trick is pictured here. The volume in April is the wake-up call. Of course, what is thatvolume? A shakeout. The breakout across the Descending Triangle line after the false signal (Remember? Thosefalse signals are often followed by valid signals), the volume, and the surging run days—all good grist for theanalyst's mill. Furthermore, the surge across the downtrend line on big volume should be recognized as animportant technical pattern regardless of what proceeds it.

Figure 37.54 $NDX, THE NASDAQ 100. Following the Basing Points Procedure in Chapter 28, an almostcompletely objective procedure may be devised for the very long-term investor to replace or augment Dow Theory.In this chart, the Basing Points Procedure is applied to weekly bars. Thus, instead of three days away, we look forthree bars away. The result is a trade that lasts around 10 years! The method gets long in 1991 at the arrow, holdsthe trade until about 2001, and reverses. Observes the bottom of 2002 and reverses again and is long into the BullMarkets of 2006. Arrows show the signals; numbers mark the Basing Points, and Stops, which would be about 5%under the Basing Points, are not illustrated.
chapter thirty-eight
Balanced and diversified
The average investor wants a clear-cut, simple, easy answer to his question,
“What do you think of the market?” To him, it must be at all times either a
Bull Market or a Bear Market. If, in answer to his insistent demand, you
reply with the question, “What particular stocks are you interested in?” he
will avoid that issue and say, “Oh, I mean in general.” (For illustrations in
this chapter see Diagrams 38.1 and 38.2.)
If you will examine the pages of any magazine or newspaper carrying a
great deal of financial advertising, you will find many advisers and advisory
services make a great point of giving unhedged opinions as to the future
course of the market, and these opinions are most frequently couched in
terms of what the market as a whole is going to do.
Now, there is just enough truth in the common belief that they all move
together to make this an exceedingly dangerous assumption. It is true, for
example, we can set up definitions of what we feel constitutes a Bull
Market or a Bear Market, such as the Dow Theory, and if a given set of
conditions meets the rules we have laid down (i.e., our definitions), then we
can say accurately, “according to my premises this is now a Bull Market”
(or a Bear Market, as the case may be). It is also true that over the years, if
we had treated the Dow Industrial Average (DIA) as if it were a stock and
had theoretically bought it and sold it according to classic Dow Theory, we
would have done very well. (EN: As is vividly illustrated in Chapter 4,
where buying and selling by the Theory netted one $795,592.01 as opposed
to $55,411.83 [as of December 29, 201]) through buying and holding. Of
course, now it is the same as a stock [ETF], DIA.)
It is also true in the great inflationary and deflationary movements, which
reflect the changes in the relative values of dollars to equities, there is a
tendency for the majority of stocks to move with the tide. Furthermore, it is
true in the day-to-day movement of stock prices that most stocks move up
or move down together.
We should never lose si


urse, now it is the same as a stock [ETF], DIA.)
It is also true in the great inflationary and deflationary movements, which
reflect the changes in the relative values of dollars to equities, there is a
tendency for the majority of stocks to move with the tide. Furthermore, it is
true in the day-to-day movement of stock prices that most stocks move up
or move down together.
We should never lose sight of the fact the Averages themselves are
abstractions, not railroads, manufacturing companies, airlines, and so on. If
the Averages move, it is because the individual stocks making up the
Averages have moved; although, it is true during a time when the Averages
are advancing, a majority of stocks are also advancing, it is not quite
possible to reverse this and make it absolute by saying because the
Averages are advancing, therefore, all stocks must advance. If we carried
this to its logical conclusion, we would arrive at the point (that some have
arrived at) at which the fact that a stock has not advanced, but rather has
declined in a Bull Market, is considered sufficient reason to make the stock
attractive for purchase on the basis it must catch up with the others.
If we examine the facts, namely, the long-term records of what stocks have
actually done, we find there are periods when most stocks go up in value
and other times when most of them go down. We find, sometimes, laggard
stocks eventually will join the procession in an upward trend.
However, this does not always happen and it can be extremely
uncomfortable to have bought stocks in a presumably Bullish Market
because they are behind the market or they are all going to go up, and then
wait for months as we watch other stocks climbing to new highs, whereas
our own securities continue to languish or decline further.
From what you already know of the market, you will surely agree it is not a
wise policy to put all your capital into buying stocks in what is clearly a
Bear Market in the Averages and in most stocks. You will agree, too, it is
not a safe thing to sell stocks short to the limit of your resources in a
skyrocketing Bull Market.
If you have to be 100% on one side or the other, it is much better to go with
the trend. In that way, you will be in line with the probabilities as shown by
a majority of stocks and by the Averages.
Nevertheless, you should realize going with the trend is not always as easy
as it sounds. We can set up definitions, as we have, of what constitutes the
Major Trend. Then the question is whether you have the patience and the
courage to maintain a position in line with these definitions through months
of uncertainty and possible adverse moves. During turning periods, it is
often hard to make the decision whether to buy or sell.
Most especially, there is the difficulty of knowing what to buy or what to
sell and when. The simple patterns and signals of the Averages do not tell
the whole story. There is a certain usefulness in regarding the market as a
whole in studying Dow Theory, just so long as we keep in mind the
Averages we are studying are generalities (high-order abstractions) and the
rules for determining their trend apply to these generalities and not
necessarily to each and every stock listed on the Stock Exchange.
In many cases, for example, a group of stocks will top out and start an
important Bearish Trend, whereas other groups of stocks are continuing to
make new highs. This occurred in 1946, when we saw a large number of
stocks topping out in January and February, and others continuing strong
until the end of May.
We think of 1929 as the year the market made its great peak and crashed in
October to start the series of breaks that continued into 1932. There is some
truth in this, but it is not the whole truth. There were some important stocks
that made their highs long before the 1929 Top. Chrysler, for example,
made its high in October 1928, and had dropped from 140 to 60 before the
Panic of 1929. There were stocks that never enjoyed a Bull Market at all in
the whole period from 1924 to 1929. By actual count of nearly 700 listed
stocks, 262 issues made their Bull Market highs before 1929, and 181
topped in 1929, but before August of that year. There were several stocks
that did not have their first downside break until after 1929. Forty-four
stocks went into new Bull Market high ground after 1929 and before mid-
1932. Only 184 of the 676 stocks studied made their Bull Market highs in
August, September, or October of 1929 and crashed in October and
November.
In other words, only 27% of the stocks acted the way everybody knows all
stocks acted. (EN: As the Dow and S&P 500 made all-time highs in 1999
and were near those highs in 2000, the same condition held true again.
Many stocks had topped and were in long downtrends. EN9: And as stocks
crashed after the top of March 2000, Dow stocks held up well compared
with NASDAQ stocks and Standard & Poor's (S&P) 500, which saw
declines of around 50% [see Figure 20.3].)
It is all right to accept the general trend as a useful device, as long as we
know it is a device only, and not a picture of the detailed reality. We have to
face the problem that continually confronts every student of the market:
how to protect ourselves from uncertainties in interpretation of the
Averages, and how to protect ourselves against stocks that are not moving
with the majority. The problem can be met, first of all, by not taking an
unreasonable amount of risk at any time (see Chapter 41).
It can also be met by using an Evaluative Index instead of switching from
all-out Bullish to all-out Bearish. By this we mean using an indicator that
will show not merely whether it is a Bull Market or a Bear Market, but how
Bullish or how Bearish it seems to be at a given time.

10
20
Diagram 38.1 The Evaluative Index shows the percentage of stocks that
appear in Bullish or Bearish Major Trends. In 1961, this Index conflicted
with “stock Averages,” suggesting a possible Major Turn.

30
40
50
60
70


arish. By this we mean using an indicator that
will show not merely whether it is a Bull Market or a Bear Market, but how
Bullish or how Bearish it seems to be at a given time.

10
20
Diagram 38.1 The Evaluative Index shows the percentage of stocks that
appear in Bullish or Bearish Major Trends. In 1961, this Index conflicted
with “stock Averages,” suggesting a possible Major Turn.

30
40
50
60
70
80
90
At first glance, this may seem not too different a conception from that of the
classic Dow Theory; the same technical methods apply. Also, during a
strongly Bullish Market, an Evaluative Index will also indicate
approximately the degree of strength. As the market begins to develop weak
spots, as did the market in 1928 and 1929, the degree of Bullishness will
gradually decline.
Before considering the use of this Index, let us outline what it is and how it
may be constructed. You will understand it is not a precise tool; it gives
only an approximate picture of the state of the market; it gives no positive
signals; and, in the final analysis, it is a reflection of the judgment and
opinion of the person who is maintaining it.
Suppose you are keeping daily charts of 100 stocks; at the end of each
week, you can mark these along the bottom of the chart with a small plus or
minus, indicating your opinion as to whether each particular stock is
moving in a Bullish Major Trend or is Bearish. In some cases, you will find
it hard to make a decision. This is not too important, however, because
these cases will not be numerous, and in the majority of stocks, you
normally will be able to mark them plus or minus on the basis of their
obvious action. If you now total the plus stocks and also the minus stocks,
including those in which you have had to make a tentative decision, you
will have two figures totaling the number of your charts. If 75 of these are
plus, you can say the market looks 75% Bullish to you. If next week the
percentage is higher, say 80%, it indicates a stronger or more Bullish
condition. If it is lower, say 70%, it shows that, on balance, fewer of your
stocks look strong; hence, the market is presumably weaker.
(EN10: A quick way to construct an Index of this sort is to run Moving
Average studies on the market, examining how many stocks are above their
50-day Moving Average, how many above and below their 200-day Moving
Average, and so on. Obviously, you can also do it as Magee did, by
examining each chart of the Dow to see whether it looks strong or not.)
As we have said before, if the Averages are making new highs, you will
expect (and find) the Evaluative Index will range well above 50%. In an
obvious Bear Market, the Index will stand considerably lower than 50%.
However, notice we do not speak, here, of signals. There is no point at
which we need to say, “Sell everything.” Neither is there a point at which
we can say, “Buy now,” in an all-out sense. The Index will float and adjust
itself continually to the shifting conditions.
It must be clear that a market in which only 53% of a large group of
representative stocks are moving Bullishly is not as strong as one in which
80% of these stocks are acting Bullish.
Therefore, you would be justified in making larger commitments on the
long side in this second case.
You would still have the problem of selection of the individual stocks to
buy, but you would be justified in making larger total commitments or in
assuming total greater risk (see again Chapter 41), than in a market that was
barely qualifying as a Bull Market.
By bringing the total of one's investment program in line with this Index, it
is possible to roll with the punches, and one would almost automatically be
withdrawn from a deteriorating market before things became too dangerous.
Furthermore, this would be accomplished without the need for torturing
decisions as to whether to sell now or wait a while.
There is a further extension of this method. If an investor were to follow the
Evaluative Index only by increasing or decreasing his long commitments
with the rise and fall of the Index, he might be better off than if he had only
the two alternatives of complete optimism or complete pessimism. In this
case, he would still be pointed always in one direction and would stand to
lose to some degree on his long commitments if the market did eventually
reverse and go into a Panic Move.
The extension of the method is to proportion capital, or a certain portion of
capital, between the long side and the short side of the market. Assuming
your interpretation of your own charts is reasonably correct in a majority of
cases, you can, at any particular time, select several stronger-than-average
stocks, and similarly, several weaker-than-average issues.
With the Index standing in the vicinity of 50% (as it did for a number of
months in mid-1956), you can then select several strong stocks to buy, and
several candidates for short sale, making commitments that will
approximately balance your total risk. In the case of an upward surge that
sweeps all before it, you will accrue losses on the short sales and eventually
may have to reverse your classification of them from minus to plus, closing
them out for a loss. In such a case, the gains on your good long positions
will more than offset the loss, assuming your choices were well made, and
the loss realized can be absorbed as insurance, namely, the price you have
paid to be in a protected position.
On the other hand, should the market collapse suddenly (as it did, for
example, at the time of President Eisenhower's illness in 1955) (EN: and as
it did on rumors of Reagan's incompetence in October 1987, and the Asian
Flu of 1998, and so on and so on), the accrual of loss in the long positions
will be offset by accrual of gains in the short positions. If the decline should
continue to a point calling for sale of the long stock, the losses here could
be considered the price of the insurance protection to the shorts provided by
the longs. (EN: In the tradi


s of Reagan's incompetence in October 1987, and the Asian
Flu of 1998, and so on and so on), the accrual of loss in the long positions
will be offset by accrual of gains in the short positions. If the decline should
continue to a point calling for sale of the long stock, the losses here could
be considered the price of the insurance protection to the shorts provided by
the longs. (EN: In the tradition of the Texas Hedge, I take a somewhat
different view of shorts. Although they would be viewed in Pragmatic
Portfolio Theory as reducing risk, I like to view shorts as another profit
opportunity with the added benefit of reducing total risk. Being short a
stock in a confirmed Uptrend is simply feckless, and vice versa.)
It is also quite possible, in a more normal market, for both the long
positions and the short positions to show gains. What we are proposing is a
systematic and continuous arbitrage or hedge. As the Evaluative Index
advances, the proportion of short positions would gradually be reduced, and
the long positions increased. As the Index declines, the reverse would
happen. (EN9: I have suggested the method outlined here be called a
“Natural Hedge,” and the implementation of the hedge be called
“Rhythmic Trading.” A Natural Hedge of the Dow would consist of a long
commitment to, for example, the DIA in a Bull Market and short positions
in Bear stocks within the Dow. Or, even better, short positions in stocks
positively correlated to the weak Dow stocks. This last because even weak
members of the Dow will tend to be cushioned by the large holdings of
passive indexers.)
This method is essentially conservative. Those who have always feared the
short sale as a purely speculative gamble might well reexamine short selling
from the standpoint of using the short sale as a regular part of their
investment program as counterbalance to the long holdings.
The result to be looked for in this conservative balanced and diversified
program is primarily protection of capital. By its very nature, it eliminates
the possibility of plunging for spectacular profits, but it also provides the
mechanism by which the technical method can stand on its merits, largely
independent of the changes and chances of the market. It makes it possible
to eliminate a large part of the anxiety and uncertainty so many traders and
investors carry every day and often late into the night.
(EN: Many modern readers are probably unaware that John Magee wrote a
weekly advisory letter for four decades. These wise and practical letters
comprise the John Magee Market Letter
Diagram 38.2 From Collected Market Letters, September 28, 1985. Magee
Evaluative Index computed on the Dow-Jones Industrials illustrating the
use of the Index to identify Tops and Bottoms in the market. A sort of
“oversold-overbought” indicator.
Archive. From this Archive, I append here the letter of September 28, 1985,
relative to the Magee Evaluative Index (MEI). It speaks very strongly for
itself.)
September 28, 1985: an oversold market
This week, the MEI fell to 9% Strong, its deepest penetration into the
oversold quadrant this year. Not since June of 1984 has this index been
lower (see Diagram 38.1). Shortly after its June low of 8% Strong, the MEI
headed steadily higher, giving an Aggressive Buy signal throughout late
June and July.
The June 1984 MEI low of 8% Strong, together with the 8% level reached
on February 25, 1984, constituted a Double Bottom oversold reading for
this index. It corresponded to the 1,079 Bottom recorded by the Dow-Jones
Industrial Average (DJIA) on June 18, 1984, after which that Index
advanced steadily to its recent July peak of 1,372.
For more than 20 years, all major stock market Bottoms have corresponded
with extremely low MEI readings. During the “turbulent period” when the
stock market oscillated violently but showed no gain at all, MEI readings of
5% Strong or less corresponded with all Major DJIA Bottoms until the June
1982 low of 9% Strong, which immediately preceded the stock market's
upward explosion.
That slightly higher than “5% Strong or less” Bottom was an important clue
that a reinvigorated stock market was at hand; the straight-line DJIA
advance from 770 to nearly 1,300 ended a 17-year “do-nothing” period for
stock prices and ushered in the “renewed upswing” period shown on the
chart.
In this context, the “8% Strong Bottom” of June 1984, and the current MEI
reading of 9% Strong, take on added meaning. If, in fact, we are in a period
of Renewed (or major secular) Upswing, stock market Bottoms will tend to
be less severe and Tops more extremely overbought than would otherwise
be the case. Both the June 1982 DJIA low and that of June 1984 fit this
model. Because secular stock market waves tend to last for many years,
even decades, the likelihood is that the current MEI reading of 9% Strong
will also define a Major DJIA low.
chapter thirty-nine
Trial and error
You will not expect to turn in a perfect record from the start. You may
indeed do poorly, which is one of the reasons we have suggested using only
a safe amount of your capital, allowing enough leeway so if you should
misread and misdirect your campaigns, or if you should encounter an
Intermediate Setback in the trend of a Major Turn, you will be able to get
back on course, undismayed, and richer in experience.
Your records of actual transactions (and notes on theoretical transactions)
will help you. As time goes on, you will discover new trading refinements.
Try these methods against your previous chart records. See whether your
improvements work out consistently to your advantage. In that way, you
can test new details of method without risking actual capital until you have
checked the operation thoroughly.
In one actual case, a trader who had shown a rather poor record of
performance through a fast-moving Bear Phase of the market, rechecked 30
of his actual trades made during that period in light of new methods he had
subsequently developed. Where the original


r advantage. In that way, you
can test new details of method without risking actual capital until you have
checked the operation thoroughly.
In one actual case, a trader who had shown a rather poor record of
performance through a fast-moving Bear Phase of the market, rechecked 30
of his actual trades made during that period in light of new methods he had
subsequently developed. Where the original record showed a loss at the rate
of about 40% per year on the capital for the time it was tied up, the changes
he introduced, applied to the same situations, would have resulted in a
profit at the annual rate of 156%. Such a result, although not conclusive,
would strongly suggest trying out the new method in all similar situations in
the future, and if the performance continued to show this advantage, to
adopt it as a permanent policy. It is only by continual checking and testing
that you can learn to pick up more of the profitable opportunities and
protect yourself better against the unexpected Reversals.
If you follow the suggestions of this book, those already given, and those in
the following chapters, you will proceed slowly and cautiously, not risking
all your capital on a single move in a single stock; subsequently, errors and
plain bad luck, when they hurt you, will not hurt you too seriously. You will
be prepared for false moves, wrong interpretations, and complete Reversals
of expected developments.
If you have worked thoughtfully and serenely, without permitting your
emotions to rule your judgment, the law of averages will bring you
continually greater success. You are not gambling blindly in this work; you
are intelligently using past experience as a guide— and it is a dependable
guide. Your operations are part of the competitive workings of a free
market; your purchases and sales are part of the process of interpreting the
trend, checking runaway inflation and crashes, and determining the value of
the American industrial plant.
The market will continue to go up and down in the future as it has in the
past. Your technical knowledge will save you from “buying at the Top” in
the final Climactic Blowoff, and it will save you from selling everything in
a fit of depression and disgust when the Bottom is being established. In
your studies of past market action, you have a strong shield against the
sudden thrusts that surprise and often defeat the novice trader.
(EN9: I have often told my students if their knowledge of this material does
nothing more than keep them from making stupid mistakes like buying a
Top or buying a downtrend or buying before a Bottom has completed
forming, then their time will have been well spent. The elimination of
amateur blunders such as these can immeasurably improve investment
performance.)
Taylor & Francis
Taylor & Francis Group
http://taylorandfrancis.com
chapter forty
How much capital to use in trading
Up to this point, we have been talking mostly in terms of points and
percentages. Little has been said about dollars. From here on we are going
to turn the spotlight on the questions revolving around money, capital, and
the dollars you will actually be using in your operations; just as an
understanding of the technical signals and patterns alone will not guarantee
your profits without a tactical method of applications, so too your tactics
alone will not ensure you profits until you have tailored your method to fit
your pocketbook, and until you have a systematic control of your trading in
terms of dollars and cents.
At the start of your charting operations, you will be using no capital. You
will be making no trades either actual or theoretical. Any commitment you
might make during the first four or five weeks on a new chart would be no
more than gambling on a hunch. It will take about two months of thankless
charting before you have any clear picture of how any of your stocks are
acting technically. From then on, your chart history will become more
valuable each week. Your first trades probably will be theoretical ones. You
will want to get the feel of the charts and learn to apply the methods you
have studied. Eventually, you will want to make an actual transaction.
(EN: The prudence of this approach can hardly be disputed. Just as markets
have changed, stock market mentality and awareness have changed. The
mere existence of this book and of the general atmosphere enable the
modern investor to progress more rapidly than the old pencil-and-paper
and slide-rule chap. The availability of computers and databases and
tutorial tools, not to mention online and offline courses in the subject, are
unparalleled resources.)
Then the question will come up, “How much of my capital shall I use for
trading purposes?” (EN: In a certain sense, this question begs the question.
It presupposes the reader has capital. If the reader does not have capital
but is gambling with the milk money or the mortgage payment, his failure is
virtually assured. Do not speculate with money whose loss will occasion
you more than passing discomfort.)
The amount will depend on your circumstances and how much of your time
and effort you plan to put into stock trading, as well as your experience in
the market. If you have been buying and selling stocks for a number of
years, you will naturally continue along the same lines, simply applying the
new techniques to your operations.
On the other hand, if stock trading is entirely a new field for you, or if it is
only a minor hobby or sideline, it would pay to make haste slowly. Some
writers have pointed out it usually takes about two years to gain enough
practical experience to operate safely in the market; during the two-year
apprenticeship period, many traders come in, gradually lose their capital,
and retire permanently from the field, leaving their money behind them.
Therefore, no matter how confident you may be or how anxious to get in
and start pitching, it would be safest to do most of your experimenting on
the theoretical basis and to use only a s


l experience to operate safely in the market; during the two-year
apprenticeship period, many traders come in, gradually lose their capital,
and retire permanently from the field, leaving their money behind them.
Therefore, no matter how confident you may be or how anxious to get in
and start pitching, it would be safest to do most of your experimenting on
the theoretical basis and to use only a small amount of your actual capital,
so that after, say, two years, if you have shown some actual profits,
consistently and regularly, even though small, you will be much better
prepared to use more of your capital wisely and safely. Conversely, if
during that time you have made repeated mistakes and have registered
many unnecessary losses, you will be able to correct your methods and
continue on a sounder basis, without having lost your main capital reserve.
In no case do you want to risk everything you can scrape together on the
theory that here is the quick way to make easy money. That simply is not
true and the chances are overwhelmingly against you if you go ahead under
any such plan.
It is better to figure out how much you can spare, how much you could
afford to spend for experience, considering the amount you start with is in
the same category as money you might use for taking a special course of
instruction, or for improving property you hope to sell. Or, to take another
example, it would be similar to the salary you might lose in accepting a
lower paid position in a new kind of work that eventually should be worth
more than your present job.
In other words, you will not depend, from the start, on any returns from the
capital you use in trading. You will plan your own budget outside of these
funds, even if that calls for trimming your budget to make that possible.
Then you can go ahead and follow your trading method free from any
pressure to take unnecessary risks, free from the need to sell stock
prematurely to meet obligations, and free from heckling fears and worries.
You can start operations with as little as $500. (EN: This is especially true
in the Internet age. Free commissions in many sites and the availability of
low-cost diversified trading instruments like index ETFs [(the SPY (S&P
500), DIA (Dow Jones Industrials), and QQQ (NASDAQ 100)] offer the
small investor more opportunity than ever before in financial market
history.) Better to have $1,000 or several thousand, but it makes little
difference, so long as you have worked out what you can afford to use
during the apprenticeship period, and as long as you are sure you will have
capital to continue your operation as you develop ability. The important
thing at the start is not how many dollars you can make, but what
percentage of increase per year you can average with the capital you are
using.
If you approach the serious business of trading in this frame of mind, you
will not be afraid to take losses when it is necessary (and there are times
when that is the only wise course to adopt). You will not be straining to
make an unreasonable or impossible profit (with the usual disastrous
results). Additionally, you will be able calmly to build your trading policy
in the sure conviction the market will still be there next year, that
opportunities will still be waiting for you, and that the basic procedures you
are developing are more valuable than any “lucky break” you might pull out
of thin air or a boardroom rumor.
chapter forty-one
Application of capital in practice
(EN: Today we would refer to this as “asset allocation,” about which many
learned books and articles have been written (see Appendix B, Resources).
The modest suggestions in this chapter are, like Magee, very pragmatic and
simple—and quite possibly more effective for the general investor than
those complicated procedures spun out by supercomputers for complicated
Street portfolios.)
Let us now restate a number of ideas we have already investigated and on
which (let's hope) we are thoroughly agreed.
1. Major Trends ordinarily run for long periods of time, covering a
tremendous number of points in total advance or decline—15733.05,
2009 to 2017.
2. Almost unbelievable profits could be made by one who could buy
stocks at the extreme Bottom of a Bear Market and sell at the extreme
Top of the following Bull Market; or sell short at the extreme peak of a
Bull Market and cover at the extreme Bottom of the following Bear
Market.
3. It is not possible to accomplish either of these desirable results.
4. It is possible to avoid becoming trapped in purchases made at or
near the extreme Bull Market Top so that losses become dangerous or
ruinous in a Major Reversal. It is also possible, of course, to avoid
such losses through ill-advised short sales near the extreme Bottom of
a Bear Market.
5. It is possible to make profits by trading in line with the Major Trend,
and in some cases, by trading on the Intermediate Corrections to the
Major Trend, or, occasionally, on the individual behavior of a stock
moving contrary to the Major Trend.
6. The greatest and most dependable profits may be made along the
Major Trend during the principal period of advance (or decline, in the
case of short sales), but not during the earliest phases when the
movement first gets under way or during the rounding off or Reversal
phenomena near the end of the movement.
Therefore, to get the greatest benefits from following the Major Trends, one
would want to have a relatively small equity in the market at the very start
of the move and very little at or near the termination of the move, but a very
substantial interest during the mid-portion when the advance or decline was
making the greatest headway.
The writers have felt it should be possible to express this relation between
the amount of capital tied up and the state of the Major Trend in a neat and
definite equation. Yet, inasmuch as the idea of a Major Trend is, itself, a
matter of definition, and because the trend is an abstraction from the
individual move


during the mid-portion when the advance or decline was
making the greatest headway.
The writers have felt it should be possible to express this relation between
the amount of capital tied up and the state of the Major Trend in a neat and
definite equation. Yet, inasmuch as the idea of a Major Trend is, itself, a
matter of definition, and because the trend is an abstraction from the
individual movements of many stocks, it does not seem possible to arrive at
any such easy solution to the problem of how much capital to use at a given
time.
Nor is it necessary to have a definite and exact answer. As we have already
stated, it is possible to set up an Evaluative Index that will give an
approximate answer good enough for all practical purposes so far as
weighing the “strength” of the trend at a particular time. (EN: To clarify and
make more explicit the concept here, I would point out the Asset Allocation
implications of the Magee Evaluative Index. If the analyst's evaluation of
the market indicated 30% of stocks were Bullish, 30% Bearish, and 40%
neutral, he might so commit his capital—30% long, 30% short, and 40%
cash. This would also assume his assessment of risk also indicated the risks
of the long and short positions were balanced, or approximately equal since
infinite precision is achievable only by the writers of academic treatises
working with perfect hindsight.)
There are, however, some other questions. Most important is the question of
how much total “risk” you are assuming because some stocks are very
conservative and others are very speculative, it is not enough to determine
what part of your capital should be applied in a market trend. The
proportion of your total capital used is not necessarily the whole measure of
your participation. The price level of a stock will affect its habits (low-
priced stocks make bigger percentage moves than high-priced stocks). The
amount of margin you are using will have an effect on the degree of risk.
There is some substance to this plan (otherwise we would not be taking the
time to discuss it here at all), but there is a serious question whether the
decision as to the amount of capital to be used at any specified time can
ever be reduced to a simple mathematical operation. (EN: Still true
although there are those who attempt it.)
Let us suppose you are convinced this is a Bull Market, in a phase of such
potency that you would be justified in using 80% of your capital. However,
you will immediately realize, from what has been said in earlier chapters, if
this money is put into a high-priced (EN: and low-beta) stock, it will not
give you as much likelihood of either profit (if you are right) or loss (if you
are wrong), as it would if put into a lower priced (EN: and high-beta) stock.
In the same way, your money put into a stock having a low Sensitivity
Index, that is, a conservative stock like a Utility stock, will not give you as
much likelihood for either profit or loss as a stock of a high Sensitivity
Index (EN: volatility), namely, a speculative stock such as an internet issue.
These factors, quite as much as the amount of actual dollars, affect your
status, and are factors in answering the question, “Am I out on a limb and,
if so, how far out?”
To make this perfectly clear, we could take 80% of our capital, say $8,000
out of $10,000, and put this amount into the market by purchasing a
conservative preferred stock, outright. A great rise in the general market
might bring us an increase in value of a few points, perhaps 4% or 5%.
Conversely, a great decline might depress the issue by about the same
amount. An example of going to the other extreme might be to purchase
$8,000 worth of options on a low-priced, extremely speculative stock, in
which the probable result within 90 days would be either a profit of several
hundred percent, or a total loss of $8,000.
Obviously, we could vary our status during the progress of the market either
by increasing or decreasing the amount of the total commitment, or by
changing the nature of the account, switching part of the total into more or
less speculative stocks, higher or lower priced stocks, and also by varying
the amount of margin used.
In Appendix A, ninth edition, and Chapter 42, we will show how the
principal factors affecting a given sum of capital used (sensitivity, price,
and margin) can be combined into one figure, which we are going to call
the Composite Leverage Index. (EN: Once again, Magee demonstrates a
practical vision and intuitive understanding both of the markets and of the
basic character of investing far ahead of investment theory and
understanding of his time. What we have in this concept is nothing less than
the original glimmerings of VAR, or Value at Risk. The concepts and
practices of VAR are succinctly summarized in Chapter 42. Composite
Leverage is a complex subject and based on manual charting. For that
reason, it has been left in the ninth edition, where the truly dedicated
scholar may study it at leisure.)
It is perfectly true you must vary your Composite Leverage (EN: risk
exposure) to take advantage of the fast-moving central portions of important
moves, using a lower Composite Leverage at the beginning of such moves
and during the tapering-off or turning periods near the end.
It is one thing to express the Composite Leverage accurately, however,
another thing to write a formula for applying specific degrees of leverage at
particular times. The method suggested at the very beginning of this chapter
has some value but owing to the Secondary Reactions and the difficulty of
determining Major Trends in individual stocks, it is not possible to make
this into the neat, pat rule we are looking for.
It must be a matter of experience, or intuition based on experience. You will
not permit your Composite Leverage factor (i.e., your Portfolio Risk Factor;
see Chapter 42, Portfolio Risk Management) to run out to a dangerous point
on the limb. Neither will you allow it to become so low du


Major Trends in individual stocks, it is not possible to make
this into the neat, pat rule we are looking for.
It must be a matter of experience, or intuition based on experience. You will
not permit your Composite Leverage factor (i.e., your Portfolio Risk Factor;
see Chapter 42, Portfolio Risk Management) to run out to a dangerous point
on the limb. Neither will you allow it to become so low during times of
good market opportunity that you are not getting full benefits from the
move.
We can keep the general shape of a Major Swing in our minds as we
consider this. Bull Markets normally rise through a series of irregular
advances and declines, starting with a moderate upward trend, and
gradually accelerating as the market approaches its ultimate top. Bear
Markets are likely to move fastest at the start and to taper off gradually
toward the end. Bear Markets are steeper than Bull Markets. These
considerations will help us to judge the times when the market will offer the
best opportunities, the times when our Composite Leverage should be
increased.
There are other factors, even harder to pin down in simple figures. We
would, at times, make switches of our holdings for reasons indirectly
related to the factors making up the Composite Leverage Index of the
stocks. We know, for example, high-grade issues, the active market leaders,
and perhaps some stocks of a more conservative nature will tend to start
their moves in a Bull Market fairly early and to continue their advance at a
fairly steady pace. Eventually, they will reach their tops and make a
Reversal Pattern. They will decline from this point, probably at a steeper
average angle than the ascent. Low-priced and low-grade issues, on the
other hand, tend to be slow in getting started, will remain dormant during
the early phases of a Bull Market, and will then suddenly and spectacularly
skyrocket in a series of moves that brings them to their ultimate Top. This
Top, however, is likely to be reached at a later point (perhaps months later)
than the point at which many of the more conservative stocks topped out.
The speculative group will then drop very fast and will return to the dead
levels of inaction before the conservative group has finished its more
leisurely Major Decline.
This means you will do well to concentrate your Bull Market trading in the
early stages, in the higher grade stocks, and in the later stages, in the lower
grade stocks. In a Bear Market, you would perhaps be able to make short
sales unsuccessfully in high-grade stocks even while some of the “cats and
dogs” were still completing their final run-up; however, you would be
watching for the opportunity to cover those shorts and go short the low-
grade stocks as soon as their Reversal was signaled.
Appendix A, ninth edition, will go into the Composite Leverage Index. It
should be a useful gauge for you in your market operations, and a
protection against overtrading. Except, do not expect to use it mechanically
as an index against the market to answer all your questions involving the
nature and size of your commitments. For in gauging the condition of the
Major Trend at any time, your personal experience and judgment must be
the final arbiters.
Put and call options
Options of various sorts have a long history in commercial markets. Nearly
2,000 years ago, the merchants who operated in the Mediterranean region
used “to arrive” at agreements that amounted to option contracts, as
insurance to reduce the risks of storm and piracy. Modern commodity
futures contracts resemble stock options in their dual nature of serving
either as trading media or as insurance devices. Options are also widely
used in real estate transactions and in various other applications.
For many years, stock options were traded only on the basis of individual
agreement between a buyer or a writer, and an opposite number, directly or
through a broker or dealer. The customer and the writer were free to decide
what stock (any stock) would be optioned, at what exercise or striking
price, for what period of time, and at what premium.
In 1973, a new method of handling option contracts was inaugurated by the
Chicago Board Options Exchange and later the American Stock Exchange,
and then to other Exchanges across the country in which call options on a
selected list of actively traded stocks are offered with standard expiration
dates (like commodity contracts) and at definite exercise prices, the
premium depending on the bids and offers of buyers and writers. An
excellent guide to this rapidly expanding market is (EN) Options as a
Strategic Investment by Lawrence G. McMillan.
(EN: In the Internet age, options and derivatives markets have attained an
astounding economic importance. One amusing way of measuring this
importance is by listing some of the great debacles that have occurred to
major traders of derivatives. Bank Negara, Malaysia's central bank, lost $5
billion in 1992-1993 through bad bets on exchange rates. Showa Shell
Sekiyu, Japan, lost $1.58 billion in 1993; Metallgesellschaft, Germany, lost
$1.34 billion in the same period. Barings Bank lost $1.33 billion on stock
index futures. From 1987-1995, known losses like this totaled $16.7 billion.
As Magee would say, etc., etc., which is appropriate considering in 2012 JP
Morgan Chase lost 2 to 5 billion trading derivatives. Of course, compared
with the estimated total market in 1995 of $25 trillion, this is a mere
bagatelle. Perhaps this is sufficient to warn the general investor that the
field is strewn with financial mines even for the sophisticated.
EN9: If the investor considers stocks a complex or difficult area [although
it is hoped this book will make it less so for him] options are exponentially
more difficult. Professionals beat amateurs at that game so thoroughly and
so often as to consider it easy money. So, the general investor should be
sternly warned that much training and study should be undertaken before
becoming fodder for the pros.
EN9: Trad