. They watch the crowd’s ability to break through recentsupport and resistance levels. They keep an eye on the flow of “paper” — cus-tomer orders that come to the floor in response to price changes. Floor17. MANAGING VERSUS FORECASTING 65
traders listen to the changes in pitch and volume of the roar on the exchangefloor.
If you trade away from the floor, you need other tools for analyzingcrowd behavior. Your charts and indicators reflect mass psychology inaction. A technical analyst is an applied social psychologist, often armedwith a computer.
17. MANAGING VERSUS FORECASTING
1 once ran into a very fat surgeon at a seminar. He told me that he had lost aquarter of a million dollars in three years trading stocks and options. When Iasked him how he made his trading decisions, he sheepishly pointed to hisample gut. He gambled on hunches and used his professional income to sup-port his habit. There are two alternatives to “gut feel”: One is fundamentalanalysis; the other is technical analysis.
Major bull and bear markets result from fundamental changes in supplyand demand. Fundamental analysts follow crop reports, study the actionsof the Federal Reserve, track industry utilization rates, and so on. Even ifyou know those factors, you can lose money trading if you are out of touchwith intermediate- and short-term trends. They depend on the crowd’semotions.
Technical analysts believe that prices reflect everything known about themarket, including all fundamental factors. Each price represents the consen-sus of value of all market participants — large commercial interests and smallspeculators, fundamental researchers, technicians, and gamblers.
Technical analysis is a study of mass psychology. It is partly a science andpartly an art. Technicians use many scientific methods, including mathemati-cal concepts of game theory, probabilities, and so on. Many technicians usecomputers to track sophisticated indicators.
Technical analysis is also an art. The bars on a chart coalesce into patternsand formations. When prices and indicators move, they produce a sense offlow and rhythm, a feeling of tension and beauty that helps you sense what ishappening and how to trade.
Individual behavior is complex, diverse, and difficult to predict. Groupbehavior is primitive. Technicians study the behavior patterns of marketcrowds. They trade when they recognize a pattern that preceded past marketmoves.66 MASS PSYCHOLOGYPoll-Taking
Political poll-taking is a good model of technical analysis. Technicians andpolltakers try to read the mass mind. Polltakers do it for political gain, tech-nicians for financial gain. Politicians want to know their chances of beingelected or re-elected. They make promises to constituents and then ask poll-takers about their odds of winning.
Polltakers use scientific methods: statistics, sampling procedures, and soon. They also need a flair for interviewing and phrasing questions; theyhave to be plugged into the emotional undercurrents of their party. Poll-tak-ing is a combination of science and art. If a polltaker says he is a scientist,ask him why every major political polltaker in the United States is affiliatedwith either the Democratic or Republican party. True science knows noparty.
A market technician must rise above party affiliation. Be neither a bullnor a bear, but only seek the truth. A biased bull looks at a chart and Says,“Where can I buy?” A biased bear looks at the same chart and tries to findwhere he can go short. A top-flight analyst is free of bullish or bearish bias.
There is a trick to help you detect your bias. If you want to buy, turn yourchart upside down and see whether it looks like a sell. If it still looks like abuy after you flip it, then you have to work on getting a bullish bias out ofyour system. If both charts look like a sell, then you have to work on purginga bearish bias.
A Crystal Ball
Most traders take price swings personally. They feel very proud when theymake money and love to talk about their profits. When a trade goes againstthem they feel like punished children and try to keep their losses secret. Youcan read traders’ emotions on their faces.
Many traders believe that the aim of a market analyst is to forecast futureprices. The amateurs in most fields ask for forecasts, while professionalssimply manage information and make decisions based on probabilities. Takemedicine, for example. A patient is brought to an emergency room with aknife sticking out of his chest—and the anxious family members have onlytwo questions: “Will he survive?” and “when can he go home?” They ask thedoctor for a forecast.17, MANAGING VERSUS FORECASTING 67
But the doctor is not forecasting —he is taking care of problems as theyemerge. His first job is to prevent the patient from dying from shock, and sohe gives him pain-killers and starts an intravenous drip to replace lostblood. Then he removes the knife and sutures damaged organs. After that,he has to watch against infection. He monitors the trend of a patient’s healthand takes measures to prevent complications. He is managing — not fore-casting. When a family begs for a forecast, he may give it to them, but itspractical value is low.
To make money trading, you do not need to forecast the future. You haveto extract information from the market and find out whether bulls or bearsare in control. You need to measure the strength of the dominant marketgroup and decide how likely the current trend is to continue. You need topractice conservative money management aimed at long-term survival andprofit accumulation. You must observe how your mind works and avoid slip-ping into greed or fear. A trader who does all of this will succeed more thanany forecaster.
Read the Market, Manage Yourself
A tremendous volume of information pours out of the markets during tradinghours. Changes in prices tell us about the battles of bulls and bears. Your jobis to analyze this information and bet on the dominant market group.
Dramatic forecasts are a marketing gimmick. People who sell advisoryservices or raise money know that good calls attract paying customers, whilebad calls are quickly forgotten. My phone rang while I was writing this chap-ter. One of the famous gurus, currently down on his luck, told me that heidentified a “once-in-a-lifetime buying opportunity” in a certain agriculturalmarket. He asked me to raise money for him and promised to multiply it ahundredfold in six months! I do not know how many fools he hooked, butdramatic forecasts have always been good for fleecing the public.
Use your common sense when you analyze markets. When some newdevelopment puzzles you, compare it to life outside the markets. For exam-ple, indicators may give you buy signals in two markets. Should you buythe market that declined a lot before the buy signal or the one that declineda little? Compare this to what happens to a man after a fall. If he falls downa flight of stairs, he may dust himself off and run up again. But if he fallsout of a third story window, he’s not going to run anytime soon; he needs68 MASS PSYCHOLOGY
time to recover. Prices seldom rally very hard immediately after a baddecline.
Successful trading stands on three pillars. You need to analyze the bal-ance of power between bulls and bears. You need to practice good moneymanagement. You need personal discipline to follow your trading plan andavoid getting high in the markets,ilClassical Chart Analysis
 
18. CHARTING
Chartists study market action, trying to identify recurrent price patterns.Their goal is to profit from trading when patterns recur. Most chartists workwith bar graphs showing high, low, and closing prices and volume. Somealso watch opening prices and open interest. Point-and-figure chartists trackonly price changes and ignore time, volume, and open interest.
Classical charting requires only a pencil and paper. It appeals to visuallyoriented people. Those who plot data by hand often develop a physical feelfor prices. Computers speed charting at a cost of losing some of that feel.
The biggest problem in charting is wishful thinking. Traders often con-vince themselves that a pattern is bullish or bearish depending on whetherthey want to buy or to sell.
Early in this century Herman Rorschach, a Swiss psychiatrist, designed atest for exploring a person’s mind. He dropped ink on 10 sheets of paper andfolded each in half, creating a symmetrical inkblot. Most people who peer atthese sheets describe what they see: parts of the anatomy, animals, buildings,and so on. In reality, there are only inkblots! Each person sees what’s on hismind. Most traders use charts as a giant Rorschach test. They project theirhopes, fears, and fantasies onto the charts.
Brief History
The first chartists in the United States appeared at the tum of the century.They included Charles Dow, the author of a famous stock market theory, and
6970 CLASSICAL CHART ANALYSIS
William Hamilton, who succeeded Dow as the editor of the Wall StreetJournal. Dow’s famous maxim was “The averages discount everything.” Hemeant that changes in the Dow Jones Industrial and Rail Averages reflectedall knowledge and hopes about the economy and the stock market.
Dow never wrote a book, only the Wall Street Journal editorials.Hamilton took over the job after Dow died and struck a blow for chartingwhen he wrote “The Turn of the Tide,” an editorial following the 1929 crash.
Hamilton laid out the principles of Dow theory in his book, The StockMarket Barometer. Robert Rhea, a newsletter publisher, brought the theoryto its pinnacle in his 1932 book, The Dow Theory.
The decade of the 1930s was the Golden Age of charting. Many innovatorsfound themselves with time on their hands after the crash of 1929. Schabaker,Rhea, Elliott, Wyckoff, Gann, and others published their research during thatdecade. Their work went in two distinct directions. Some, such as Wyckoffand Schabaker, saw charts as a graphic record of supply and demand in themarkets. Others, such as Elliott and Gann, searched for a perfect order in themarkets — a fascinating but futile undertaking (see Section 6).
In 1948, Edwards (who was a son-in-law of Schabaker) and Magee pub-lished Technical Analysis of Stock Trends. They popularized such conceptsas triangles, rectangles, head-and-shoulders, and other chart formations, aswell as support and resistance and trendlines. Other chartists have appliedthese concepts to commodities.
Markets have changed a great deal since the days of Edwards and Magee.In the 1940s, daily volume of an active stock on the New York StockExchange was only several hundred shares, while in the 1990s it oftenexceeds a million. The balance of power in the stock market has shifted infavor of bulls. Early chartists wrote that stock market tops were sharp andfast, while bottoms took a long time to develop. That was true in their defla-tionary era, but the opposite has been true since the 1950s. Now bottomstend to form quickly while tops tend to take longer.
The Meaning of a Bar Chart
Chart patterns reflect the tides of greed and fear among traders. This bookfocuses on daily charts, but you can apply many of its principles to otherdata. The rules for reading weekly, daily, hourly, or intraday charts are verysimilar.
Each price is a momentary consensus of value of all market participants18. CHARTING 71
Amateurs (open)Professionals (close)Max power of bears (low)
Max power of bulls (high) |
Figure 18-1. The Meaning of a Bar Chart
Opening prices are set by amateurs, whose orders accumulate overnightand hit the market in the morning. Closing prices are largely set by mar-ket professionals, who trade throughout the day. Note how often open-ing and closing prices are at opposite ends of a bar.
The high of each bar marks the maximum power of bulls during thatbar. The low of each bar marks the maximum power of bears during thatbar. Slippage tends to be less when you enter or exit positions duringshort bars.
 
expressed in action. Each price bar provides several pieces of informationabout the balance of power between bulls and bears (Figure 18-1).
The opening price of a daily or a weekly bar usually reflects the ama-teurs’ opinion of value. They read morning papers, find out what happenedthe day before, and call their brokers with orders before going to work.Amateurs are especially active early in the day and early in the week.
Traders who researched the relationship between opening and closing pricesfor several decades found that opening prices most often occur near the high orthe low of the daily bars. Buying or selling by amateurs early in the day createsan emotional extreme from which prices recoil later in the day.
In bull markets, prices often make their low for the week on Monday or72 CLASSICAL CHART ANALYSIS
Tuesday on profit taking by amateurs, then rally to a new high on Thursdayor Friday. In bear markets, the high for the week is often set on Monday orTuesday, with a new low toward the end of the week, on Thursday or Friday.
The closing prices of daily and weekly bars tend to reflect the actions ofprofessional traders. They watch the markets throughout the day, respond tochanges, and become especially active near the close. Many of them takeprofits at that time to avoid carrying trades overnight. :
Professionals as a group usually trade against the amateurs. They tend tobuy lower openings, sell short higher openings, and unwind their positions asthe day goes on. Traders need to pay attention to the relationship betweenopening and closing prices. If prices closed higher than they opened, thenmarket professionals were probably more bullish than amateurs. If pricesclosed lower than they opened, then market professionals were probablymore bearish than amateurs. It pays to trade with the professionals andagainst the amateurs. :
The high of each bar represents the maximum power of bulls during thatbar. Bulls make money when prices go up. Their buying pushes priceshigher, and every uptick adds to their profits. Finally, bulls reach a pointwhere they cannot lift prices — not even by one more tick. The high of a dailybar represents the maximum power of bulls during the day, and the high of aweekly bar marks the maximum power of bulls during the week; the high ofa 5-minute bar reflects the maximum power of bulls during that 5-minuteperiod. The highest point of a bar represents the maximum power of bullsduring that bar.
The low of each bar represents the maximum power of bears during thatbar. Bears make money when prices go down. They keep selling short, theirselling pushes prices lower, and every downtick adds to their profits. Atsome point they run out of either capital or enthusiasm, and prices stopfalling. The low of each bar shows the maximum power of bears during thatbar. The low of a daily bar marks the maximum power of bears during thatday, and the low of a weekly bar identifies the maximum power of bears dur-ing that week.
The closing tick of each bar reveals the outcome of a battle betweenbulls and bears during that bar. If prices close near the high of the daily bar,it shows that bulls won the day’s battle. If prices close near the low of theday, it shows that bears won the day. Closing prices on daily charts of thefutures markets are especially important. The amount of money in youraccount depends on them because your account equity is “marked to market”each night.
The distance between the high and the low of any bar reveals the inten-18. CHARTING 73
sity of conflict between bulls and bears. An average bar marks a relativelycool market. A bar that is only half as long as average reveals a sleepy, disin-terested market. A bar that is two times taller than average shows a boilingmarket where bulls and bears battle all over the field.
Slippage (see Section 3) is usually lower in quiet markets. It pays to enteryour trades during short or normal bars. Tall bars are good for taking profits.Trying to put on a position when the market is running is like jumping on amoving train. It is better to wait for the next one.
Japanese Candlesticks
Japanese rice traders began using candlestick charts some two centuriesbefore the first chartists appeared in America. Instead of bars, these chartshave rows of candles with wicks at both ends. The body of each candle rep-resents the distance between the opening and closing prices. If the closingprice is higher than the opening, the body is white. If the closing price islower, the body is black.
The tip of the upper wick represents the high of the day, and the bottom ofthe lower wick represents the low of the day. The Japanese consider highs andlows relatively unimportant, according to Steve Nison, author of JapaneseCandlestick Charting Techniques. They focus on the relationship betweenopening and closing prices and on patterns that include several candles.
The main advantage of a candlestick chart is its focus on the strugglebetween amateurs who control openings and professionals who control clos-ings. Unfortunately, most candlestick chartists fail to use many tools ofWestem analysts. They ignore volume and have no trendlines or technicalindicators. These gaps are being filled by modern American analysts such asGreg Morris, whose Candlepower software combines Western technicalindicators with classical candlestick patterns.
Market Profile
This charting technique for tracking accumulation and distribution duringeach trading session was developed by J. Peter Steidlmayer. Market Profilerequires access to real-time data—a constant flow of quotes throughout theday. It assigns one letter of the alphabet to each half-hour of trading. Eachprice level reached during that half-hour is marked with its own letter.
As prices change, more and more letters fill the screen, creating a bell-74 CLASSICAL CHART ANALYSIS
shaped curve. When prices erupt in a trend, Market Profile reflects that bybecoming elongated. Market Profile is sometimes combined with LiquidityData Bank. It tracks intraday volume of trading by several groups — floortraders, hedgers, and off-the-floor traders.
Efficient Markets, Random Walk, and Nature’s Law
Efficient Market theory is an academic notion that nobody can outperformthe market because any price at any given moment incorporates all availableinformation. Warren Buffet, one of the most successful investors of our cen-tury, commented: “I think it’s fascinating how the ruling orthodoxy cancause a lot of people to think the earth is flat. Investing in a market wherepeople believe in efficiency is like playing bridge with someone who’s beentold it doesn’t do any good to look at the cards.”
The logical flaw of Efficient Market theory is that it equates knowledgewith action. People may have knowledge, but the emotional pull of thecrowd often leads them to trade irrationally. A good analyst can detect repet-itive patterns of crowd behavior on his charts and exploit them.
Random Walk theorists claim that market prices change at random. Of:
course, there is a fair amount of randomness or “noise” in the markets, justas there is randomness in any other crowd milling around. An intelligentobserver can identify repetitive behavior patterns of a crowd and make sensi-bie bets on their continuation or reversal.* People have memories, they remember past prices, and their memoriesinfluence their buying and selling decisions. Memories help create supportunder the market and resistance above it. Random Walkers deny that memo-ties of the past influence our behavior in the present.
As Milton Friedman has pointed out, prices carry information about theavailability of supply and the intensity of demand. Market participants usethat information to make their buying and selling decisions. For example,consumers buy more merchandise when it is on sale and less when prices arehigh. Financial traders are just as capable of logical behavior as homemakersin a supermarket. When prices are low, bargain hunters step in. A shortagecan lead to a buying panic, but high prices choke off demand.
Nature’s Law is the rallying cry of a clutch of mystics who opposeRandom Walkers in the financial markets. Mystics claim that there is a per-fect order in the markets, which they say move like clockwork in response toimmutable natural laws. R. N. Elliott even titled his last book Nature’s Law.19. SUPPORT AND RESISTANCE 75
The “perfect order” crowd gravitates to astrology and looks for linksbetween prices and the movements of the planets. Most mystics try to hidetheir astrological bent, but it is easy to draw them out of a shell. Next timesomeone talks to you about natural order in the markets, ask him aboutastrology. He will probably jump at the chance to come out of the closet andtalk about the stars.
Those who believe in perfect order in the markets accept that tops andbottoms can be predicted far into the future. Amateurs love forecasts, andmysticism provides a great marketing gimmick. It helps sell courses, tradingsystems, and newsletters.
Mystics, Random Walk academics, and Efficient Market theorists haveone trait in common. They are equally divorced from the reality of the mar-kets. Extremists argue with one another but they think alike.
19. SUPPORT AND RESISTANCE
A ball hits the floor and bounces. It drops after it hits the ceiling. Supportand resistance are like a floor and a ceiling, with prices sandwiched betweenthem. Understanding support and resistance is essential for understandingprice trends and chart patterns. Rating their strength helps you decidewhether the trend is likely to continue or to reverse.
Support is a price level where buying is strong enough to interrupt orreverse a downtrend. When a downtrend hits support, it bounces like adiver who hits the bottom and pushes away from it. Support is representedon a chart by a horizontal or near-horizontal line connecting several bot-toms (Figure 19-1).
Resistance is a price level where selling is strong enough to interrupt orreverse an uptrend. When an uptrend hits resistance, it stops or tumblesdown like a man who hits his head on a branch while climbing a tree.Resistance is represented on a chart by a horizontal or near-horizontal lineconnecting several tops.
It is better to draw support and resistance lines across the edges of conges-tion areas instead of extreme prices. The edges show where masses of tradershave changed their minds, while the extreme points reflect only panic amongthe weakest traders.
Minor support or resistance causes trends to pause, while major support orresistance causes them to reverse. Traders buy at support and sell at resis-tance, making their effectiveness a self-fulfilling prophecy.76 CLASSICAL CHART ANALYSIS
British Pound
Support and resistance zonesoften change their roles
h,\
1h fly‘SU Ejun ja
Figure 19-1. Support and Resistance
Draw horizontal lines through the upper and lower edges of congestionareas. The bottom line marks the support-the level at which buyers over-power sellers. The upper line identifies resistance, where sellers over-power buyers. Areas of support and resistance often switch their roles.Note how the level of support in March became the line of resistance inMay. The strength of these barriers increases each time prices touchthem and bounce away.
Beware of false breakouts from support and resistance. The letter Fmarks false breakouts on this chart. Amateurs tend to follow breakouts,while professionals tend to fade (trade against) them. At the right edge ofthe chart, prices are hitting strong resistance. This is the time to look fora shorting opportunity, with a protective stop slightly above the line ofresistance.
 
Memories, Pain, and Regret
Support and resistance exist because people have memories. Our memoriesprompt us to buy and sell at certain levels. Buying and selling by crowds oftraders creates support and resistance.
If traders remember that prices have recently stopped falling and turnedup from a certain level, they are likely to buy when prices approach that19. SUPPORT AND RESISTANCE 77
level again. If traders remember that an uptrend has recently reversed afterrising to a certain peak, they tend to sell and go short when prices approachthat level again.
For example, all major rallies in the stock market from 1966 until 1982ended whenever the Dow Jones Industrial Average rallied to 950 or 1050.The resistance was so strong that traders named it “A Graveyard in the Sky.”Once the bulls rammed the market through that level, it became a major sup-port area.
Support and resistance exist because masses of traders feel pain andregret. Traders who hold losing positions feel intense pain. Losers are deter-mined to get out as soon as the market gives them another chance. Traderswho missed an opportunity feel regret and also wait for the market to givethem a second chance. Feelings of pain and regret are mild in trading rangeswhere swings are small and losers do not get hurt too badly. Breakouts fromtrading ranges create intense pain and regret.
When the market stays flat for a while, traders get used to buying at thelower edge of the range and shorting at the upper edge. In uptrends, bearswho sold short feel pain and bulls feel regret that they did not buy more.Both feel determined to buy if the market gives them a second chance. Thepain of bears and regret of bulls make them ready to buy, creating supportduring reactions in an uptrend.
Resistance is an area where bulls feel pain, bears feel regret, and both areready to sell, When prices break down from a trading range, bulls whobought feel pain, feel trapped, and wait for a rally to let them get out even.Bears regret that they have not shorted more and wait for a rally to give thema second chance to sell short. Bulls’ pain and bears’ regret create resis-tance—a ceiling above the market in downtrends. The strength of supportand resistance depends on the strength of feelings among masses of traders.
Strength of Support and Resistance
A congestion area that has been hit by several trends is like a cratered battle-field. Its defenders have plenty of cover, and an attacking force is likely toslow down. The longer prices stay in a congestion zone, the stronger theemotional commitment of bulls and bears to that area. When prices approachthat zone from above, it serves as support. When prices rally into it frombelow, it acts as resistance. A congestion area can reverse its role and serveas either support or resistance.78 CLASSICAL CHART ANALYSIS
The strength of every support or resistance zone depends on three factors:its length, its height, and the volume of trading that has taken place in it. Youcan visualize these factors as the length, the width, and the depth of a con-gestion zone.
The longer a support or resistance area — its length of time or the numberof hits it took—the stronger it is. Support and resistance, like good wine,become better with age. A 2-week trading range provides only minimal sup-port or resistance, a 2-month range gives people time to become used to itand creates intermediate support or resistance, while a 2-year range becomesaccepted as a standard of value and offers major support or resistance.
As support and resistance levels grow old, they gradually become weaker.Losers keep washing out of the markets, replaced by newcomers who do nothave the same emotional commitment to old price levels. People who lostmoney only recently remember full well what happened to them. They areprobably still in the market, feeling pain and regret, trying to get even.People who made bad decisions several years ago are probably out of themarkets and their memories matter less.
The strength of support and resistance increases each time that area is hit.When traders see that prices have reversed at a certain level, they tend to beton a reversal the next time prices reach that level.
The taller the support and resistance zone, the stronger it is. A tall con-gestion zone is like a tall fence around a property. A congestion zone whoseheight equals 1 percent of current market value (four points in the case of theS&P 500 at 400) provides only minor support or resistance. A congestionzone that is 3 percent tall provides intermediate support or resistance, and acongestion zone that is 7 percent tall or higher can grind down a major trend.
The greater the volume of trading in a support and resistance zone, thestronger it is. High volume in a congestion area shows active involvementby traders —a sign of strong emotional commitment. Low volume shows thattraders have little interest in transacting at that level—a sign of weak supportor resistance.
  
Trading Rule:
  
1. Whenever the trend you are riding approaches support or resistance,tighten your protective stop. A protective stop is an order to sell belowthe market when you are long or to cover shorts above the marketwhen you are short. This stop protects you from getting badly hurt by19. SUPPORT AND RESISTANCE 79
an adverse market move. A trend reveals its health by how it actswhen it hits support or resistance. If it is strong enough to penetratethat zone, it accelerates, and your tight stop is not touched. If a trendbounces away from support or resistance, it reveals its weakness. Inthat case, your tight stop salvages a good chunk of profits.
2. Support and resistance are more important on long-term charts than onshort-term charts. Weekly charts are more important than dailies. Agood trader keeps an eye on several timeframes and defers to thelonger one. If the weekly trend is sailing through a clear zone, the factthat the daily trend is hitting resistance is less important. When aweekly trend approaches support or resistance, you should be moreinclined to act.
3. Support and resistance levels are useful for placing stop-loss and pro-tect-profit orders. The bottom of a congestion area is the bottom lineof support. If you buy and place your stop below that level, you givethe uptrend plenty of room. More cautious traders buy after an upsidebreakout and place a stop in the middle of a congestion area. A trueupside breakout should not be followed by a pullback into the range,just as a rocket is not supposed to sink back to its launching pad.Reverse this procedure in downtrends.
Many traders avoid placing stops at round numbers. This superstitionbegan with off-the-cuff advice by Edwards and Magee to avoid placing stopsat round numbers because “everybody” was placing them there. Now, iftraders buy copper at 92, they place a stop at 89.75 rather than 90. Whenthey sell a stock short at 76, they place a protective stop at 80.25 rather than80. These days there are fewer stops at round numbers than at fractionalnumbers. It is better to place your stops at logical levels, round or not.
True and False Breakouts
Markets spend more time in trading ranges than they do in trends. Mostbreakouts from trading ranges are false breakouts. They suck in trend-fol-lowers just before prices return into the trading range. A false breakout is thebane of amateurs, but professional traders love them."
Professionals expect prices to fluctuate without going very far most of thetime. They wait until an upside breakout stops reaching new highs or a80 CLASSICAL CHART ANALYSIS
downside breakout stops making new lows. Then they pounce —they fadethe breakout (trade against it) and place a protective stop at the latestextreme point. It is a very tight stop, and their risk is low, while there is a bigprofit potential from a pullback into the congestion zone. The risk/rewardtatio is so good that professionals can afford to be wrong half the time andstill come out ahead of the game.
The best time to buy an upside breakout on a daily chart is when youranalysis of the weekly chart suggests that a new uptrend is developing. Truebreakouts are confirmed by heavy volume, while false breakouts tend tohave light volume. True breakouts are confirmed when technical indicatorsreach new extreme highs or lows in the direction of the trend, while falsebreakouts are often marked by divergences between prices and indicators.
20. TREND AND TRADING RANGE
Traders try to profit from changes in prices: Buy low and sell high, or sellshort high and cover low. Even a quick look at a chart reveals that marketsspend most of their time in trading ranges. They spend less time in trends.
A trend exists when prices keep rising or falling over time. In anuptrend, each rally reaches a higher high than the preceding rally and eachdecline stops at a higher level than the preceding