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FIGURE 273.1.1. DELL. The breakaway or air pocket gap continues to astound, so frequently choosing to occur at horizontal lines. Anexceptionally alert trader might have avoided the air pocket, observing the broken trendlines. The average technician would have got outand shorted the breakaway gap. Seen one tulip, seen them all.
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FIGURE 273.2. The benefits of the “Wintel” partnership are reflected in Intel’s chart.The trader might have been in and out of Intel several times based on tighteningtrendlines, while the long-term investor would have patiently waited out the — callit a “rectangular wedge” — which never was violated on the downside. The steeperthe trendline the more likely — even the more certainly — it will be broken.
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FIGURE 273.3. NOKIA. (NOK) Not enough is made of the marking of zones of support and resistance (highs and lows) with horizontaltrendlines. These benchmarks help the technician to mark the running of the tide, just like Dow’s stakes on the beach. Notice how the highof ’99 influences the high of ’04. The breaking of horizontal lines here after the breaking of the steepest trendline once again tells the talefor the technician.
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FIGURE 273.5. YAHOO. (YHOO). A superb trendline which should have kept the technician long until April of 2000 — and then gothim out. Especially when combined with the top horizontal trendline. The extravagant volume at the very top is the exclamation point onthe warning.
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FIGURE 273.5.1. Any resemblance between this chart and Amazon, (Figure 205.7.2)is not strictly coincidental. Readers will remember Magee’s principle that birds of afeather flock together. Internet goony birds certainly do, or did. Yahoo looks in thisguise somewhat stronger than Amazon, but then selling books and mortar is a harderrow to hoe than selling electronic images (best business in the world). And againsuch an attractive fundamental story. Gooks (or geeks) on skates helping revolutionize the wild frontier. We love these stories. But not enough to stop drawing lines onthe chart and selling them when the violate our lines. Even love must obey the ruleof the ruler.
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FIGURE 273.6. APPLE. (APPL). Apple is an especial delight because it illustrates vividly one of the central principles of technical analysis:Ignore (or take with a cellar of salt) the news. Anytime the media swarms on a company, be skeptical. If we believed the media, Applewould have more lives than a cat, considering how many times the media has written it off as dead. It is also a chartist’s design as illustratedin my Basing Point studies (Chapter 28), and here, by trendlines (horizontal and sloped) and a large fan. Readers years from now willwant to observe how the trendlines here forecast Apple’s future. Figure 274 vividly illustrates the technical signal that kicked off Apple’srun, complete with triangle and run day, and wake up volume.
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FIGURE 274. The file of press clippings predicting the death of Apple weighs asmuch as the daily output of the Augean Stables. And is worth as much. One wonderswhy the press likes to beat on Apple so. Especially when the wizard is up to hisnever ending tricks. And when the wizard, (Steve Jobs) has millions of fanatics readyto support his next trick. And, although the Beatles are mad at Jobs and Apple, Appleis now a music company as well as a computer company. The smooth as siliconlubricant iPod made music to investor’s ears and Apple took off on another run. Thestart of the latest trick is pictured here. The volume in April is the wake up call. Andof course, what is that volume? A shakeout. The breakout across the descendingtriangle line after the false signal (Remember? Those false signals are often followedby 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 shouldbe recognized as an important technical pattern regardless of what proceeds it.
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FIGURE 275. $NDX, THE NASDAQ 100. Following the Basing Point Procedure in Chapters 28 and 28.1, an almost completely objectiveprocedure may be devised for the very long term investor to replace or augment Dow Theory. In this chart, the Basing Point Procedure isapplied to weekly bars. Thus, instead of three-days-away we look for three-bars-away. The result is a trade which lasts around 10 years!The method gets long in 1991 at the arrow, holds the trade till about 2001 and reverses. Observes the bottom of 2002 and reverses againand is long into the bull markets of 2006. Arrows show the signals. Numbers mark the Basing Points. Stops, which would be about 5%under the Basing Points, are not illustrated.
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FIGURE 276. BASING POINTS PROCEDURE. In Figure 210.1 the use of Basing Points calculated on wave lows was documented. For thegreat majority of investors that will be sufficient. In Figure 210 Magee laid out the entire procedure, including advancing stops based ona new high 3% above the previous wave high. This chart shows stops so generated at 11.33 and 13.72. These stops would have stoppedout the trader in this case sooner than the wave low Basing Points. There are pluses and minuses to this part of the procedure. A midtrend blowoff might cause an premature exit from the position leaving the trader to grasp for a new entry point, unless the position wereconstructed with scale-in scale-out units as recommended in Chapter 42. We also see in this chart the result of not honoring stops, as Applefalls off the table in the Reagan Crash of 1987.
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Balanced and DiversifiedThe 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 aBull Market or a Bear Market. If, in answer to his insistent demand, youreply with the question, “What particular stocks are you interested in?,” hewill avoid that issue and say, Oh, I mean in general.And if you will examine the pages of any magazine or newspapercarrying a great deal of financial advertising, you will find that many advisers and advisory services make a great point of giving unhedged opinionsas to the future course of the market, and these opinions are most frequentlycouched 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 movetogether, to make this an exceedingly dangerous assumption. It is true, forexample, that we can set up definitions of what we feel constitutes a BullMarket or a Bear Market, such as the Dow Theory, and if a given set ofconditions meets the rules we have laid down (our definitions, that is), thenwe 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, ifwe had treated the Dow Industrial Average as if it were a stock, and hadtheoretically bought it and sold it according to classic Dow Theory, we wouldhave done very well. EN: As is vividly illustrated in Chapter 5.1, where buyingand selling by the Theory netted one $362,212.97 as opposed to $39,685.03 (EN9:$347,895.10 December 31, 2004) through buying and holding. Of course now it isa stock, DIA.It is also true that in the great inflationary and deflationary movements,which reflect the changes in the relative values of dollars to equities, thereis a tendency for the majority of stocks to move with the tide.And it is furthermore true that in the day-to-day movement of stockprices, it appears that most stocks move up or move down together.But we should never lose sight of the fact that the Averages themselvesare abstractions, not railroads, manufacturing companies, airlines, etc. If theAverages move, it is because the individual stocks making up the Averageshave moved. And while it is true that during a time when the Averages areadvancing, a majority of stocks are also advancing, it is not quite possibleto reverse this and make it absolute by saying that because the Averages areadvancing, therefore all stocks must advance. If we carried this to its logicalconclusion, we would arrive at the point (which some have arrived at) where577
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the fact that a stock has not advanced, but has declined in a Bull Market, isconsidered sufficient to make the stock attractive for purchase on the basisthat it must catch up with the others.If we examine the facts, that is, the long-term records of what stockshave actually done, we find that there are periods when most stocks go upin value and other times when most of them go down. We find, sometimes,that laggard stocks will eventually join the procession in an upward trend.But this does not always happen. And it can be extremely uncomfortableto have bought stocks in a presumably Bullish Market, because they arebehind the market, or because they are all going to go up, and then wait formonths as we watch other stocks climbing to new highs while our ownsecurities continue to languish or decline further.From what you already know of the market you will surely agree thatit is not a wise policy to put all your capital into buying stocks in what isclearly a Bear Market in the Averages and in most stocks. And you will agree,too, that it is not a safe thing to sell stocks short to the limit of your resourcesin a skyrocketing Bull Market.If you have to be 100% on one side or the other, it is much better to gowith the trend. In that way, you will be in line with the probabilities as shownby a majority of stocks, and by the Averages.But you should realize that going with the trend is not always as easyas it sounds. We can set up definitions, as we have, of what constitutes theMajor Trend. Then the question is whether you have the patience and thecourage to maintain a position in line with these definitions through monthsof uncertainty and possible adverse moves. During turning periods it is oftenhard to make the decision to buy or sell.And most especially, there is the difficulty of knowing what to buy orwhat to sell, and when.The simple patterns and signals of the Averages do not tell the wholestory. There is a certain usefulness in regarding the market as a whole instudying Dow Theory, just so long as we keep in mind that the Averages weare studying are generalities (high-order abstractions), and the rules fordetermining their trend apply to these generalities and not necessarily toeach and every stock listed on the Stock Exchange.In many cases, for example, a group of stocks will top out and start animportant Bearish Trend while other groups of stocks are continuing to makenew highs. This occurred in 1946, when we saw a large number of stockstopping out in January and February, and others continuing strong until theend of May.We think of 1929 as the year the market made its great peak, and crashedin October to start the series of breaks that continued into 1932. There issome truth in this; but it is not the whole truth. There were some importantstocks 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 thePanic of 1929. There were stocks which never enjoyed a Bull Market at allin the whole period from 1924 to 1929. By actual count of nearly 700 listed
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stocks, 262 issues made their Bull Market highs before 1929, 181 topped in1929, but before August of that year. There were several stocks which didnot have their first downside break until after 1929. Forty-four stocks wentinto new Bull Market high ground after 1929 and before mid-1932. Only 184of 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 knowsall stocks acted. EN: As the Dow and S&P 500 made all-time highs in 1999 andwere near those highs in 2000, the same condition held true again. Many stocks hadtopped and were in long downtrends. EN9: And as stocks crashed after the top ofMarch 2000 Dow stocks held up well compared to NASDAQ stocks and the S&P500, which saw declines of around 50%. See Figure 203.3.It is all right to accept the general trend as a useful device, so long aswe know it is a device only, and not a picture of the detailed reality. We haveto face the problem which 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 which are not moving withthe majority.The problem can be met, first of all, by not taking an unreasonableamount of risk at any time (see Chapter 41).It can also be met by using an Evaluative Index instead of switchingfrom all-out Bullish to all-out Bearish. By this we mean using an indicatorthat will show not merely whether it is a Bull Market or a Bear Market, buthow Bullish or how Bearish it seems at a given time.At first glance, this may seem not too different a conception from thatof classic Dow Theory. The same technical methods apply. Also, during astrongly 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 graduallydecline.Before considering the use of this Index, let us outline what it is andhow it may be constructed. You will understand it is not a precise tool; itgives only an approximate picture of the state of the market; it gives nopositive signals; and, in the final analysis, it is a reflection of the judgmentand opinion of the person who is maintaining it.Suppose you are keeping daily charts of 100 stocks. At the end of eachweek, you can mark these along the bottom of the chart with a small plusor minus, indicating your opinion as to whether each particular stock ismoving in a Bullish Major Trend, or is Bearish. In some cases, you will findit hard to make a decision. This is not too important, however, since thesecases will not be numerous, and in the majority of stocks, you will normallybe able to mark them plus or minus on the basis of their obvious action. Ifyou now total the plus stocks and also the minus stocks, including those inwhich you have had to make a tentative decision, you will have two figurestotaling the number of your charts. If 75 of these are plus, you can say thatthe market looks 75% Bullish to you. If next week the percentage is higher,
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say 80%, it indicates a stronger or more Bullish condition. If it is lower, say70%, it shows that, on balance, there are fewer of your stocks that look strong,hence the market is presumably weaker.As we have said before, if the Averages are making new highs, you willexpect (and find) that the Evaluative Index will range well above 50%. In anobvious Bear Market, the Index will stand considerably lower than 50%.But notice that we do not speak, here, of signals. There is no point atwhich we need to say, “Sell everything.” Neither is there a point at whichwe can say, “Buy now,” in an all-out sense. The Index will float and adjustitself continually to the shifting conditions.It must be clear that a market in which only 53% of a large group ofrepresentative stocks are moving Bullishly is not as strong as one in which80% of these stocks are acting Bullish.Therefore, you would be justified in making larger commitments on thelong side in this second case.You would still have the problem of selection of the individual stocks tobuy. But you would be justified in making larger total commitments, or inassuming total greater risk (see again Chapter 41), than in a market that wasbarely qualifying as a Bull Market.By bringing the total of one’s investment program into line with thisIndex, it is possible to roll with the punch; and one would almost automatically be withdrawn from a deteriorating market before things became toodangerous. Furthermore, this would be accomplished without the need fortorturing decisions as to whether to sell now or wait a while.There is a further extension of this method. If an investor were to followthe Evaluative Index only by increasing or decreasing his long commitmentswith the rise and fall of the Index, he might be better off than if he had onlythe two alternatives of complete optimism or complete pessimism. But inthis case, he would still be pointed always in one direction, and would standto lose to some degree on his long commitments if the market did eventuallyreverse and go into a Panic Move.The extension of the method is to proportion capital, or a certain portionof capital, between the long side and the short side of the market. Assumingthat your interpretation of your own charts is reasonably correct in a majorityof cases, you can, at any particular time, select several stronger-than-averagestocks, and similarly, several weaker-than-average issues.With the Index standing in the vicinity of 50% (as it did for a numberof months in mid-1956), you can then select several strong stocks to buy, andseveral candidates for short sale, making commitments that will approximately balance your total risk. In the case of an upward surge that sweepsall before it, you will, of course, accrue losses on the short sales, and mayeventually have to reverse your classification of them from minus to plus,closing them out for a loss. But in such a case, the gains on your good longpositions will more than offset the loss, assuming your choices were wellmade; and the loss realized can be absorbed as insurance, the price you havepaid to be in a protected position.
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On the other hand, should the market collapse suddenly (as it did, forexample, at the time of President Eisenhower’s illness in 1955) (EN: and asit did on rumors of Reagan’s incompetence in October 1987, and the Aisian Flu of1998, etc., etc....), the accrual of loss in the long positions will be offset byaccrual of gains in the short positions. And if the decline should continue toa point calling for sale of the long stock, the losses here could be consideredthe 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.While they would be viewed in Pragmatic Portfolio Theory as reducing risk, I liketo view shorts as another profit opportunity with the added benefit of reducing totalrisk. Of course, being short a stock in a confirmed Uptrend is simply feckless. Andvice versa.It is also quite possible, in a more normal market, that both the longpositions and the short positions will show gains.What we are proposing is a systematic and continuous arbitrage orhedge. As the Evaluative Index advances, the proportion of short positionswould gradually be reduced, and the long positions increased. As the Indexdeclines, the reverse would happen. (EN9: I have suggested that the methodoutlined here be called a “Natural Hedge,” and the implementation of the hedge becalled Rhythmic Trading. A Natural Hedge of the Dow would consist of a longcommitment to, for example, the DIA in a bull market and short positions in bearstocks within the Dow. Or, even better, short positions in stocks positively correlatedto the weak Dow stocks. This last because even weak members of the Dow will tendto be cushioned by the large holdings of passive indexers.)This method is essentially conservative. Those who have always fearedthe short sale as a purely speculative gamble might well reexamine shortselling from the standpoint of using the short sale as a regular part of theirinvestment program as counterbalance to the long holdings.The result to be looked for in this conservative balanced and diversifiedprogram is primarily protection of capital. By its very nature, it eliminatesthe possibility of plunging for spectacular profits.But it also provides the mechanism by which the technical method canstand on its merits, largely independent of the changes and chances of themarket. It makes it possible to eliminate a large part of the anxiety anduncertainty that so many traders and investors carry every day and oftenlate into the night.EN: Many modern readers are probably unaware that John Magee wrote aweekly advisory letter for four decades. These wise and practical letters comprisethe John Magee Market Letter Archive. From this Archive I append here the letterof September 28, 1985, relative to the Magee Evaluative Index. It speaks verystrongly for itself:
September 28, 1985: An Oversold MarketThis week, the Magee Evaluative Index fell to 9% Strong, its deepest pen