ops and Bottoms, andRight-Angle Triangles.
The DiamondIf you are sure that what you have is a valid Diamond Pattern, the rules fortrading will be the same as those we have already covered in connectionwith breakouts from Symmetrical Triangles. As in the case of such Triangles,new commitments should wait for a definite breakout; and commitmentsalready in force would have to remain until such a breakout had occurred,either declaring a Reversal, or indicating a probable continuation of theoriginal trend.
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22PARAMOUNT PICTURES
20
PX
191941–1943
18171615141312Sales100’s
5040302010S O
N
D
J
F
M
A
M
J
J
A
S
O
N
D
J
F
M
FIGURE 219. A Double Bottom in Paramount Pictures. Double Tops and DoubleBottoms are not as common as many traders like to think. They require considerabletime to develop and must conform to specifications as to price range and time, andalso (on upside breakouts from Double Bottoms) as to volume. They are easier tospot on weekly charts than on dailies.This is a weekly chart of “PX” from September 1941 through March 1943. A Bottomwas made on climactic volume at 11¾ during the “Pearl Harbor Panic” Move. Thencame a rise lasting 8 weeks which brought “PX” back to 15⅝ — a rise, incidentally,on feeble volume, strongly suggesting the possibility of another crack-up to evenlower levels. This rise, you will notice, was a considerable one, amounting to 35%of the price at the December low.The downward move, however, which lasted to mid-April, was on low volumeand ended precisely at the December low of 11¾. (Note: it is not necessary that movesof this sort end at exactly the same level; the second Bottom could have been a bithigher or lower without spoiling the pattern.)The second week in July shows the first sign of a possible Reversal when the priceadvanced on increased volume, but it did not close above 15⅝, and was, therefore,not a breakout. Two weeks later, on heavy volume, “PX” had moved up to 16½,closing the week at 16. This is a true breakout, and purchases would have been inorder on reactions from this point on.The move continued up for 3 years to an ultimate Top at 85.
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28ASSOCIATED DRY GOODS
DG
262422
1945
20
XD .25
18Sales100’s
XD .25
19
5040302010JANUARY FEBRUARYMAYMARCHAPRIL6 13 20 27 3 10 17 24 3 10 17 24 31 7 14 21 28 5 12 19 26 2
JUNE9 16 23 30
FIGURE 220. A Right-Angled Broadening Formation in Associated Dry Goods. Abeautiful example of a breakout through Multiple Tops, followed by an importantmove. This is, however, a pattern that is more fun to observe in retrospect than tofollow as an active trader. The stock had moved up from an important Bottom around4, established in 1938, 1940, and 1942. At the time of this chart in 1945, “DG” wasstarting the accelerating climb that eventually ended with the 1946 Rounding Top atover 70. (See Figure 213.)If you had been holding the stock, you would have been watching for a substantialcorrective move after the advance from 12 to 20. In late February and the first weekof March, “DG” went into new Bull Market high-ground, reacted to Support around19 to 19½, and then advanced again in the week of March 17, failing in this move tomake a new high. Ten days later, “DG” had reacted to 18½, closing below the previousMinor Bottom. An inexperienced observer might, at this point, have commented“Double Top” and planned to sell “DG” at once or even to make a short sale.However, the pattern was not large enough in duration nor extent of price movementto qualify as a Double Top, nor did it conform to any other recognizable pattern ofReversal. Nor was the volume as high as one would expect on an important Top.The rally in early April carried through to a decisive breakout of more than 3% inthe move which reached 22⅞ on April 18. This move was a near penetration of themiddle Top, and confirmed the uptrend. If you still held your long stock, you wouldnot rest easier, and in any case, you would have looked for a chance to buy on areaction after the breakout. If you had tried to buy at the 21½ Support Level, youwould have been left behind, but if you had put your order in a little higher, say at22, you would have had a nice profit on the advance to 25⅞, where you would havesold on a tight stop at 25¾.
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AMERICAN CAN
AC
1946–1947
96
XD .75
Sales100’s
XD .75
88
5040302010FEBRUARYDECEMBER JANUARY7 14 21 28 4 11 18 25 1 8 15 22 1
MARCHAPRILMAY8 15 22 29 5 12 19 26 3 10 17 24 31
FIGURE 221. A Diamond Pattern in American Can. The daily chart covers theperiod from 3 December 1946, through May 1947, inclusive. For background on thissituation, keep in mind that “AC” made its Bull Market Peak in October 1945 whenit reached 112. The tendency of high-grade, high-priced stocks to top-out early at theend of a Bull Market has already been noted. The first decline carried nearly to 90and was followed by a rally to 106. The stock then dropped to below 80 and a secondrally brought us to the situation we see here.You will notice at once that the moves have a gradual “rounding” appearance, dueto the fact that, at this price, conservative stocks do not make large percentage moves.If charted on a scale having larger vertical intervals, the patterns would look verymuch like those in more speculative stocks.The first part of the pattern is similar to a Broadening Top. The first Minor Peakat 96 is followed by a reaction to 92. The second peak carries even higher, to 98; andthe reaction this time goes down to 91¼. A third rally takes “AC” to 99. So far, wehave the five Reversal points of a Broadening Top, needing only a close below 91¼to confirm the Bearish indications. However, the next decline fails to break out ofthe pattern, and for several weeks, we have a narrowing picture like a SymmetricalTriangle.Eventually, the stock makes a clean breakout to 89, which is the signal to get outof longs and to consider short sales on the next rally. As a matter of fact, the 3-weekrally which then started never made an upside penetration of the Resistance Levelat 94, the level of the apex of the converging lines bounding the latter part of theDiamond.American Can did not make a spectacular move down from this point, which isnot surprising considering the markdown that had already taken place in “AC,” andconsidering the habits and price of the stock, and the general condition of the market.It did not, however, again rise to the level shown here, and, in fact, retreated to the80 level.To review the nature of the Diamond — it is not a common pattern. It is somewhatlike a Complex Head-and-Shoulders with a bent neckline. It resembles, at the start,a Broadening Top, and its latter phase narrows like a Symmetrical Triangle.
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WedgesThere is no need to set forth detailed rules for policy within a Wedge andduring its formation, since the general principles taken up in connectionwith trendlines and Support and Resistance, would take you out of such asituation at the first opportunity after the convergent nature of the patternbecame clear. At the very worst, your stops (which we hope you maintainfaithfully in all situations) will take you out before the consequences becomeserious.Regarding new purchases (from a Falling Wedge breakout) or short sales(from a Rising Wedge), the same volume characteristics would be expected:notably increased volume on an upside breakout from a Falling Wedge; lesspronounced volume action on the first stages of breakout from a RisingWedge. New commitments, in line with the implications of the breakout,may be placed on rallies or reactions after a clear breakout closing occurs,carrying beyond the trendlines forming the Wedge.
One-Day ReversalsOne-Day Reversals are not technical patterns suitable for trading in the samesense as the important Reversal and Consolidation pictures we have examined. They are mainly useful as a gauge in helping to find the precise Topor Bottom of a Minor Move in order to protect profits on commitmentspreviously made. The One-Day Reversal, the Exhaustion Gap, and the dayof exceptionally heavy volume following several days of movement in aMinor Trend are strong indications that the move may have run out. Any ofthese three signals is worth watching for; any two of them together carrymore weight than one alone; and the appearance of all three carries verystrong implications of a Minor (EN: or even a Major) Top or Bottom.So far as trading on movements signaled by One-Day Reversals, thistype of trading would lie almost in the field of gambling, or at least tradingfor quick, small profits on short moves. It would not be the same kind oftrading at all that we have been studying in the greater part of this book.The indications and some suggestions for trading on those one-day movesare covered in the discussion of them in Chapter 10.
Flags and PennantsIn many cases, the total decline from a Flag in an uptrend will bring theprice back to a point where the stock may be bought according to our regulartrading tactics, that is, the decline may carry down to the Basic (Red)Trendline, to the Blue Parallel, or make a 40 to 50% correction of the rising“mast” preceding the Flag. If the “mast” move is the first such move out ofa level or only moderately rising trend, and if the Major Trend of the market
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3028GULF MOBILE & OHIO RR.
GFO
2624194522
201918171615Sales100’s
25020015010050JANUARY FEBRUARYMARCHAPRILMAY6 13 20 27 3 10 17 24 3 10 17 24 31 7 14 21 28 5 12 19 26 2
JUNE9 16 23 30
FIGURE 222. Gulf, Mobile, and Ohio builds a beautiful Wedge, as shown on thisdaily chart for the first half of 1945. This was the move which terminated the spectacular rise of “GFO,” its final Bull Market Top.Immediately after the downside breakdown from the Wedge, “GFO” came downto 18¾, and from this Intermediate low, which was reached in August, rallied into along Rectangle between 23¾ and 26¾ from which it eventually broke down in aseries of crashes that found it, in May 1947, selling for 6⅛!It is rather hard, with a formation of this sort, to say at what precise point theconvergence of the trends is established. The breakout move late in April was, ofcourse, normal; the stock was a buy on the next reaction. The following advance inMay, which reached 23½, did not carry out a Parallel Trend Channel, and we saw atendency to converge as prices retreated on the reaction. The next three advances allrepeated and confirmed the Wedge picture, and at the top, we see a sort of “bunchingup” as prices make little or no headway. The chances are that at 11 an alert traderwould have taken profits on long commitments after the high volume appeared atthe top of the Minor Move ending June 4 and 5. In any case, he would have maintained a protective stop at all times to take him out if and when a downside breakoutoccurred.
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is Bullish, we would be justified in buying at the first opportunity, whichwould be on the Blue Parallel. In such a case we would expect, and ordinarilyget, some further reaction, but it is important to get in early because sometimes the reaction is very brief, and does not meet either of the other requirements for the correction. It is most important in a situation like this that thevolume drop off sharply. Volume must decrease and remain slight. Anyincrease of volume during the formation of the Flag should be reviewed ascasting suspicion on the entire pattern, except, of course, the increasingvolume that characteristically attends the start of the breakout drive. Thisdrive is usually so virile that we would be safe in placing a tight (⅛ point)stop under the close of any day during formation of a Flag or Pennant thatshowed notably increased volume. So that if the volume indicated failure ofthe pattern, we would be taken out at once; but if the breakout was underway, we would probably be left in, since the stock would ordinarily moveup then without a reaction, very often making a Breakaway Gap.In downward movements, when the Major Trend of the market is Bearish, the same suggestions would apply, with one difference. The final highday of the Flag-type of rally may be on high volume, and, of course, mayalso show the Exhaustion Gap or One-Day Reversal. If a short sale has beenmade into such a day showing high volume, gap, or One-Day Reversal, astop order placed above the peak of the Flag will protect you should theadvance be resumed unexpectedly.In either the up-moving or down-moving manifestations of this type ofaction, there may be Flags having horizontal Tops and Bottoms, which are,of course, Rectangles. If the drying-up of volume and other aspects of thepicture, including the sharp upward or downward move preceding it, suggest a Flag-type Consolidation, you would be justified in making a commitment on the sixth Reversal point, or for that matter, at almost any point inthe pattern (since you cannot expect this pattern to continue very long).Flags and Pennants which do continue too long (over 3 weeks) are opento question. Stops should then be set at the usual computed distance aboveor below their extreme Tops or Bottoms (as the case may be). The fairlyfrequent appearance of Flag-like Formations which eventually fail is unfortunate, since it is particularly hard to give up hoping with this kind ofpattern, and it is necessary to set the 3-week time limit to prevent the stockfrom drifting all the way back to previously established stop levels. On theother hand, breakout moves from these patterns, when completed normally,are among the fastest and most profitable forms of market action.The question remains what to do in the case of stocks you may be holdingas they go into Flag or Pennant Formation. Obviously, they should be heldif you are long and the move leading to the Flag is up; or short positionsshould be retained if the move is down. However, this would not happen
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2422
1945
20191817
G
161514MARTIN-PARRY
MRT
13
XD .15
1211Sales100’s
125100755025APRILMAY7 14 21 28 5 12 19 26 2
AUGUSTJUNEJULYSEPTEMBER9 16 23 30 7 14 21 28 4 11 18 25 1 8 15 22 29
FIGURE 223. A Pennant in Martin–Parry. This type of pattern is fairly common infast-moving markets. The extraordinary point about Flags and Pennants (and sometimes other Consolidation Patterns in fast moves) is their tendency to form almostexactly halfway between Bottom and Top.Just before this move, “MRT” had built a Rectangle between 10 and 12 lasting7 months, which followed the 1944 rise from around 4 to 12. The May breakout onheavy volume carried “MRT” right to the top of the Pennant without any adequatereaction. Note the increase of volume at the top of that rise. For 3 weeks prices driftedoff with a drying up of volume that is clearly shown in the chart. The pattern didnot correct the entire first phase, but found Support at the Minor Peak at 14½.Suddenly, on high volume, the move was resumed, and this time went right upto 24¾. The chances are that traders who were still long their original stock or whohad bought in around 15 on the Pennant would have sold after the high volume ofJune 6 when “MRT” reached 19⅞.
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17
GG
16LEHIGH VALLEY R . R .
LVG
1514
495
GG
1945–1946G
131211
Sales100’s
125100755025OCTOBER NOVEMBER DECEMBERJANUARYFEBRUARY6 13 20 27 3 10 17 24 1 8 15 22 29 5 12 19 26 2 9 16 23 2
MARCH9 16 23 30
FIGURE 224. This daily chart of Lehigh Valley R.R. through late 1945 and early1946 shows a variety of gaps. At this particular time, “LV” was completing a Secondary Corrective Move before making one more (and as it turned out, final) effortto exceed the 1945 Top just above 17. This long-term situation could be used for adiscussion of Double Tops, since the Bottom of the intervening move was violatedin the summer of 1946 and the stock continued a downward course to below the5 level.Not all gaps are significant; for example, the first gap shown, on October 3, whenthe stock was moving in a narrow range on low volume. The gap on Saturday,November 3, however, is important, since the Saturday volume (when doubled) ishigh. The move failed to qualify by a 3% new high closing as a true breakout, butthe implications of the move were Bullish and might well have justified purchaseson Minor Reactions. The low-volume gaps on these reactions were of no particularinterest.It is not until the third week of January that we see another gap that looks like areal breakaway. On January 14, with high volume, “LV” moved up and out in a rushthat took it to 15⅞ on January 16, closing at 15½. The second appearance of volumehere would have suggested application of progressive stops, and long trades wouldhave been closed out at 15⅜.New purchases could have been made on the reaction at 14½. A second advanceaccompanied by a Breakaway Gap developed on January 23. If we consider thesecond gap (of January 24) a Runaway or Measuring Gap, we would estimate theprobable top of this move at around 17¾. However, when a third gap appeared onJanuary 28 with a One-Day Reversal and climactic volume, it would be clear thatthis move was about finished, and progressive stops would be used to clear out longsat 16¾.Note the attempt to rally after the sharp drop, and the One-Day Island formed bytwo gaps as “LV” fails to hold at the 15 level.
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ordinarily if you had followed the trading rules strictly. In most cases, yoursignals calling for tight (⅛ point) progressive stops would have appearedduring the formation of the “mast.” You would have been taken out of thepicture somewhere along the way, possibly at the extreme top of the mast(though ordinarily, you could not count on being so fortunate).If, however, no signal should appear, and you still are holding a positionas the Flag starts to make its appearance, by all means hold your position.The odds favor a continuation of the original move.Now if you have been holding the stock long (in a Bull Market), andhave seen it break out and start leaping to new highs, say from 20 to 32, andyou have been stopped out at 30, and then you see the price advance, haltand during the next several days retreat, with the rather high previousvolume drying up to practically nothing (it must be a drastic drying-up, andno mistake about it), then you are justified in buying right back in again,even at a higher price than you received only a few days before.
GapsIf you are long a stock which is in a well-marked pattern formation, or inan area of dull movement within fairly narrow limits, and the stock suddenlybreaks out on the upside with high volume and a gap, that is a Bullishindication. You will hold the stock until signs of exhaustion appear as therise continues, or reappearance of high volume, or another gap or One-DayReversal. Then, particularly if two or all three of these indications show upat the same time, you can protect your commitment with tight progressivestops. You will have to consider whether a second gap should be consideredan exhaustion gap or a continuation gap, depending on the volume and thespeed of the rise, as discussed in the chapters on gaps and their measuringimplications.Ordinarily, after a Breakaway Gap, regardless of whether you sell on thenext Minor Top, you would consider the move Bullish, and would prepareto make a purchase on the next reaction.Now if you are long a stock, and during the course of a sharp rise itdevelops a gap after several days of the move, you must make your decisionas to whether or not it is a Continuation (Runaway) Gap. If so, you wouldprepare to hold the stock for a further rise approximately equal to the riseup to the gap; and you would watch the approach to the ultimate objectiveindicated very closely, so that, on the appearance then of Reversal signals,you could protect your holding with tight stops.If you are satisfied that a gap following a good rise is actually an Exhaustion Gap, then you should protect your stock with a tight progressive stopat once.In Bear Markets, you would apply these same rules in reverse to yourshort sales, remembering that a downside breakaway is not necessarilyaccompanied by the high volume you expect on an upside breakaway.
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Where you are long or short a stock which is moving in a PatternFormation, and the stock then makes a Breakaway Gap in the adverse direction, the commitment should be closed out immediately at the market, oron tight progressive stops.
Support and ResistanceWhen you are long a stock, you do not want to see it violate any MinorBottoms previously made. Neither do you want to see it violate any of thepreceding Minor Tops which it has surpassed. Therefore, your stop orderswill be placed at a computed distance, as explained in Chapter 27 on stoporders, using both the Minor Bottoms and the Minor Tops as Basing Points.Normally, the Minor Bottom most recently formed will be at the approximatelevel of the preceding Minor Top, so that often these Basing Points willcoincide. Ordinarily, therefore, in a rising trend, we look to the most recentlyformed Minor Bottom. When the stock has, for 3 days, made a price rangewhich is entirely above the entire range of the day marking this Bottom, youmay move up your stop protection to a place indicated by this new BasingPoint.The same procedure will apply in Bear Markets; the “three-day” rulebeing used to confirm Basing Points established by Minor Peaks and alsoby the preceding Minor Bottoms. But, ordinarily, it will be sufficient to usethe Minor Peaks as Basing Points.Intermediate Tops and Bottoms are used in determining the probableobjectives of Intermediate Moves, since previous Tops constitute Supportunder Intermediate Reactions, and previous Bottoms indicate Resistanceover Intermediate Rallies.Multiple Tops are Support Levels. Multiple Bottoms are Resistance Levels. The neckline of a Head-and-Shoulders Pattern is a Support or ResistanceLevel, as the case may be. The apex of a Symmetrical Triangle is a strongSupport and Resistance point which may show its effect again on a subsequent move. Any congestion or area at a certain price level or within narrowprice limits may provide Support or Resistance when a stock moves againto that price or range.
TrendlinesWe have already gone into the methods of following trends in stocks, andthe use of the Top and Bottom Trendlines (Basic and Return Lines) as indicators of Bullish and Bearish opportunities, and as price determinants forexecuting purchases or short sales.There remains the tactical problem of the stock in which you are committed, which is acting badly, but which has neither broken out of a recognized pattern nor violated an established Minor Peak. This is not a commonsituation, but it can present a very difficult problem when it does come up.
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1944
18171615NORTHERN PACIFIC
NP
14Sales100’s
125100755025MAYAPRILJUNE8 15 22 29 6 13 20 27 3 10 17 24 1
AUGUSTSEPTEMBERJULY8 15 22 29 5 12 19 26 2 9 16 23 30
FIGURE 225. This daily chart in Northern Pacific, covering 6 months during 1944,shows several examples of Support and Resistance. The entire chart covers only partof the series of Consolidations that took place in 1943 and 1944 preceding the 1945–46advance that carried beyond 38.Support and Resistance phenomena appear, of course, on many, in fact on most ofthe charts in this book, and you will find them on the charts you set up for yourself.There is nothing unique or even unusual about the Support–Resistance action in“NP.”Starting at the left in April, after the downside move on volume to 14¼, notice therecovery to 15⅝ where the move stops at the Resistance Level of the preceding2 weeks. After the formation of the Symmetrical Triangle, there is a breakaway movewith a gap which runs right on up to above 17, where a small Rectangle is builtduring the next 3 weeks. The stock ultimately breaks down from this pattern onconsiderable volume. It is doubtful whether one would want to trade on this as anormal reaction after the breakout from the Triangle, because of the downside volumeand the implications of the Rectangle.However, note how the reaction stops cold at the 15 line, the apex level of theTriangle, and then moves right on up. Rather surprisingly, there is only a 3-dayhesitation at the Bottom of the Rectangle, but a little setback occurs at the Top of thatpattern.The July Top might be classed as a Head-and-Shoulders or Complex or RoundingTop; in fact, it is almost a Rectangle, and after the downside breakout, prices hesitateat the level of the Top of the May Rectangle, continue down, find temporary Supportagain at the April Support Shelf around 16, and ultimately wind up a bit under 15.Although “NP” actually did penetrate and close slightly below the apex of theTriangle, the violation was barely 3%, and it is interesting to note that this SeptemberBottom was the lowest point reached. From here, the stock started its climb to the38 level, which was reached in December 1945.
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38AMERICAN STEEL FOUNDRIES
36
FJ
3419473230
XD 50C
26Sales100’s
XD 50C
28
50403020108 15 22 1
MARCHAPRILMAYJUNEJULY8 15 22 29 5 12 19 26 3 10 17 24 31 7 14 21 28 5 12 19 26 2
FIGURE 226. Trendlines in American Steel Foundries. This daily chart shows thetendency of trendlines to develop along straight channels. We have already pointedout that these channels are frequently easier to see in retrospect than during theirformation, that stocks move in perfect channels only occasionally, and that all channels come to an end, frequently without warning. In this case, the long trend channeldoes give a warning of Reversal.In 1946, “FJ” had declined from 48 to a Support Level of 30. From here it ralliedfor 3 months in a Trend Channel that brought us to the February Top at 37. The nextdecline broke the previous trend, and volume developed at the bottom of this break.If you will follow the entire chart, you will notice that volume nearly always showsan increase at the points of Reversal, which are also usually points of contact withthe Trend Channel. Notice also the way the Corrective Rallies tend to stop at or nearthe previous Minor Bottoms in the downward trend, and how reactions tend to stopat the previous Minor Tops in the upward trend.Trading on this situation would have been profitable. The Secondary IntermediateRally up to February approached the Resistance Level marked by a 1946 Bottomaround 4