0, and a correction of the drop from 48 to 30 would indicate short salesaround 37 (which objective was just barely reached). Such sales, if made, would havebeen covered after the first drop (week of March 1) around 33¼. New shorts at 34½would have been closed in the week of March 15 at about 31½. Shorts made on therally of the March 22 week around 33 would be covered in the week of April 19 at30. If shorted again, the same week at 31, the sale would have been covered after theClimactic Bottom in the week of May 24; and the combination, here, of great volumeand a One-Day Reversal would have warned against further shorts.The Rising Channel, being a Secondary, presumably of limited extent, would notoffer any great inducement to long-side trading in the absence of other good reasons.
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Let us say the Major Trend is Bullish, and a certain stock which has beenmoving up irregularly in a Parallel Trend Channel confirms its uptrend bya long, more or less continuous advance and calls for repurchase on the nextreaction. You buy on the reaction, and the stock continues down; that is, thereaction continues with prices sagging for days and weeks, without anyrallies, Consolidations, or Corrections that are sufficiently well-defined toserve as Basing Points for stop orders.In the absence of clear indications during the reaction, and also duringthe preceding large upward move, your stop would be placed at a computeddistance below the top of the preceding rise. And if the reaction continues downuntil that level is reached, you will have sustained an abnormally large loss.In a case like this, you should examine the trendlines making up thelong advance in the Trend Channel. The points of contact with the BasicTrendline can serve as a fair emergency substitute for Minor Bottoms. Yourstop level should, therefore (in the absence of more definite Basing Points),be placed at the computed distance below the last point at which the stockmade contact with the bottom trendline and moved decisively up away fromit. If penetration and close below this point occurs without catching the stop,sell on tight progressive stops. EN: The editor feels that such situations shouldoccur only in position building or pyramiding cases. Every effort should be madeto join trends on breakout or origination, whatever the source. There is no excusefor “chasing stocks” in the modern environment where literally monitoring all stocksis possible with a computer, and instructing the system to alert one to the conditionsattending breakouts. EN9: On the other hand, human frailty being what it is wewill all find ourselves chasing a train at some time or other.The reverse of this rule would apply to the same type of situation in aBear Market, where stops for short sales would be placed at the computeddistance above the point at which the stock made contact with and fell awayfrom the upper trendline.The changes of angularity and direction in Intermediate trendlines arehelpful in showing the gradual turning of a Major Trend.
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chapter thirty-four
A Quick Summationof Tactical MethodsThere are three types of tactical operations: (1) Getting into new commitments; (2) getting out of commitments which have moved as expected andshow a profit; and (3) getting out of commitments which have not movedas expected, whether the transaction shows a profit or a loss.The principles of taking profits based on trends, Resistance and SupportLevels, measuring implications of patterns, and most especially, on the dailytechnical and volume action of the stock, already have been covered. Theseprofit-taking operations seldom present very difficult problems, since thepicture has developed normally and in the way you hoped and expected itwould. The “stepping off” point is usually easy to determine.The more difficult problems arise in making new commitments correctly,and in the very important defensive operations of getting out of losingcommitments with the least possible loss.It should be emphasized that a stock which has ceased to act in a Bullishmanner and which should, therefore, be sold is not necessarily a short saleon the next rally. In other words, the signal that shows weakness or failureof a move in one trend is not always a signal to make new commitments onthe opposite side of the market. More often than not, in fact, it is nothing ofthe kind.We know that certain moves, such as adverse breakouts from Symmetrical Triangles or Rectangles, advise us simultaneously to get out of commitments in what is now clearly the “wrong” direction and to make new commitments in the “right” direction. The simple failure of a trendline, however,where the stock merely penetrates an old Minor Bottom without completinga Head-and-Shoulders or other Reversal Pattern, although reason enough toget out of commitments which are showing losses, is not sufficiently conclusive, by itself, to justify reversing policy and making new commitmentsin the opposite direction. Therefore we separate the two types of signals asfollows:Get out of present commitments• On adverse breakout from Head-and-Shoulders Formation.• On adverse breakout from Symmetrical Triangle.
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Technical Analysis of Stock Trends• On adverse breakout from Rectangle.• On establishment of new Minor low or new Minor high in adversedirection.• On adverse breakout from Diamond.• On adverse breakout from Wedge.• On One-Day Reversal if marked by heavy volume or a gap.• On adverse breakout from Flag or Pennant.• On clear penetration of any Resistance or Support Level in the adverse direction.• On an adverse Breakaway Gap.• On the appearance of an Island after a move in the favorable direction.• On penetration of basic trendline in the absence of pattern or otherfavorable criteria.Note: It is understood that all breakouts must close in the breakoutarea. A closing 3% beyond the Support, trend, or pattern is sufficientto give the danger signal. All takeouts are performed by the use of⅛-point progressive stops.Make new commitments• In line with the Major Dow Trend, or to a limited extent in countertrend moves as insurance to reduce overall risk.• On breakout from Head-and-Shoulders Pattern.• On breakout from Symmetrical Triangle, provided it is not workinginto the final third of its length toward the apex.• On breakout from Right-Angle Triangle.• On breakout from Rectangle, or (possibly) on points of contact, beginning with the sixth Reversal.• On breakout from a Broadening Top.• On breakout from Double or Multiple Top or Bottom. (By this ismeant breakout through the Bottom of the valley between Tops, orupside penetration of the “dome” between Bottoms.)• On breakout from Wedge, or (possibly) commitments within theWedge in the last third of its length as it approaches its apex.• On Flags and Pennants, after sufficient Secondary or Corrective Moveby the pattern, or (possibly) within the pattern, provided that volumeand all other indications tend strongly to confirm the pattern.• On clear penetration of a well-defined Support or Resistance Area.• On Breakaway Gap (possibly).• After formation of an important and well-defined Island followinga considerable move.• On contact with, or penetration of, the “favorable” trendline if bothtrendlines are moving in the Major Trend direction. (Blue TopTrendline in a Bull Market, Red Bottom Trendline in a Bear Market.)
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Note: Breakouts and penetrations must show a closing in the breakout area and must conform to volume requirements. Breakout closings should conform to the 3% rule.New commitments (marked “possibly”) may be made in certain caseswithin some patterns: Rectangles, Wedges, Flags, and Pennants. Exceptionalcare should be used in such cases.It is extremely difficult to catch Breakaway Gaps, and we would notrecommend this as a general practice. EN: This is not so difficult as it was inMagee’s time due to modern communications, computers, and the Internet.All commitments, except those just noted, are made on the next following reaction or rally, to rules previously stated.All commitments are protected by stops from the moment they are made.Stops are moved, as conditions justify moving them, but always in thefavorable direction, never in the adverse direction.
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chapter thirty-five
Effect of Technical Tradingon Market ActionThe question often is asked whether the very fact that traders are studyingmethods and patterns tends to create those very patterns and trends — inother words, whether the technical method sets up, to some extent, anartificial market in which the market action is merely the reflection of chartaction instead of the reverse.This does not seem to be true. The charts we make today seem to followthe old patterns; the presumption is very strong that markets have followedthese patterns long before there were any technicians to chart them. Thedifferences mentioned briefly in Part One, due to changed margin requirements, restraining of manipulative practices, etc., seem to have changedthese habits, if at all, only in degree and not in their fundamental nature.The market is big, too big for any person, corporation, or combine tocontrol as a speculative unit. (EN9: And even beyond big in the 21st century.Gargantuan.) Its operation is extremely free, and extremely democratic in thesense that it represents the integration of the hopes and fears of many kindsof buyers and sellers. Not all are short-term traders. There are investors,industrialists, employees of corporations, those who buy to keep, those whobuy to sell years later — all grades and types of buyers and sellers.And not all short-term traders are technicians by any manner of means.There are those who trade on fundamentals for the short term; those whorely on tips, hunches, on reading the stars, on personal knowledge of thecompany. They are all part of the competitive market, they are all usingmethods different from yours — and sometimes they will be right and youwill be wrong.The technician using the various tools of technical analysis, Dow Theory,Point-and-Figure charts, oscillators, scale order systems, and monthly, weekly,and daily charts is in the minority. The cold attempt to analyze a situationon the basis of the market record alone does not appeal to many people.Technical analysis leaves out the warmth and human interest of the boardroom, the trading room, the fascinating rumors of fat extra dividends tocome, the whispered information on new patents, and the thrilling study ofthe quarterly earnings reports. (EN9: Unless I am mistaken the only appearanceof irony in Magee’s work.)
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It is the influence of all these rumors, facts, and statistics that causespeople to buy and sell their stocks. It is their actions that build the familiarchart patterns. You are not interested in why they are doing what they aredoing. So far as your trading is concerned, you are interested only in theresults of their actions.The habits and evaluative methods of people are deeply ingrained. Thesame kinds of events produce the same kinds of emotional responses, andhence, the same kinds of market action. These characteristic approaches areextremely durable. It is not quite true that “you can’t change human nature,”but it is true that it is very difficult to change the perceptive habits of alifetime. And since the “orthodox” investors greatly outnumber the technicians, we may confidently assume that technical trading will have little orno effect on the typical behavior of free markets.EN: This statement by Magee is still true in principle. And, it should be notedthat in modern markets professional investors attempt to learn (or perhaps it is “themysterious and anomalous market”) what makes systems and other investors successful. They then take action to frustrate those methods which are inimical to theirself-interest. For example, locals and professionals will search for stops above acongestion zone in an attempt to cause the market to break away. This might be inan attempt to create a trend, or it might be in an attempt to create a bull trap.The proliferation of systems trend traders in the futures markets has, some ofthose traders feel, created conditions hostile to systems traders as a group. The moralof the story is that the trader/investor must be ever alert for the false move and thechanging rhythm of the markets.No one has been able to quantify chart analysis, nor to disguise his own activitiesfrom the x-ray of the charts. Nor has anyone changed human nature to eliminatetreachery and perfidy and truculent defense of self-interest.EN9: And – dramatic drum roll – in 2005 Smith-Barney fires its entire technicalanalysis staff. What to make of this is left to the imagination of the reader. Somecommentators attribute it to the bearish outlook of the technical staff as opposed tothe need of the firm to sell long positions to its customers. In my view an unintendedvalidation of the craft. When you have to shoot the messenger it says somethingabout the state of the market, as well as something about the industry.Also, in conversation at a meeting of the Technical Securities Analysts Association of San Francisco (tsaasf.org), Larry Williams: “I hate technical analysis.” Iam reasonably certain that the “technical analysis” referred to is number drivenanalysis.
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chapter thirty-six
Automated Trendline:The Moving AverageThere was a time back in 1941 when we were still filled with starry-eyedignorance, and we felt that if only we worked hard enough and lookedshrewdly enough, we would discover the sure, unbeatable formula or systemthat would solve all our problems in the stock market, and all we wouldhave to do for the rest of life was apply the magic and telegraph our brokerperiodically from Nassau, or Tahiti, or Switzerland, or wherever we happened to be enjoying life at the time.We have learned (we hope) quite a bit since then. We have learned mostparticularly a number of things not to do; and by not repeating the sameerrors over and over, we have been able to improve our performance substantially. We have also learned that (to date) (EN: still true in the 21st century)there are no sure, unbeatable formulas or systems in the market, that eventhe most useful and generally dependable forecasting methods must beregarded as statements of probability only, subject to revision and vulnerableto failure at times.One of the useful tools, and one of the first many students of marketaction adopt, is the trendline. Whether a stock is moving generally up, orgenerally down, or generally sideways, there seems to be a tendency for theMajor Trend to continue, to persist. It is true that every trend is broken sooneror later, and the fact that it has been broken is often significant. But given awell-established trend, the probabilities certainly appear to favor its continuance rather than its Reversal.However, as with all other market studies, there are times and conditionsin which the simple trendline action seems “not quite good enough.” Onefeels that there should be some mechanical or mathematical way of determining the trend that might avoid some of the perplexities of choosing theright point through which to draw a trendline. And, it was back in 1941 thatwe delightedly made the discovery (though many others had made it before)that by averaging the data for a stated number of days, or weeks, or months,one could derive a sort of Automated Trendline which would definitelyinterpret the changes of trend over the past 30 days, or 200 days, or 12months, or whatever period was chosen. It seemed almost too good to betrue. As a matter of fact, it was too good to be true.
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The Moving Average is a fascinating tool, and it has real value in showing the trend of an irregular series of figures (like a fluctuating market) moreclearly. It also has value in that it can be used to cancel out the effect of anyregular cyclical variation, such as a normal seasonal range of temperaturesin order to get a better picture of the true secular trend.The trouble with a Moving Average (and which we discovered longsince, but keep bumping into from time to time) is that it cannot entirelyescape from its past. The smoother the curve (longer cycle) one has, the more“inhibited” it is in responding to recent important changes of trend. Andthere is a very bad fault of Moving Averages in that “the tail tends to wagthe dog”; the figures back to the first date of the current tabulation, perhaps6 months ago, or a year ago, if they are large, may unduly affect the presentaverage, and may conceal or mask some important feature by distorting thecurve.We feel the Moving Averages trendlines are useful. But they should beunderstood and used with discretion, and with a full perception of theirlimitations.Now that we have gone through some of the caveats of Moving Averages, let us give you some of the ways to construct them. Moving Averagescan be classified as Simple Moving Averages, Weighted or Exponential Moving Averages, and Linear Moving Averages. We prefer, and have found overthe years, that the simple methods work just as well and sometimes betterthan the more complicated Moving Averages, and the others are more usefulwhen using computers.For this reason, we will concentrate on Simple Moving Averages. Themost common are the 50-day and the 200-day Moving Averages. If you wantto increase the sensitivity of a Moving Average, shorten the Moving Averageby using 10 or 20 days. Another way is to increase the lead time by startingon the third day for the 10-day Moving Average, or on the 20th day for a50-day Moving Average, etc.To construct a Simple Moving Average, whether it is 5 days, 10 days,50 days or 200 days, you add the price of 5 days, and divide by 5, or the10 days and divide by 10, or the 50 days by 50, or 200 days by 200. A simpleway of doing the 5-day Moving Average, instead of adding all 5 prices eachtime, is to drop day 1 and add day 6. A similar method can be used in doingthe 50-day Moving Average or the 200-day Moving Average. Instead ofadding the 50-day Moving Average each time, just drop the first day of theprevious average and add the 51st day. The same with the 200-day MovingAverage; drop the first day of the previous 200 and add the 201st day.Another way of doing the 200-day Moving Average is to take one day of theweek of 30 weeks, such as Wednesday or Thursday, add them and divideby 30. This will give you the same Moving Averages as you would havedoing 200. Another way to put it is, on the second day, take the total, addthe new day’s price, and subtract the oldest day’s price from your 5-dayMoving Average, 10-day Moving Average, 50-day, or 200-day, whicheverway you are doing it. Repeat the process on a daily basis and divide by the
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representative day — for the 5-day, you would divide by 5; for the 10-day,you would divide by 10; for the 50-day, divide by 50; and for the 200-day,you would divide by 200.
Sensitizing Moving AveragesThe shorter the time period, the greater the sensitivity you will develop inyour Moving Average. The 5-day Moving Average will be much more sensitive than a 10-day. The problem with short-term Moving Averages is thatyou can have a greater number of false moves. Shorter Moving Averages aremore suitable for commodities. On commodities, we would even adviseusing a 30-hour, a 3-day, and a 6-day Moving Average.It is often better to use two Moving Averages, one of shorter durationand one of longer duration. In addition, you can use channels, a MovingAverage of lows, and a Moving Average of highs.
Crossovers and PenetrationsAs a general rule, consider the crossing of two lines by the price line as asell or buy signal in the direction of the crossover or penetration.1. Uptrends — Long positions are retained as long as the price trendremains above the Moving Average Line.a. When the price line intersects or penetrates the Moving AverageLine on the upside, it activates a buy signal.b. When the price line goes above the 200-day Moving Average, butfalls sharply toward it without penetration, it is a buy signal.c. When the price line falls below the Moving Average Line whilethe line is still rising, it could be a buy signal.d. When the price line spikes down too fast and far below a decliningMoving Average Line, a short-term rebound toward the line maybe expected: a possible whipsaw trap.2. Downtrends — Short positions are held as long as the price trendremains below the Moving Average. When the price trend reaches abottom and turns upward, a penetration of the Moving Average is abuy signal.a. When the price line moves above the average line while the average line is still falling, it is a sell signal.b. When the stock price line moves below the average line and risestoward it, but fails to penetrate and breaks down again, it is a sellsignal.c. If the price line rises too fast above the rising average line, a shortterm reaction may be expected: could be a whipsaw.d. Occasionally, penetration of the Moving Average Line will occurin close conjunction with the penetration of a trendline, thenaccording to its direction, it is a buy or sell signal.
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Technical Analysis of Stock Trends3. Horizontal, Diagonal or Sideways Movements — If the fluctuationsare broad in comparison to the length of the Moving Averages beingused, the price trend will fluctuate back and forth as the MovingAverage, true to its character or purpose, moves horizontally.4. Gaps — Moving Averages, depending on their length, may have atendency to be penetrated in close proximity to a Breakaway Cap,particularly at the beginning of a Major Phase of an Intermediatecycle, and also in such cases where Breakaway Gaps occur at thebeginning of correction phases.
Area Patterns can be a pitfall for the Moving Averages. Normally, theMoving Average oscillates through the center of these areas producing buyand sell signals in rapid succession. In Area Patterns, the Moving Averageis a headache to the trader because he never knows which penetration is theone preceding either the renewal of the trend or Confirmation of a Reversal.When trading areas develop in the form of Triangles — Descending,Declining, or Symmetrical — the Moving Average will trend through thecenter of the Triangle. The technician has some small advantage in judgingwhich of the series of penetrations of a Moving Average is the importantone. When the Triangle reaches its apex, and the stock breaks out in onedirection or another and penetrates the Moving Average, the penetration islikely to be the most important one during the sideways movement of theTriangle’s development. Penetrations occur many times in close conjunctionwith the penetration of a trendline.As a price derivative product, the Moving Average can be a trend indicator by the way it fits a trendline. But, nevertheless, it should be consideredan adjunctive tool to everything else you have learned in relation to technicalanalysis.A 150-day Moving Average is charted on the following page.
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Chapter thirty-six:
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Automated Trendline: The Moving Average
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$INDUA LAST-MonthlyCreated with TradeStation www.TradeStation.com
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FIGURE 227. 150-day moving average (dotted line). Up to the 1980s (the periodduring which Ronald Reagan tripled the national debt) trading the 150-day movingaverage (buying on an up crossover and selling on a down crossover) gave a tradersomewhat the same advantage that trading the Dow Theory afforded. In the 1980s,the system stopped working. But here in 1929 it would have been a life saver as canbe seen.
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chapter thirty-seven
“The Same Old Patterns”To the newcomer, the market appears filled with wonders and mysteries asthe landscape of Mars will appear to the first space travelers to land there.There are strange rumblings, apparently unexplainable upheavals, weirdgrowths. An unknown stock will suddenly emerge from a morass of debtand deficit, and proceed to soar to great heights. An old and trusted issuewill paradoxically sag and droop, although apparently rooted in the soil ofeconomic stability. All will seem peaceful and secure; and suddenly, theground opens up and swallows values in a sensational market break.Such a newcomer, perhaps not realizing what appears unusual andalarming is only the normal fluctuation and adjustment that goes on continually in the market according to the changing evaluations of millions ofinvestors, will feel frightened, insecure, and indecisive. He may scurry fromboardroom to boardroom, personally or on the telephone, scan the financialpages, talk with friends, accumulate a mass of conflicting information, andend up shutting his eyes and making a blind stab in the hope that he maycome up with the right answer.Some never, even after years of contact with the market, achieve a tranquil and assured approach.But it is possible to learn something about the basic nature of stocktrends. It is possible to know, within reasonable limits, about what might beexpected in certain situations. And it is also possible to find ways of copingwith these situations, including the exceptional cases that persist in doingthe unexpected. To repeat: It is possible to deal successfully with the unexpected and with that which cannot be precisely predicted.To put it another way, it is possible to be wrong part of the time, andstill to be successful on the balance. And to do this, it is only necessary tohave a background of experience sufficient to know what will usually happen under particular conditions, about how often the unexpected will occur,and how to deal with the unexpected when it does happen. These are thesame general problems that would confront the space traveler, the chemist,the physician, or almost anyone else in his daily affairs.There are men who have observed the market long enough and carefullyenough to discover that there are not quite so many unexpected events asthe newcomer might be led to believe.
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FIGURE 228. A 1952 Major Head-and-Shoulders Top in U.S. Smelting, Refining & Mining. This stock had moved up froma bottom at 33 in 1950 to the peak at nearly 88 shown here. The decline carried down to 37. This chart shows the typicalhigh volume on the left shoulder. The volume at the head is a little higher than in the “ideal” pattern. Light volume on theright shoulder is a definite warning. Notice the Pullback Rally to the neckline in the last week of August. Also the SecondaryRecovery in November and December. There also appears at the left side of this chart in 1951 a beautiful example of anAscending Triangle, indicating the resumption of the previous interrupted advance.
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The charts in this book are, in the main, the same as used for examplesin the first edition in 1947. Some of them show situations from 1928 and1929, others from the 1930s and 1940s. EN: And still others from the 1990s andthe 2000s. The reader can hardly overlook the similarities that occur in various stocks at different times during corresponding phases of their trends orturning points.We have said that these same patterns, trends, and Support Resistancephenomena repeat themselves over and over again, and that they may beobserved by anyone in his own current charts for any period of time, in anynormally active stocks, and on any exchange or market.By way of demonstration, there were included in this chapter of the fifthedition a number of typical technical examples, similar to those alreadydiscussed, but taken from the period 1947 to 1966. EN: The eighth editionincludes examples taken up through the turn of the millennium. It would bepossible to include ten times the number of good examples, for almost everysituation that has been previously illustrated has appeared again and againin recent years.
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FIGURE 229. Downtrends seldom show the perfect and regular trendlines we oftensee in uptrends. But in spite of the irregular, ragged rallies and spotty volume action,the basic principles are about the same as for advances. Notice that in this 6-monthperiod Inspiration Copper had no rally which