URE 179.5.2. A Rounding Bottom in Silver 1998-2005. The apparent RoundingBottom in silver, combined with the same pattern in gold, would seem to cast a pallover the economic situation for some time to come in 2005. This coincides with theapparent long-term patterns setting up in the securities markets. If the best whichcan be hoped for in securities is a 1965-1982 kind of widely whipping market commodities may react as they did in the 1970s. With tidal wave markets. These marketscan be traded by the well capitalized chart analyst who is well seasoned. Tyros ofcourse will lose money learning the game whatever markets they trade. Their chanceswill be immeasurably improved by applying the techniques taught in this book. Inaddition to the technical pattern pictured here there is every reason to suspect thata large fundamental shortage of silver bullion exists and will worsen. Ted Butler, atdoomgloom.com, is a long-term silver analyst (and associate of the editor) whoanticipates that a new silver blow off is coming. One wonders what Nelson andBunker Hunt are doing at present. A very cautious investor (like Warren Buffet whois reported to be long $1B (billion) silver bullion) may defeat futures silver volatilityby buying the bullion.
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SIK05(D) -Daily COMEX L = 6.900 –0.003 –0.04% B = 6.920 A = 6.935 O = 6.900 Hi = 6.905 Lo = 6.900 C = 6.900 V = 6
1
8.000
7.500
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M
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FIGURE 179.5.3. Silver May 2005. While the long-term silver outlook may be bullish, the short term will be very volatile, especially for the thinly capitalized trader.Then short-term tactics must be adopted. The island top here at 1 is a gentle invitationto the trader to take his profits and be gone. Even to short, with a stop just abovethe high. The run day after 1 adds a note of urgency to the invitation. The gap ispunishment for the hard of hearing and a bonus for the quick witted (everybodywho survives in futures is either quick witted or extremely well financed). The stopmoves down to the top of the gap day, then to the top of the next gap day and forthe very apt profits are taken on the next run day down. On the principle of sellweakness, buy weakness. The tight trendline at 2 crossed by the heavy run day is abuy signal with the stop moving to the bottom of the gap at 3 where it is taken outa few days later by the long range day down. The run day at 4 is a short signal withthe stop being at the day’s high. Is it necessary to say that short-term futures tradingcan be quite rapid? Or, there is always bullion. Or associated stock plays.
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USU04(D) -Daily CBOT L = 110 24/32 +1 24/32 +1.61%
0 = 109 1/32
315C = 110 24/32
115114 16/32113 16/32112 16/32111 16/32110 24/32110 16/32109 16/32108 16/32108107106105104 16/32103 16/32102 16/32102
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FIGURE 179.5.4. Treasury Bonds. The double pump triple nod head fake is aspecialty of futures markets. The fear and greed factor is multiplied by 10, like theleverage. But here in September 2004 Bonds we can see how simple chart analysiscan serve the trader. The downtrend from March (1) is completely manageable witha simple trendline and trend analysis. The end of the downtrend in May is markedby two strong run days. At any rate the stop would have been at May 1st, using aBasing Point kind of analysis. If we were going to trade it long here this would havebeen traded for a scalp (because we don’t know whether there is a bottom or not).The break of the trendline at 2 is an engraved invitation to get long and the trendlineat 3 keeps us long until broken by the signal day at the end of July. Which wouldput us short again, a two-day trade as the signal day on the trendline at 4 puts uslong again. Obviously we are using very tight, very short trendlines and long rangedays (or run days) as signals. The use of the run day as a signal, combined withother indicators, is common in my experience among traders.
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CR0504-CRB Index (Apr 2005) 306.00 2.25 0.74%
306303300297294291288285282279276273270Sep
OctNovDec05Feb1998–2004 Prophet Financial Systems, Inc. Terms of use apply.
Mar
FIGURE 179.5.5. Commodity Research Bureau Index. April 2005 Futures. Just astriangles often work in securities they often work in futures. Breakaway gap. Secondbreakaway gap. Runaway gap. Second runaway gap. The formation before the secondrunaway gap is somewhat quizzical — it might be considered a flag, but it has thesame effect, and depending on the trader’s operating methods the stop would be justunder the gap/runday anyway. It will not take much study for the reader to see thatthe principles of chart analysis used in this entire book are validated here. The maindifference is in the setting of stops, and in fact, the same stop methods may be usedif the trader is sufficiently well financed.
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$CRY0(D) -Weekly NYBOT L = 294.09 +1.03 +0.35% B = 0.00 A = 0.00 O = 293.08 Hi = 294.12 Lo = 292.96 C = 294.09 V = 0
307.00294.09288.00270.00253.00
234.65
237.00222.00208.00195.00
1998
1999
2000
2001
2002
2003
20042005Created with TradeStation
FIGURE 179.5.6. Commodity Research Bureau. Long-term view. It does not takemuch analysis of this 10 year CRB chart to see a huge double bottom, and to considerits implications. If China and India are going to compete with us for natural resourceswe could see an entirely new economic paradigm, if the reader will excuse the term.Clearly there is a bull market in commodities. In Chapter 42, Pragmatic PortfolioManagement, it is suggested that capital should flow to markets that are moving,rather than remaining committed to markets which are mired in mulish trends.Furthermore it is suggested in that chapter that a good natural hedge is to go longthe uptrend of an index and short the components of it which are in downtrends.The CRB is somewhat thin but might lend itself to this strategy.
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chapter seventeen
A Summary and SomeConcluding CommentsWe began our study of technical stock chart analysis in Chapter 1 with adiscussion of the philosophy underlying the technical approach to the problems of trading and investing. We could ask that the reader turn back nowand review those few pages to recapture a perspective on the subject whichmust have been dimmed by the many pages of more or less arduous readingthat have intervened.It is easy, in a detailed study of the many and fascinating phenomenawhich stock charts exhibit, to lose sight of the fact that they are only therather imperfect instruments by which we hope to gauge the relative strengthof supply and demand, which, in turn, exclusively determines what way,how fast, and how far a stock will go.Remember that, in this work, it doesn’t matter what creates the supplyand the demand. The fact of their existence and the balance between themare all that count. No man, no organization (and we mean this verbatim etliteratim) can hope to know and accurately appraise the infinity of factualdata, mass moods, individual necessities, hopes, fears, estimates, andguesses which, with the subtle alterations ever proceeding in the generaleconomic framework, combine to generate supply and demand. But thesummation of all these factors is reflected virtually instantaneously in themarket.The technical analyst’s task, then, is to interpret the action of the marketitself — to read the flux in supply and demand mirrored therein. For thistask, charts are the most satisfactory tools thus far devised. Lest you becomeenrapt, however, with the mechanics of the chart — the minutiae of dailyfluctuations — ask yourself constantly, “What does this action really meanin terms of supply and demand?”Judgment is required, and perspective, and a constant reversion to firstprinciples. A chart, as we have said and should never forget, is not a perfecttool; it is not a robot; it does not give all the answers quickly, easily, andpositively, in terms that anyone can read and translate at once into certainprofit.We have examined and tested exhaustively many technical theories,systems, indexes, and devices which have not been discussed in this book,
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chiefly because they tend to short-circuit judgment, to see the impossible bya purely mechanical approach to what is far from a purely mechanicalproblem. The methods of chart analysis that have been presented are thosewhich have proved most useful, because they are relatively simple and, forthe most part, easily rationalized; because they stick closely to first principles;because they are of a nature that does not lead us to expect too much ofthem; because they supplement each other and work well together.Let us review these methods briefly. They fall roughly into four categories.1. The Area Patterns or formations of price fluctuation which, with theirconcomitant volume, indicate an important change in the supply–demand balance. They can signify Consolidation, a recuperation orgathering of strength for renewed drive in the same direction as thetrend which preceded them. Or they can indicate Reversal, the playing out of the force formerly prevailing, and the victory of the opposing force, resulting in a new drive in the reverse direction. In eithercase, they may be described as periods during which energy isbrewed or pressure built up to propel prices in a move (up or down)which can be turned to profit. Some of them provide an indicationas to how far their pressure will push prices. These chart formations,together with volume, furnish the technician with most of his “getin” and many of his “get out” signals.Volume, which has not been discussed in this book as a featureapart from price action, and which cannot, in fact, be utilized as atechnical guide by itself, deserves some further comment. Rememberthat it is relative, that it tends to naturally run higher near the top ofa Bull Market than near the bottom of a Bear Market. Volume “followsthe trend,” i.e., it increases on rallies and decreases on reactions inan overall uptrend, and vice versa. But use this rule judiciously; donot place too much dependence on the showing of a few days, andbear in mind that even in a Bear Market (except during Panic Moves),there is always a slight tendency for activity to pick up on rises.(“Prices can fall of their own weight, but it takes buying to put themup.”)A notable increase in activity, as compared with previous days orweeks, may signify either the beginning (breakout) or the end (climax) of a move, temporary or final. (More rarely, it may signify a“shakeout.”) Its meaning, in any given case, can be determined byits relation to the price pattern.2. Trend and trendline studies supplement Area Patterns as a means ofdetermining the general direction in which prices are moving and ofdetecting changes in direction. Although lacking, in many cases, thenice definition of Area Formations, they may frequently be used for“get in” and “get out” purposes in short-term trading, and theyprovide a defense against premature relinquishment of profitablelong-term positions.
SM
MARCHAPRILJULYMAYAUGUST SEPTEMBER OCTOBER NOVEMBER DECEMBER JANUARY FEBRUARYJUNE6 13 20 27 4 11 18 25 1 8 15 22 29 6 13 20 27 3 10 17 24 31 7 14 21 28 5 12 19 26 2 9 16 23 30 7 14 21 28 4 11 18 25 1 8 15 22 1 8 15 22 29
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SPIEGEL , INCORPORATED
FIGURE 198. Spiegel’s Bear Market started in April 1946 from a Symmetrical Triangle which changed into aDescending Triangle. Note the Pullback in June, and two Flags. This history is carried on in Figure 199.
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FIGURE 199. Overlapping Figure 198, this chart shows the move which ensued from the wide Descending Triangleof early 1947, culminating in a Reversal Day on May 19. Note various Minor and Intermediate Resistance Levels.
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3. Support and Resistance Levels are created by the previous tradingand investment commitments of others. They may serve to indicatewhere it should pay to take a position, but their more importanttechnical function is to show where a move is likely to slow downor end, and at what level it should encounter a sudden and importantincrease in supply or demand.Before entering a trade, look both to the pattern of origin for anindication of the power behind the move, and to the history of Support–Resistance for an indication as to whether it can proceed without difficulty for a profitable distance. Support–Resistance studiesare especially useful in providing “cash-in” or “switch” signals.4. Broad market background, including the Dow Theory, should not bescorned. This time-tested device designates the (presumed) prevailing Major Trend of the market. Its signals are “late,” but, with all itsfaults (and one of these is the greatly augmented following it hasacquired in recent years, resulting in a considerable artificial stimulation of activity at certain periods), it is still an invaluable adjunctto the technical trader’s Toolkit.The general characteristics of the various stages in the stock market’sgreat Primary Bull and Bear cycles, which were discussed in our Dow Theorychapters, should never be lost to view. This brings us back to the idea ofperspective, which we emphasized as essential to successful technical analysisat the beginning of our summary. That stock which does not, to some degree,follow the Major Trend of the market as a whole is an extraordinary exception. More money has been lost by buying perfectly good stocks in the laterand most exciting phases of a Bull Market, and then selling them, perhapsfrom necessity, in the discouraging conditions prevailing in a Bear Market,than from all other causes combined!So keep your perspective on the broad market picture. The basic economic tide is one of the most important elements in the supply–demandequation for each individual stock. It may pay to buck “the public,” but itdoes not ever pay to buck the real underlying trend.Major Bull and Bear Markets have recurred in fairly regular patternsthroughout all recorded economic history, and there is no reason to supposethat they will not continue to recur for as long as our present system exists.It is well to keep in mind that caution is in order whenever stock prices areat historically high levels, and that purchases will usually work out welleventually when they are at historically low levels.If you make known your interest in your charts, you will be told thatthe chart analyst (like the Dow theorist) is always late — that he buys afterprices have already started up, maybe not until long after the “smart money”has completed its accumulation, and that he sells after the trend has unmistakably turned down. Partly true, as you have no doubt already discoveredfor yourself. But the secret of success lies not in buying at the very lowestpossible price and selling at the absolute top. It is in the avoidance of large
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losses. (Small losses you will have to take, and as quickly as possible aswarranted by the situation.)One of the most successful “operators” Wall Street has ever seen, amultimillionaire and a nationally respected citizen today, is reputed to havesaid that never in his entire career had he succeeded in buying within5 points of the bottom or selling within 5 points of the top! EN: BernardBaruch, if I am not mistaken. And for perspective, the 5 points mentioned constitutedroughly 10% of the market at that time.Before we leave this treatise on theory and proceed to the more practicalmatters of application and market tactics which are the province of thesecond part of this book, the reader will, we hope, forgive one more admonition. There is nothing in the science of technical analysis that requires onealways to have a position in the market. There is nothing that dictates thatsomething must happen every day. There are periods — sometimes longmonths — when the conservative trader’s best policy is to stay out entirely.And there is nothing in technical analysis to compel the market to go aheadand complete (in a few days) a move that the charts have foretold; it willtake its own good time. Patience is as much a virtue in stock trading as inany other human activity.
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chapter 17.1
Technical Analysis and Technologyin the 21st Century:The Computer and the Internet,Tools of the Investment/Information RevolutionThe purpose of this chapter is to put computer and information technologyinto proper context and perspective for chart-oriented technical analysts.In John Magee’s time, in his office in Springfield, MA, there was a chartroom — a room filled with all-age chartists from teenagers to senior citizens.These people spent all their time keeping charts and assisting Magee ininterpretation. These were wonderful and intelligent people who developedmarvelous insights into the stocks they charted. They created the manualcharts which adorn this book.Today that room and all those technicians have been replaced by a beige(sometimes lime) box which sits crowded on our desktops and which is oftenworshipped as a fount of insight and wisdom: “Computer, analyze mystocks.”Unfortunately the computer does not have the discrimination and pattern recognition ability of the people in that chart room. Undeterred by thisweakness in computer technology, traders and investors have poured incalculable money and effort into computer-aided research attempting to discover the keys to market success. More money has been spent in this effortthan was ever put into the search for the philosopher’s stone. Much of itwas wasted, but it has not all been spent in vain. In some areas it has beenquite productive. But no fail-safe algorithm has, in spite of all this effort,been found for investment success, and certainly not for stock trading. Theresearch has demonstrated that even the algorithm of “buy low sell high”has fatal flaws in it.In order to fully understand the importance of the computer, the readershould appreciate some basic differences in participants’ approach to themarkets. Or, we might say, schools of analysts/investors. We will not botherwith fundamental analysts here, as they are of a different religious persuasion. Chart analysts, or we could say, Magee-type technical analysts, pretty325
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much confine their analysis of the market to the interpretation of bar charts.(This does not mean that their minds must be closed to other inputs. On thecontrary — anything which works.) Another chart analyst school uses pointand figure charts, and another candlestick charts. Another breed of technicalanalysts takes basic market data, price and volume, and uses them as theinput to statistical routines which calculate everything from moving averages to mystically designated indicators like %R or Bollinger Bands(cf. Appendix C). These are called statistical or number-driven technicalanalysts. All these analysts, or what have you, attempt to invest or tradestocks and other financial instruments (not including options) using someform of what is called technical analysis — that is they all take, as input totheir analysis, hard data, data which people cannot lie about, misrepresent,and manipulate, unlike the data which are input to fundamental analysis(earnings, cash flow, sales, etc.).Using number-driven or, if you will, statistical technical analysis, theselatter schools attempt, just as chart analysts do, to predict market trends andtrading opportunities. This can be more than a little difficult since the stockand bond markets are behavioral markets. That is, the stock markets aredriven by human emotion, as perhaps the most important of many variablesinfluencing price. And human emotion and behavior, its manic and itsdepressive elements, have not yet been quantified. But some chart analystsbelieve that they can recognize it when they see it on the charts.In another area, the computer has yielded much more dramatic andprofitable results. But that is in a model-driven market, namely the optionsmarkets. Quantitative analysts, those who investigate and trade the optionsmarkets, are a breed apart from technical analysts. In an interesting irony,emotion-driven markets, the stock markets, are used as the basis for derivatives, or options whose price is determined largely by the operation ofalgorithms called models. Quantitative analysts believe, as does this editor,that the options markets can be successfully gamed through quantitativeanalysis. Results of skilled practitioners indicate this belief is accurate.Alas, life is not so simple for the simple stock trader. Stock prices havingnothing to do with mathematics, except for being expressed as natural numbers, are not susceptible to easy prediction as to their future direction. Noteven with Magee chart analysis or any other form of analysis — technical,fundamental, or psychic. (From a theoretical point of view each trade madebased on a chart analysis should be looked at as an experiment made toconfirm a probability. The experiment is ended quickly if the trend does notdevelop.) The fact that chart analysis is not mechanizable is important. It isone reason chart analysis continues to be effective in the hands of a skilledpractitioner. Not being susceptible to mechanization, counter-strategies cannot be brought against it, except in situations whose meaning is obvious toeveryone, for instance, a large important Support or Resistance Level or aglaringly obvious chart formation. These days everyone looks at charts totrade even if they don’t believe in their use. In these obvious cases somemarket participants will attempt to push prices through these levels in order
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to profit from volatility and confusion. Indeed, human nature has notchanged much since Jay Gould and Big Jim Fisk.When these manipulations of price occur, they create false signals —bull and bear traps. Interestingly, the failure of these signals may constitutea reliable signal in itself — but in the direction opposite to the original signal.
The Importance of Computer TechnologyOf what use and importance then is this marvelous tool — the most interesting tool man (homo) has acquired since papyrus? (Numerous computersoftware packages are available which are capable of executing the functionsdescribed in the following discussion.) If the computer can’t definitivelyidentify profitable opportunities, what good is it?Probably the most important function the computer has for the MageeAnalyst is the automation of rote detail work. Data can be gathered bydownloading from database servers. Charts can be called up in an instant.Portfolio accounting and maintenance and tax preparation can be disposedof with one hand while drinking coffee with the other. All in all this mightmake it sound as though the computer is a great tool, but with a pretty dulledge. Not strictly true. There is at least one great leap forward for MageeAnalysts with this tool, leaving aside the rote drudgery it saves. This greatadvantage is portfolio analysis. In Resources (Appendix D), a complex portfolioanalysis of the kind used by professional traders (Blair Hull and OptionsResearch Inc.) is illustrated. Even simpler portfolios of the average investorcan benefit from the facilities afforded by most portfolio programs, either onthe net or in commercial software packages (locations and software identifiedin Resources).Another advantage is the ability to see basic data displayed in manydifferent forms: point and figure charts, candlestick charts, close-onlycharts — these are prepared in the flick of an eyelash, and may indeedcontribute to understanding the particular situation under the magnifyingglass. The effortless quantification of some aspects of analysis may beuseful — volume studies, for instance, and given the popularity of movingaverages, seeing the 50- and 200-day moving averages can be interesting.These moving averages are considered significant by many market participants — even fundamental analysts. The analysis of any of these should beconsidered in relation to the current state of the market as understood bythe careful chart analyst.But what about (the strangely named) stochastics, Bollinger Bands, %R,MACD, Moving Averages (plain vanilla, exponential, crossover, etc.),price/volume divergence, RSI (plain vanilla and Wilder), VP Trend, TCI,OBV, Upper/Lower Trading Bands, ESA Trading Bands, and AcmDis? Well,there is a certain whiff of alchemy to some of them, and some have someusefulness sometimes. And, all systems work beautifully at least twice intheir lives: in research, and in huge monumental Bull Markets. These numberdriven indicators are also the times when trading genius is most likely to be
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discovered. These are briefly explored by a former editor in Appendix C.EN9: It is also true, as I have said, that you can drive a nail with a screwdriver.And the inventor of a tool may be fabulously successful with it while its adopterslose their assets.It is also possible that the excess of technical information created by theseindicators may be like the excess of fundamental information — anothershell to hide the pea under, another magician’s trick to keep the investorfrom seeing what is truly important, and what is necessary and sufficient toknow to trade well. Perhaps the investor would be better off with a behavioral model, since the markets are behavioral. Number-driven technical analysis can do many things, some like Dr. Johnson’s dog which walked on itshind legs, but they cannot put the market in perspective. Only the humanmind can do that. Number-driven models after all do not consider skirtlengths, moon cycles, sun spots, the length of the economic cycle, the bullishor bearish state of the market (if Bear Markets still exist) EN9: A wry ironicalcomment written before the market crash of the 2000s. In the end, the humanbrain is still the only organ capable of synthesizing all this quantitative andqualitative information and assessing those elements which cannot bereduced to ones and zeros. The educated mind is still the best discriminatorof patterns and their contexts.
Summary 1The computer is a tool, a powerful tool, but a tool nonetheless. It is not anintelligent problem solver or decision maker. We use a mechanical ditchdigger to dig a ditch, but not to figure out where the ditch should be.The multitude of indicators and systems should be viewed with a skeptical eye and evaluated within the context of informed chart analysis. Sometimes an indicator or technique will work for one user or its inventor butstrangely mislead the chart analyst who tries to use it — or buys it, evenbased on a verified track record.So the experienced investor keeps his methods and analysis simple untilhe has definitive knowledge of any technique, method, or indicator he wouldlike to add to his repertoire. And, most of all, he depends on his ownobservations and experience to evaluate his own and others trading techniques.
Other Technological Developments of Importanceto the Technical Magee Analyst and All InvestorsThe computer is not the only technological development of interest to thetechnical investor. A number of information revolution technologies need tobe put in perspective. These are