. (EN9: An extremely wise observationwhich the present Editor has developed at greater length in the theory of “naturalhedging.” And, given the complexity of modern markets profits may be made on bothsides of the hedge, and this should be the objective.)
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By using an Evaluative Index (see Chapter 38) instead of, or in additionto, the Averages, it is possible to say, “The market appears to be about 60%Bullish,” or “55% Bullish,” instead of merely Bullish or Bearish. This takesaccount of the fact that some markets are more Bullish or more Bearish thanothers; and it enables the investor to “roll with the punch” instead of havingto take an all-out position one way or the other. (EN9: I have called this“Rhythmic Trading.”)It should be noted, however, that while he may take such a partialposition against the (presumed) Major Trend, he will continue to use thebulk of his capital in situations which accord with the main trend. He willnever risk the larger part of his assets in opposition to the trend, and he willmake any countermoves with a clear understanding that they are of thenature of insurance and serve this purpose even though they ultimately maybe closed out as small losses.Summarizing all these implications of the Dow Theory: do not make amajority of your commitments against the Major Trend. During periods ofpotential Reversal, gradually reduce your long holdings, and make shortsales to a limited amount in weak stocks; but do not attempt to anticipateeither a Major Top or Major Bottom in the Averages by making an all-outcommitment counter to the main trend.EN: Regarding specific formations, the following suggestions are made:
Head-and-Shoulders TopA. If you are long a stock, should a breakout down through the necklineoccur, with a closing at least 3% below the neckline, next morningplace a stop ⅛ point below the last close. Continue to place such“tight stops” if not caught the first day, ⅛ point under each day’sclose until one is caught.B. Short sales may be made after a breakout, on a recovery of 40% ofthe distance from the top of the right shoulder to the bottom of thebreakout move, or on a recovery to a line drawn down across thetop of the head and right shoulder, or on a Pullback to the neckline,whichever point is reached first. If the breakout move continuesdown another day, or for several days, the 40% recovery would bebased on the entire move from the top of the right shoulder to thelowest point reached.
Head-and-Shoulders BottomEN: The editor, long distressed by the paradox of the term “Head-and-ShouldersBottom,” proposes that this formation be renamed in technician’s nomenclature to“the Kilroy Bottom.” See Figure 23.1.
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A. If you are short a stock, should a breakout on increased volume occur,penetrating the neckline and closing at least 3% above it, place a stopnext morning to cover at ⅛ point higher than the close. If such a stopis not caught, continue each day to place a stop ⅛ point higher thanthe previous day’s close until one is caught.B. New purchases may be made after a breakout, on a reaction of 40%of the distance from the bottom of the right shoulder to the top ofthe breakout move (which reaction must be on decreasing volume),or on a reaction to a line drawn across the bottom of the head andthe right shoulder, or on a Throwback to the neckline, whichever isreached first. As in the case of the Top Formation, this 40% reactionis figured on the entire distance of the breakout move if it shouldcontinue up for several days.
Complex or Multiple Head-and-ShouldersThe same tactical suggestions apply to these as to the simple Head-andShoulders. Definitions and special features of these formations are coveredin Chapter 7.
Rounding Tops and BottomsIt is difficult to set precise rules for trading on these gradual changes oftrend. In the case of Rounding Tops, if one is long the stock, the generalappearance of a Rounding Formation, extending over a period of severalweeks, leveling off from the rise and then turning down, very likely with atapering off of volume nearing the top of the rise and a pick-up of volumeas the turn starts down, would suggest getting out of the stock at the marketas soon as the picture looks more or less definite. A short sale of a RoundingTop could be very profitable; but no exact rule could be stated except that,in the absence of fixed Basing Points, one would want to be very certain thatthe formation was unmistakably a Rounding Top. It would need to be wellformed and following a long rise, and extending over a period of some weeksin its formation. It would also need to be protected with a stop above theTop of the curve, as explained in the chapter on stops.You would not be likely to be short a stock on a Rounding Bottom. Thelong and gradual rounding appearance with dull volume, followed by asudden revival on greatly increased volume, would be signal enough tocover if you should find yourself in this uncomfortable position. Purchaseswould be justified in a stock whose chart showed a Rounded Bottom orSaucer, after the first spasm of activity following a long, dull period ofdormancy. You would buy, according to the rules we have given for purchases on reactions, not on the breakout, but on the reaction following it,which would almost surely come.
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3634BRANIFF AIRWAYS
BNF
323019452826242220
H
Sales100’s
125100755025
S
S
S
H
S
AUGUSTSEPTEMBER OCTOBER NOVEMBERDECEMBERJULY7 14 21 28 4 11 18 25 1 8 15 22 29 6 13 20 27 3 10 17 24 1 8 15 22 29
FIGURE 212. Head-and-Shoulders (or Kilroy) Bottom in Braniff Airways, 1945.Strictly speaking, a Continuation Head-and-Shoulders after a Secondary Correctionin the Bull Market. A Major Bottom, reversing a long Bear Market, would normallytake much longer to form.Here we see heavy volume on the left shoulder, somewhat less on the head, andvery little on the right shoulder, with a sharp increase, as required, on the breakoutmove of September 21. The breakout was followed by a Throwback to the necklineon diminishing volume, providing a good opportunity for purchases at 23. Theupward move was resumed, and again there was a reaction to the neckline Support.A second reaction of this sort is not unusual. The closing at 22¾ on October 19, belowthe previous Minor Bottom, and on increased volume, was mildly disturbing. But inview of the strength of the pattern and breakout, we would not have sold the stock,and the protective stop at 21⅞ was not even threatened. On October 25, the advancewas resumed with a Breakaway Gap and continued up to 29½, where the move wassigned off with a One-Day Reversal and Exhaustion Gap.Notice that on reaching 29½, “BNF” went into a Consolidation Pattern for over 3weeks, making an Ascending Triangle, before leaping to 37½. Notice also (we mightas well get all we can out of these examples) that the Ascending Triangle takes shapeat approximately the halfway point of the whole advance. We are already familiarwith this tendency of stocks in fast moves to form “halfway” patterns.
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7268ASSOCIATED DRY GOODS
DG
6460565219464844Sales100’s
5040302010JANUARYFEBRUARY5 12 19 26 2 9 16 23 2
MARCHMAYJUNEAPRIL9 16 23 30 6 13 20 27 4 11 18 25 1 8 15 22 29
FIGURE 213. Associated Dry Goods winds up its Bull Market Trend with a Rounding Top. This is a daily chart for the first 6 months of 1946.The advance in “DG” from 4 to above 72 in just 3½ years, when seen on monthlycharts, is a smooth, accelerating curve which emerged from a long Bottom Formationthat had lasted 5 years from 1938 through 1942.As we enter the final 6 months leading up to the ultimate peak, note first the actionduring January and February. “DG” had just completed a fast run-up in the lastquarter of 1945, and was about due for a Consolidation or a Secondary Correction.On reaching 48, it turned back to 45, advanced to 50½, to 51, and finally to 52, andthen reacted to 44 at the end of February. Had the move on January 22 gone a littlelower and closed below the January 3 low, and then been followed by an even lowerclosing on February 26, we would have had to consider this January–February patterna completed Broadening Top, a definite Reversal signal. However, the pattern wasnot perfect, and, therefore, not valid, but the erratic price action shows incipientweakness.It is not unusual in these last stages, when public participation is running high,for the climactic advances to be spectacular and fast. And that is what we see here.A 5-point Breakaway Gap occurred on March 25, followed by an advance whichpetered off at 63½, reacted, and then ran up to over 68.From here on, the move advanced slowly, with suggestions of a Convergent Trendand a succession of “heads” and “shoulders,” and volume dropped off as the Topwas reached. The drop on June 4 to below the May 7 Minor Bottom on increasedvolume would complete the Rounding Top and call for immediate sale if we werestill long; and the penetration of the “neckline” on June 18 was a conclusive break.
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34G32GREYHOUND CORP
G
302826
1945
2422Sales100’s
125100755025AUGUSTSEPTEMBER OCTOBERNOVEMBER DECEMBERJULY7 14 21 28 4 11 18 25 1 8 15 22 29 6 13 20 27 3 10 17 24 1 8 15 22 29
FIGURE 214. Greyhound: a Rounding Bottom in 1945. A Continuation Pattern afterthe May run-up to over 29 and reaction to Support at 24, the 1944 high.In July, volume ran fairly high on downside days, drying up as we entered August.August 10 showed a spurt of volume on the upside, then more dullness.The various small moves through August and September would not give us anybasis for trading operations. The move to a new high in the pattern on August 31suggested an upturn, and again on September 19–20, we see another little push upto the 26 level. Still not conclusive, however.The move which got under way in the week ending October 13 is more definite.This decisive move with good volume carries right out of the “Bowl” in an almostvertical ascent. Not a big move, but a clear indication of the probable trend. We wouldlook for a point to buy “G” on a correction of 40–50% of the entire move up fromthe Bottom, or on a return to near the Support Level around 26. The purchase wouldprobably be made around 26½. Notice the drying up of volume on this reaction.The advance from here to 30, marking an entirely new Bull Market high, camealmost immediately. On November 3, with very heavy volume for a Saturday, “G”closed at 30, and since this volume was not on the day of breakout, we would haveclosed out the transaction on a tight stop at 29⅞ on Monday (unless we had electedto wait out the next Minor Reaction for a further advance).Two weeks later, on the basis of the reaction to good Support, we would havebought “G” again at about 29 (you cannot figure on getting the extreme low priceon any reaction). The following advance carried up to 34¼ in 2 days. At that point,profits could have been taken or the stock held for the longer term. “G,” it might benoted, continued up eventually to 54.
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Symmetrical TrianglesA. If you already have a position in the stock. During the formation of aSymmetrical Triangle, you may be unable to make any change inyour holdings. Let us say you have bought the stock on a reactionafter a Bullish Move. The next upsurge fails to make a new high andgives no sufficient volume signal to cause you to sell out. The nextreaction fails to carry below the previous one. You are “locked” intothe Triangle, and you cannot safely sell, since the Triangle that hasformed may eventually break out in the original direction and showyou a good profit (in fact, the odds favor that it will break out in thatdirection). In case of a breakout move (which, of course, must be onincreased volume on the upside), you can close it out for a profit(according to rules for trading we have already given), and immediately mark it as a rebuy on the next reaction. If the breakout is down(whether or not on increased volume), with a closing outside theTriangle, you should protect yourself with a tight (⅛ point) stop thenext day, and continue to set such tight progressive stops under eachday’s close until it is sold.If you are short the stock, the same rules in reverse would apply,except that the breakout in the right direction (down) would requireno volume confirmation, and the adverse breakout (up) would needsuch increased volume.B. If you do not have a position in the stock. Stay away from any stocksmaking Symmetrical Triangles until a clear and definite breakoutclose has been made. After such a breakout, if on the upside, buy onthe next reaction if the Major Trend is up, or if on the downside, sellshort on the next rally if the Major Trend is down. Rules for makingsuch commitments have already been given.Note: avoid breakouts from Symmetrical Triangles of the type which havecontinued to narrow until the breakout point comes far out toward the apex.The most reliable breakouts occur about two thirds along the Triangle.
Right-Angle TrianglesThe same rules would apply to Right-Angle Triangles as to SymmetricalTriangles (see Chapter 8 on Triangles). Early breakouts are more dependablehere, as in the case of Symmetrical Triangles. Volume confirmation is moreimportant on upside breakouts from Ascending Triangles and is not strictlyrequired on downside breakouts from Descending Triangles. Commitmentsalready made are retained until the breakout and then closed out in the sameway as any transaction that shows a gain.
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S
HS
52
ALLIED STORES
LS
4844G
4038SC
3634
SC
194632Sales100’s
125100755025
S
HS
JULYAUGUSTSEPTEMBER OCTOBER NOVEMBERDECEMBER6 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
FIGURE 215. Symmetrical Triangle in Allied Stores, a Consolidation in the 1946decline. Notice heavy volume as “LS” crashed to the first Reversal point of the patternon September 10, and the drying up of volume during the successive swings of theTriangle. In Point-and-Figure charts, this type of pattern is known as a PendulumSwing, since it does seem to come to rest like a pendulum. Often, volume will pickup somewhat at each Reversal point, but a valid Triangle must show some overalldecrease of volume.If, by some unhappy chance, you were then long “LS,” you should have had yourprotective stop at 33⅛, 8% below the Bottom reached at 36. However, the move downout of the Triangle on Friday and Saturday, October 4 and 5, although on slightvolume, was a true breakout (remember that downside breakouts do not requirevolume confirmation), and you would have been justified in selling your long commitment at the market on Monday. You would have received about 38½. To justifya short sale, however, the breakout would have had to close at least 3% outside theTriangle. The return to the border of the pattern at 40 was interesting, and you willnotice that volume increased characteristically as the decline really got under wayon October 9 and 10.No question about the validity of this breakout. Short sales were in order on areturn to the border of the Triangle, or a 40–50% Correction of the breakout move,say at 38½ to 39. The rally carried to the apex of the Triangle, then broke away fastfor the decline to 33 where, on October 30, a Selling Climax and One-Day Reversaloccurred — a signal to take profits.Notice the small Head-and-Shoulders in August. This was a Continuation Patternmarking the top of the rally before the September–November crack-up.
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Since the Ascending and Descending Triangles carry a directional forecasting implication that the Symmetrical Triangles do not have, it is possibleto make new commitments on reactions within an Ascending Triangle orrallies within a Descending one. However, since the flat horizontal side ofone of these Triangles represents a supply or demand area of unknownmagnitude, and since, therefore, such a Triangle can be (and sometimes is)turned back before the horizontal line has been decisively penetrated, itmight be better policy to note such formations in the making, and wait untilthe decisive breakout before making the new commitment.
Broadening TopsPresumably, you would not be long a Broadening Top. The early Reversalsin the pattern would have taken you out of the stock, if you follow the tacticalrules based on trendlines, as previously outlined, long before completion ofthe pattern. Neither would you be tempted to buy into such a pattern, sincethe trend indications would be clearly against a move.On the other hand, a Broadening Top, after its completion, offers excellent opportunities for a short sale. After downside penetration and closebelow the fourth point of Reversal in the pattern, you are justified in sellingshort on a rally of about 40% of the distance covered from the extreme top(fifth point of Reversal), and the lowest point reached on the breakout move.The stop, of course, would be placed at the proper distance above the fifthReversal, that is, the extreme top of the pattern.
RectanglesA. If you already have a commitment in the stock. The early moves of aRectangle may provide no volume signals to permit you to get out.And there will, of course, be no “breakout” moves during the formation of a Rectangle that will allow you to take a profit. However, assoon as the character of the Rectangle is well established (and thatwill require at least four Reversals to set up a clear Top and Bottom),you may trade on the Tops and Bottoms, that is, sell at or near theTop; or buy at or near the bottom. Since, as in the case of SymmetricalTriangles, there is a definite presumption in such formations that theyare more likely to lead to continuous moves than to Reversals, thiswould mean that you would probably pass up your first opportunityto get out (on the fifth Reversal), and would indeed probably decideto “ride along” in the expectation of a continuation of the originalmove, which will be in the “right” direction for your commitment.In the case of a breakout in the right direction, you would disposeof your commitment according to the rules for trading already stated.If in the wrong direction, use the tight (⅛ point) progressive stops,the same as with the Triangles.
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1918CONTINENTAL MOTORS
CMR
171615141319451211Sales100’s
125100755025JULYAUGUSTSEPTEMBER OCTOBERNOVEMBER DECEMBER7 14 21 28 4 11 18 25 1 8 15 22 29 6 13 20 27 3 10 17 24 1 8 15 22 29
FIGURE 216. An Ascending Triangle. “CMR,” after emerging from the doldrumsin 1943, forged up to about 12 early in 1945. The first 8 months of the year on amonthly chart showed an Ascending Triangle with Top at 12¼. On daily charts,however, we see the more detailed aspects of this large pattern. For instance, thefinal reaction of the whole (monthly) formation in August became here a SymmetricalTriangle. The breakout from this pattern carried out the minimum measuring requirements, bringing the price again to the 12¼ Top, from which point there was a reactionwhich was stopped cold at 11, the apex of the Triangle. A purchase on the reactionafter the powerful breakout from the Triangle, say around 11½, would have beenclosed out on progressive stops, starting September 28 when “CMR” reached 14, thesale being consummated October 2 at 14⅞, a highly profitable move.Profit-taking of this sort would largely explain the stopping of the rise and theformation of a Consolidation Pattern which turned out to be the Ascending Trianglewith Top at 16¼, lasting 8 weeks. Notice the November 7 volume when price wentthrough the 16¼ level, but failed to close outside the pattern; and the volume onNovember 30 when a clean, decisive breakout move closed at 17. This move ran to20, and purchases would have been made at 18 or less on the reaction. The next wavetook “CMR” to its ultimate Bull Market Top at 24 in January. On the ratio scale, theTop of the Ascending Triangle was exactly halfway between the September Bottomat 11, and the extreme high of 24. This type of halfway consolidation is typical ofFlags and Pennants, and this is a very similar case.
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3
1
485
5P
242
22
4B
201918
CERTAIN–TEED PRODUCTS
CT
1946
17Sales100’s
125100755025APRILMAY30 6 13 20 27 4 11 18 25 1
JUNEJULYAUGUSTSEPTEMBER8 15 22 29 6 13 20 27 3 10 17 24 31 7 14 21
FIGURE 217. A Broadening Top. This somewhat rare but beautiful and highlydependable formation developed as CertainTeed made its Bull Market Peak in 1946.A quick glance at the volume scale in this daily chart shows the high volume on thefinal stages of the advance, the dullness during the development of the Top Pattern,and the increased volume after the breakout.As we all know by now (or go back to Chapter 10 and review the specifications),a Broadening Top is a Five-Point Reversal, differing from the Head-and-Shoulders,Triangles, Rectangles, etc., in that each Reversal must be at a new high or low forthe pattern. It is, if you wish, a sort of reversed Triangle with its apex to the left, theswings becoming continually wider.In the second week of May, “CT” (the symbol has since been changed to “CRT”)made a new Bull Market high at 25¼ (marked “1”). The reaction carried back toSupport at the previous Minor Peak (point “2”) and the following week, “CT”advanced to another new high at 3, closing ⅛ point above the previous Top.Another week had brought “CT” down to point “4” with a closing at 22½, threequarters of a point below point “2.” This, in itself, is not sufficient reason for makingshort commitments. Three weeks later, “CT” closed at 25⅝, another new high, atpoint “5.” Finally, the stock dropped to 21½ on July 23, and at this point (marked“B”), the pattern was completed. Notice the tendency of volume to rise at eachReversal point of the pattern.Long holdings would be sold at the market the day after the breakout. But shortsellers should wait for a correction of 40–50% of the move from point “5” to point“B.” If shorts were put out at 23, we would not worry if the stock advanced for atime, as it did, without making a new high. The downside move in “CT” went quicklyto 15½, and within 12 months to 11½.
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26REMINGTON RAND
RR
2422
1944–1945
Sales100’s
5040302010OCTOBER NOVEMBER DECEMBERJANUARY FEBRUARYMARCH7 14 21 28 4 11 18 25 2 9 16 23 30 6 13 20 27 3 10 17 24 3 10 17 24 31
FIGURE 218. Rectangles in Remington Rand. This is part of a long Bull Market risethat carried “RR” from under 10 to above 50 in the period from 1942 to 1946. Thelast 3 years of this advance were almost continuous, as seen on monthly charts,without any extensive reactions. When we put the chart on a daily basis, such as thissection covering the end of 1944 and the early months of 1945, right in the middleof the advance, we see that the rise was not actually continuous but was built up ofsteps in an ascending “staircase” of Accumulation Patterns. Each sharp advance onincreased volume is followed by a period of dullness and slight recession.A picture of this type suggests the methodical campaign of buyers who intendedto purchase large blocks of the stock for large long-term advances without creatinga “skyrocket” market by their own buying operations. Presumably each advance waschecked by the temporary distribution of part of the stock held by such buyers, andreaccumulation started on reactions.In October and November, there is a well-marked Rectangle between 20¾ and 22.A purchase could have been made at or near the bottom limit, say at 21, on the fifthReversal on November 14. The move out of pattern in the week of December 2 didnot carry 3% out of pattern, but about 2 weeks later a move got under way thatqualified as a valid breakout, with volume confirmation as required on upside moves.Notice the volume increase and One-Day Reversal on December 20 as this moveneared its Top. Purchases would have been made at about 22½ on the basis of anormal correction, and you would have expected Support at the 22 level. This Supportwas respected, but the move did not advance beyond 23¾, made this same Top 3times in a period of 2 weeks, and returned again to 22¼.There was no question about the breakout on January 25. Extent and volume weredecisive. Notice the gap and One-Day Reversal on the following day as this MinorMove reached its end.In mid-March, as you will see, “RR” plunged down from its high of 27, but thedecline was stopped in its tracks at the top level of the January Rectangle, a goodSupport shelf. Never again during the Bull Market did “RR” even threaten this level,since it moved up in April and continued its long march to the 1946 Top.
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B. If you are not committed in the stock. Trades can be made within theRectangle on the fifth and subsequent Reversals. Since there is theslight probability that the move will eventually continue in the samedirection as the preceding move leading up or down to the Rectangle,it might be best to wait until the sixth Reversal for new commitments,which would set your interests in the same direction as a continuation. And, of course, short sales can be made after any downsidebreakout close from a Rectangle, or purchases after an upside breakout close with increased volume. Both the short sales and the longpurchases would be made on the Corrective Move following thebreakout.
Double Tops and BottomsDouble and Multiple Tops or Bottoms are not valid unless they conform tothe requirements for such formations. Chapter 9 on these patterns shouldbe read carefully in this connection.A. If you are long a stock. On penetration and close at a price lower thanthe extreme Bottom of the pattern between the Multiple Tops, disposeof the stock on tight (⅛ point) progressive stops.B. If you are short a stock. On penetration of the highest point of theInverted Bowl or rise between the Bottoms, with a close above thatpoint, close out the short sale on tight stops.C. If you are not committed in the stock. Consider a penetration and closebeyond the limit of the correction between the Tops (or Bottoms) asa signal of Reversal, and make new commitments on rallies or reactions.
Right-Angled Broadening FormationsThe handling of these on breakouts through the horizontal side would besimilar to what has been said about Multiple T