Technical Analysis

of Stock Trends

Eleventh Edition

Robert D. Edwards John Magee W. H. C. Bassetti

J Routledge % Taylor & Francis Croup A PRODUCTIVITY PRESS BOOK Contents

Preface to the eleventh edition xv Preface to the tenth edition xvii Preface to the ninth edition xxi Preface to the eighth edition xxv In memoriam xxxv Preface to the seventh edition xxxvii Preface to the fifth edition xli Preface to the fourth edition xliii Preface to the second edition xlv Foreword xlvii

Part I: Technical theory

Chapter 1 The technical approach to trading and investing 3 Definition of 4

Chapter 2 Charts 7 Different types of scales 8

Chapter 3 The 11 The Dow Averages 12 Basic tenets 12 Tide, wave, and ripple 14 Major trend phases 14 Principle of confirmation 16

Chapter 4 The Dow Theory's defects 21 The Dow Theory is too late 21 The Dow Theory is not infallible 23 The Dow Theory frequently leaves the Investor in doubt 23 The Dow Theory does not help the Intermediate Trend investor 23 The Dow Theory in the 20th and 21st centuries 26

Chapter 5 Replacing Dow Theory with John Magee's Basing points Procedure 31 The fractal nature of the market 31

vii viii Contents

Chapter 6 Important Reversal Pattems 41 Important Reversal Patterns 42 Time required to reverse a trend 42 The Head-and-Shoulders Top Formation 44 is important 44 Breaking the neckline 47 Variations in Head-and-Shoulders Tops 49 Price action following confirmation: the measuring formula 52 Relation of Head-and-Shoulders to Dow Theory 55

Chapter 7 Important Reversal Patterns: continued 57 Head-and-Shoulders (EN: or Kilroy) Bottoms 57 Multiple Head-and-Shoulders Patterns 59 Tendency to symmetry 61 A leisurely pattern 65 Rounding Tops and Bottoms 66 How Rounding Turns affect trading activity 70 The Dormant Bottom Variation 73 Volume pattern at Tops 74

Chapter 8 Important Reversal Patterns: the Triangles 77 Symmetrica! Triangles 79 Some cautions about Symmetrica! Triangles 82 How prices break out of a Symmetrica! 88 A typical Triangle development 90 Reversal or Consolidation 94 The Right-Angle Triangles 97 A planned distribution 98 Descending Triangles 98 Volume characteristics same as the Symmetrica! type 99 Measuring implications of Triangles 100 Triangles on weekly and monthly charts 100 Other Triangulär formations 100

Chapter 9 More important Reversal Patterns 103 The Rectangles, Double and Triple Tops 103 Pool Operations 105 Relation of rectangle to Dow Line 112 Rectangles from Right-Angle Triangles 113 Double and Triple Tops and Bottoms 113 Distinguishing characteristics 115 Double Bottoms 118 Triple Tops and Bottoms 118

Chapter 10 Other Reversal phenomena 121 The Broadening Formations 121 Volume during Broadening Formations 122 A typical example 128 Contents ix

The Orthodox Broadening Top 130 Why no Broadening Bottoms? 135 Right-Angled Broadening Formations 135 The Diamond 137 Wedge Formations 139 The Falling Wedge 142 Wedges on weekly and monthly charts 143 Rising Wedges common in Bear Market Railies 144 The One-Day Reversal 144 The Selling Climax 145 Short-term phenomena of potential importance 147 Spikes . 147 Runaway Days 148 Key Reversal Days 148

Chapter 11 Consolidation Formations 151 Flags and Pennants 151 The Pennant: a pointed Plag 153 The measuring formula 154 Reliability of Flags and Pennants 156 Where they may be expected 157 Plag pictures on weekly and monthly charts 158 Rectangular Consolidations: an early phase phenomenon 159 Head-and-Shoulders Consolidations 160 Scallops: repeated Saucers 162 Modern versus old-style markets 168

Chapter 12 Caps .....171 Which gaps are significant? 171 Closing the 171 Ex-dividend gaps 174 The common or area gap 175 Breakaway gaps 177 Continuation or runaway gaps and the measuring rule 182 Two or more runaway gaps 184 Exhaustion gaps 185 The 186 Gaps in the Averages 187

Chapter 13 189 Normal trend development 190 The explanation 191 Estimating Support-Resistance potential 193 Locating precise levels 196 Significance of Support failure 197 Populär misconceptions 198 The round figures 200 Repeating historical levels 200 X Contents

Pattern Resistance 202 Volume on breaks through Support 205 Support and Resistance in the Averages 206

Chapter 14 Trendlines and Channels 207 The Trendline 207 How Trendlines are drawn 209 Arithmetic versus logarithmic scale 211 Tests of authority 216 Validity of penetration 220 Amendment of Trendlines 222 Double Trendlines and trend ranges 222 Trend Channels 223 Experimental Lines 224 Consequences of Trendline penetration: Throwbacks 224 Intermediate Downtrends 225 Corrective trends: the Fan Principle 226

Chapter 15 Major Trendlines 229 Major Downtrends 242 Major Trend Channels 242 Trendlines in the Averages 243 Trading the Averages in the 21st Century 244

Chapter 16 Technical analysis of commodity charts 245 Technical analysis of commodity Charts, part 2: a 21st-century perspective 249 Rocket scientists 249 Turtles? 250 The application of Edwards and Magee's methods to 21st-century futures markets 252 Stops 258 A variety of methods 259 Everything you need to know as a chart analyst trading futures 259

Chapter 17 A summary and concluding comments 261 Technical analysis and technology in the 21st Century: the Computer and the internet: tools of the investment/information revolution 265 The importance of Computer technology 267 Summary 1 268 Other technological developments of importance to the technical Magee analyst and all Investors 268 The Internet: the eighth wonder of the modern World (EN9: Appendix B, Resources, for the ninth edition has been enormously expanded and is of paramount importance to modern investors.) 268 Marking-to-market 269 Separating the wheat from the chaff 270 Chaff 270 Summary 2 270 Advancements in investment technology, part 1: developments in finance theory and practice 271 Contents xi

Options 271 Quantitative analysis 272 Options pricing models and their importance 273 Futures on Indexes 273 Options on futures and Indexes 274 Modern Portfolio Theory 275 The wonders and joys of Investment technology 275 Advancements in investment technology, part 2: futures and options on futures on the Dow-Jones Industrial Index at the CBOT 275 Investment and hedging strategies using the CBOT® DJIASM futures contract 276 Settlement of futures contracts 276 Marking-to-market 276 Fungibility 276 Differences between cash and futures 277 Dow Index futures 277 Using stock index futures to control exposure to the market 277 Investment uses of Dow Index futures 279 Situation 1: Portfolio protection 279 Situation 2: Increasing exposure with futures 280 Situation 3: Using bond and index futures for asset allocation 280 Perspective 282 Options on Dow Index futures 282 Option premiums 283 283 Exercising the Option 284 Using futures options to participate in market movements 284 Profits in rising markets 284 Exploiting market reversals 285 Using puts to protect profits in an appreciated portfolio 285 Situation 1 285 Improving portfolio yields 286 Situation 2 286 Using option spreads in high- or low-volatility markets 286 Situation 3 286 Situation 4 287 Perspective 287 Recommended further study 287

Part II: Trading tactics

Chapter 18 The tactical problem 293 Strategy and tactics for the long-term investor—What's a speculator? What's an Investor? 297 One definition of the long-term investor 299 The strategy of the long-term investor 299 Rhythmic investing 300 Summary 302 xii Contents

Chapter 19 The all-important details 303 The simplest and most direct way to use a Computer for charting analysis 304 Summary 305

Chapter 20 The kind of Stocks we want: the speculator's viewpoint 307 The kind of Stocks we want: the long-term investor's viewpoint 310 Changing opinions about conservative investing 310 The kinds of Stocks long-term Investors want: the long-term investor's viewpoint 311 Construction of the Index Shares and similar Instruments 311 An outline of instruments available for trading and investing 312 The importance of these instruments: diversification, dampened risks, tax, and technical regularity 313 Summary 313

Chapter 21 Selection of Stocks to chart 315

Chapter 22 Selection of Stocks to chart: continued 319

Chapter 23 Choosing and managing high-risk Stocks: tulip Stocks, Internet sector, and speculative frenzies 325 Managing tulipomanias and Internet frenzies and...Bitcoin 326 Detailed techniques for management of the runaway issues 328 Hope Springs eternal and there is one born every second 332

Chapter 24 The probable moves of your Stocks 341

Chapter 25 Two touchy questions 345 The use of margin 345 Short selling 346

Chapter 26 Round lots or odd lots? 351

Chapter 27 Stop Orders 353 The progressive stop 355 Stop Systems and methods 357 A brief survey of stop methods 358 Some other stop methods 358 358 Parabolic stop and reverse 359 Target stops 359 A natural method used by the Turtles 359

Chapter 28 What is a Bottom and what is a Top? 361 Basing Points 362 Basing Points: a case analyzed 364 The Basing Points paradigm 365 Key to Figure 28.2 analysis 366 A narrative of the events in the chart 367 Contents xiii

The complete Basing Points Procedura: taking into consideration the setting of Basing Points on both wave lows and new highs 368 The complete Basing Points procedura 369 Two Charts giving a long-view perspective on the complete (Variant 2) procedura 370 The repräsentative case fully analyzed using wave lows and new highs 370 A narrative of the events in the chart 371

Chapter 29 Trendlines in action 373 Buying stock, "going long" 375 Liquidating, or selling a long position 378 Selling stock short 379 Covering short sales 379 Additional suggestions 380 General outline of policy for trading in the Major Trend 380

Chapter 30 Use of Support and Resistance 383

Chapter 31 Not all in one basket 389 EN: diversification and costs 390

Chapter 32 Measuring implications in technical chart patterns 391

Chapter 33 Tactical review of chart action 393 The Dow Theory 393 Head-and-Shoulders Top 400 Head-and-Shoulders Bottom 401 Complex or multiple Head-and-Shoulders 403 Rounding Tops and Bottoms 403 Symmetrica! Triangles 406 Right-Angle Triangles 408 Broadening Tops 408 Rectangles 408 Double Tops and Bottoms 409 Right-Angled Broadening Formations 409 The Diamond 409 Wedges 409 One-Day Reversais 410 Flags and Pennants 410 Caps 411 Support and Resistance 414 Trendlines 414

Chapter 34 A quick summation of tactical methods 417 Get out of present commitments 417 Make new commitments 418

Chapter 35 Effect of technical trading on market action 419 xiv Contents

Chapter 36 Automated trendline: the 421 Sensitizing Moving Averages 422 Crossovers and penetrations 422 The PENTAD Moving Average System from Formula Research 424

Chapter 37 The same old patterns 427 Not all the same 428

Chapter 38 Balanced and diversified 481 September 28,1985: an oversold market 486

Chapter 39 Trial and error 487

Chapter 40 How much capital to use in trading 489

Chapter 41 Application of capital in practice 491 Put and call options 493

Chapter 42 Portfolio risk management 495 Overtrading: a paradox 496 Risk of a Single stock 498 Risk of a portfolio 499 EN9: Risk and trend 499 Value-at-Risk procedura 499 Pragmatic Portfolio Theory (and practice) 500 Pragmatic portfolio risk measurement 500 Determining the risk of one stock 500 Determining the risk for a portfolio 501 Measuring maximum drawdown (maximum retracement) 502 Pragmatic portfolio analysis: measuring the risk 502 Portfolio Ordinary or Operational Risk 502 Portfolio risk over time 503 Portfolio extraordinary or catastrophic risk 503 Controlling the Risk 503 Summary of Risk and Money Management Procedures 503 Infinitely more sophisticated risk and money management procedures—Ralph Vince and optimal f 504

Chapter 43 Stick to your guns 505

Appendix A: The Dow Theory in practice 507 Appendix B: Resources 523 Appendix C: Technical Analysis: beyond Edwards & Magee 537 List of Illustrations and Text Diagrams 565 Alphabetic Index of Stock Charts 579 Glossary 595 Bibliography 621 Index 623