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 technical analysis 4 Chapter 2 Charts 7 Different types of scales 8 Chapter 3 The Dow Theory 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 Volume 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! Triangle 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 gap 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 Island Reversal 186 Gaps in the Averages 187 Chapter 13 Support and Resistance 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 Volatility 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 Average True Range 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