Technical Analysis of Stock Trends: Robert D. Edwarayjohn Magee 'f.H.C. Bassetti

TECHNICAL ANALYSIS
of STOCK TRENDS
TENTH EDITION
Robert D. Edwarayjohn Magee
'f.H.C. Bassetti
P r e s s
Taylor &. Francis Group

Boca Raton London New York
CRC Press is an imprint of the
Taylor & Francis Group, an informa business
Contents
Preface to the tenth edition
Preface to the ninth edition
Preface to the eighth edition
Inmemoriam
v
Preface to the seventh edition ...
Preface to the fifth edition
Preface to the fourth edition
Preface to the second edition
Foreword
xv
xix
xxiii
xxxiii
xxxv
xxxix
xli
xliii
xlv
-.
Section I: Technical theory

Chapter 1 The technical approach to trading and investing
Definition of technical analysis
Chapter 2 Charts
Different types of scales
3
4
:
7
8
Chapter 3 The Dow Theory

The Dow Averages
Basic tenets
Tide, wave, and ripple
:
Major trend phases
Principle of confirmation
11
12
12
14
14
16
Chapter 4 The Dow Theory's defects

The Dow Theory is too late
The Dow Theory is not infallible
The Dow Theory frequently leaves the investor in doubt
The Dow Theory does not help the Intermediate Trend investor
The Dow Theory in the 20th and 21st centuries
21
21
23
23
23
24
Chapter 5 Replacing Dow Theory with John Magee's Basing Points Procedure
The fractal nature of the market
31
31
Chapter 6 Important Reversal Patterns

Important Reversal Patterns
41
42
vi
Contents
Time required to reverse a trend

The Head and Shoulders
Volume is important
Breaking the neckline
Variations in Head-and-Shoulders Tops
Price action following confirmation: the measuring formula
Relation of Head and Shoulders to Dow Theory
43
44
45
47
49
53
55
Chapter 7 Important Reversal Patterns: continued

Head-and-Shoulders (EN: or Kilroy) Bottoms
Multiple Head-and-Shoulders Patterns
Tendency to symmetry
A leisurely pattern
Rounding'Tops and Bottoms
How Rounding Turns affect trading activity
The Dormant Bottom variation
Volume pattern at Tops
57
57
59
61
65
66
70
73
75
Chapter 8 Important Reversal Patterns: the Triangles

Symmetrical Triangles
Some cautions about Symmetrical Triangles
How prices break out of a Symmetrical Triangle
A typical Triangle development
Reversal or Consolidation
The Right-Angle Triangles
A planned distribution
Descending Triangles
Volume characteristics same as the Symmetrical type
Measuring implications of Triangles
Triangles on weekly and monthly charts
Other Triangular formations
77
78
80
80
82
86
92
92
94
95
98
99
100
Chapter 9 Important Reversal Patterns: continued

The Rectangles, Double and Triple Tops
Pool operations
Relation of rectangle to Dow Line
Rectangles from Right-Angle Triangles
Double and Triple Tops and Bottoms
Distinguishing characteristics
Double Bottoms
Triple Tops and Bottoms
103
103
105
108
109
Ill
113
116
117
Chapter 10 Other Reversal phenomena

The Broadening Formations...
Volume during Broadening Formations
A typical example
The Orthodox Broadening Top
Why no Broadening Bottoms?
Right-Angled Broadening Formations
121
121
122
123
124
126
128
Contents
The Diamond
Wedge Formations
The Falling Wedge
Wedges on weekly and monthly charts
Rising Wedges common in Bear Market Rallies
The One-Day Reversal
The Selling Climax
Short-term phenomena of potential importance
Spikes
Runaway Days
'..
Key Reversal Days
vii
129
130
134
135
136
136
140
144
145
147
148
'
.-..-
Chapter 11 Consolidation Formations

Flags and Pennants
The Pennant: a pointed Flag
'.
.'.
The measuring formula
.*;
Reliability of Flags and Pennants
Where they may be expected
Flag pictures on weekly and monthly charts
Rectangular Consolidations: an early phase phenomenon
Head-and-Shoulders Consolidations
Scallops: repeated Saucers
Modern versus old-style markets
:,
)..
151
151
153
154
156
157
158
159
160
162
166
Chapter 12 Gaps
Which gaps are significant?
Closing the gap
Ex-dividend gaps
The common or area gap
Breakaway gaps
Continuation or runaway gaps and the measuring rule....;
Two or more runaway gaps
Exhaustion gaps
i
The Island Reversal
Gaps in the Averages
.171
171
171
172
173
174
177
179
181
184
186
Chapter 13 Support and Resistance

Normal trend development
The explanation
Estimating Support-Resistance potential
Locating precise levels
Significance of Support failure
Popular misconceptions
The round figures
Repeating historical levels
Pattern Resistance
Volume on breaks through Support
Support and Resistance in the Averages
189
190
191
193
196
197
198
200
200
202
205
206
viii
Contents
Chapter 14 Trendlines and Channels

TheTrendline
How Trendlines are drawn
Arithmetic versus logarithmic scale
Tests of authority
Validity of penetration
Amendment of Trendlines
Double Trendlines and trend ranges
Trend Channels
Experimental Lines
:.
Consequences of Trendline penetration: Throwbacks
Intermediate Downtrends
Corrective trends: the Fan Principle
207
207
208
211
211
214
216
216
...218
219
220
221
225
Chapter 15 Major Trendlines

.1
Major Downtrends
.
Major Trend Channels
Trendlines in the Averages
Trading the Averages in the 21st century
229
237
238
244
244
Chapter 16 Technical analysis of commodity charts

Technical analysis of commodity charts, part 2: A 21st-century perspective...'.
Rocket scientists
Turtles?
The application of Edwards and Magee's methods to 21st-century futures markets
Stops
A variety of methods
Everything you need to know as a chart analyst trading futures
The return of the great markets of the 1970s
247
251
252
253
254
258
261
261
262
Chapter 17 A summary and concluding comments

Technical analysis and technology in the 21st century: the computer and the
Internet: tools of the investment/information revolution
The importance of computer technology
Summary 1
Other technological developments of importance to the technical Magee analyst
and all investors
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.)
Marking-to-market
Separating the wheat from the chaff
Chaff
Summary 2
Advancements in investment technology, part 1: Developments in finance theory
and practice
Options
Quantitative analysis
Options pricing models and their importance
263
267
269
270
270
270
271
272
272
272
273
273
274
275
Contents
Futures on indexes
Options on futures and indexes
Modern Portfolio Theory
The wonders and joys of investment technology
Advancements in investment technology, part 2: futures and options on futures on
the Dow-Jones Industrial Index at the CBOT
Investment and hedging strategies using the CBOT DJIASM futures contract
Settlement of futures contracts
Marking-to-market
Fungibility
<-.....,..
Differences between cash and futures
Dow Index futures
Using stock index futures to control exposure to the market
Investment uses of Dow Index futures
Situation 1: Portfolio prptection
Situation 2: Increasing exposure with futures
Situation 3: Using bond and index futures for asset allocation
Perspective
Options on Dow Index futures
Option premiums
Volatility
Exercising the option
:..
Using futures options to participate in market movements
Profits in rising markets
Exploiting market reversals
Using puts to protect profits in an appreciated portfolio
Situation 1
Improving portfolio yields
Situation 2
Using option spreads in high- or low-volatility markets
Situation 3
Situation 4
.'.
Perspective
Recommended further study
Section II: Trading tactics
Midword
ix
1275
276
277
277
277
278
278
278
278
279
279
279
281
281
282
282
284
284
285
285
286
286
286
287
287
287
v.287
...287
288
288
289
289
289
291
Chapter 18 The tactical problem

Strategy and tactics for the long-term investor. What's a speculator, what's
an investor?
One definition of the long-term investor
The strategy of the long-term investor
Rhythmic investing
Summary
295
299
301
301
302
304
Chapter 19: The all-important details

The simplest and most direct way to use a computer for charting analysis
Summary
305
306
307
Contents
Chapter 20 The kind of stocks we want: the speculator's viewpoint

.....309
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
312
An outline of instruments available for trading and investing
313
The importance of these instruments: diversification, dampened risks, tax, and,
most important, technical regularity
314
Summary
316
Chapter 21 Selection of stocks to chart
317
Chapter 22 Selection of stocks to chart: continued
321
Chapter 23 Choosing and managing high-risk stocks: tulip stocks, Internet

sector, and speculative frenzies
Managing tulipomanias and Internet frenzies
Detailed techniques for management of the runaway issues
Hope springs eternal and there is one born every second
327
328
330
334
Chapter 24 The probable moves of your stocks
343
Chapter 25 Two touchy questions

The use of margin
Short selling
347
347
348
Chapter 26 Round lots or odd lots?

Chapter 27 Stop orders
The progressive stop
Stop systems and methods
A brief survey of stop methods
Some other stop methods
Average True Range '
Parabolic stop and reverse
Target stops
A natural method used by the Turtles
353
.'.
355
357
359
360
360
360
361
361
361
Chapter 28 What is a bottom, what is a top?

;
363
Basing Points
364
Basing Points: a case analyzed
366
The Basing Points paradigm
367
Key to Figure 28.2 analysis
368
A narrative of the events in the chart
369
The complete Basing Points Procedure: taking into consideration the setting of
Basing Points on both wave lows and new highs
370
The complete Basing Points procedure
371
Two charts giving a long-view perspective on the complete (Variant 2) procedure.... 372
The representative case fully analyzed using wave lows and new highs
372
A narrative of the events in the chart
373
Contents
xi
Chapter 29 Trendlines in action

Buying stock, "going long"
Liquidating, or selling a long position
Selling stock short
Covering short sales
Additional suggestions
General outline of policy for trading in the Major Trend
375
376
377
380
381
381
382
Chapter 30 Use of Support and Resistance
385
Chapter 31 Not all in one basket
391
EN: diversification and costs
392
Chapter 32 Measuring implications in technical chart patterns
393
Chapter 33 Tactical review of criart action

The Dow Theory
Head-and-Shoulders Top
Head-and-Shoulders Bottom
Complex or multiple Head-and-Shoulders
Rounding Tops and Bottoms
Symmetrical Triangles
Right-Angle Triangles
Broadening Tops
Rectangles
Double Tops and Bottoms
Right-Angled Broadening Formations
The Diamond
Wedges
One-Day Reversals
Flags and Pennants
Gaps
Support and Resistance
Trendlines
Chapter 34 A quick summation of tactical methods
Get out of present commitments
Make new commitments
395
395
402
403
405
405
.'.
408
410
410
410
411
411
411
412
412
412
413
416
416
419
...
; 419
420
Chapter 35 Effect of technical trading on market action
421
Chapter 36 Automated trendline: The Moving Average

Sensitizing Moving Averages
Crossovers and penetrations
The PENTAD Moving Average system from Formula Research
423
424
424
426
Chapter 37 The same old patterns

Not all the same
429
430
xii
Contents
Chapter 38 Balanced and diversified
483
September 28,1985: an oversold market
488
Chapter 39 Trial and error
489
Chapter 40 How much capital to use in trading
491
Chapter 41 Application of capital in practice

Put and call options
Chapter 42 Portfolio risk management
Overtrading: and a paradox
Risk of a single stock
Risk of a portfolio
:
EN9: Risk and trend
,
:
Value-at-Risk Procedure
,
Pragmatic Portfolio Theory (and practice)
Pragmatic portfolio risk measurement
Determining the risk of one stock
Determining the risk for a portfolio
Measuring maximum drawdown, or maximum retracement
Pragmatic portfolio analysis: measuring the risk
':..
Portfolio Ordinary or Operational Risk
Portfolio risk over time
Portfolio extraordinary or catastrophic risk
Controlling the Risk
Summary of Risk and Money Management Procedures
Infinitely more sophisticated risk and money management proceduresRalph
Vince and optimal f
493
495
497
498
500
501
501
501
502
502
502
503
...504
504
504
505
505
505
505
:
506
Chapter 43 Stick to your guns
507
Appendix A The Dow Theory in practice

Five years of Dow interpretation
The first severe test
Failure to confirm
Signs of Major Turn
The Bull signal
The first correction
Bull Trend reaffirmed
The Rails falter
The spring of 1946
Final Up-Thrust
The Bear Market signal
509
509
510
512
513
515
516
517
518
519
521
521
Appendix B Resources
Section 1: important and indispensable sites
Section 2: references for further study
On risk
'.
525
525
526
526
Contents
xiii
On candlesticks
On futures
On portfolio management
Section 3: investment-oriented sites
Brokerage Houses
Section 4: the Sharpe Ratio
Section 5: calculating volatility
Section 6: the essence of fundamental analysis
The Elliott Wave Theory: perspective and comments
Section 7: software packages and Internet technical analysis sites
AIQ: TRADING EXPERT PRO
METASTOCK9.0
Tradestation 2000i and Tradestation 8
The Internet: prophet (http://www.thinkorswim.com)
The Internet: http://www.stockcharts*'com
A brief summary
t
Section 8: the Leverage Space Portfolio Model
526
526
526
526
528
529
529
530
530
533
533
533
534
534
534
534
534
Glossary
Bibliography
Index
539
565
567

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What are some of the important reversal patterns discussed in the document?

What are some of the important reversal patterns discussed in the document?

What are some of the defects of the Dow Theory mentioned?

What are some of the defects of the Dow Theory mentioned?

TECHNICAL ANALYSIS

Taylor &. Francis Group

Section I: Technical theory

Chapter 3 The Dow Theory

Chapter 4 The Dow Theory's defects

Chapter 6 Important Reversal Patterns

Time required to reverse a trend

Chapter 7 Important Reversal Patterns: continued

Chapter 8 Important Reversal Patterns: the Triangles

Chapter 9 Important Reversal Patterns: continued

Chapter 10 Other Reversal phenomena

Chapter 11 Consolidation Formations

Chapter 13 Support and Resistance

Chapter 14 Trendlines and Channels

Chapter 15 Major Trendlines

Chapter 16 Technical analysis of commodity charts

Chapter 17 A summary and concluding comments

Chapter 18 The tactical problem

Chapter 19: The all-important details

Chapter 20 The kind of stocks we want: the speculator's viewpoint

Chapter 22 Selection of stocks to chart: continued

Chapter 23 Choosing and managing high-risk stocks: tulip stocks, Internet

Chapter 24 The probable moves of your stocks

Chapter 25 Two touchy questions

Chapter 26 Round lots or odd lots?

Chapter 28 What is a bottom, what is a top?

Chapter 29 Trendlines in action

Chapter 30 Use of Support and Resistance

Chapter 31 Not all in one basket

EN: diversification and costs

Chapter 32 Measuring implications in technical chart patterns

Chapter 33 Tactical review of criart action

Chapter 35 Effect of technical trading on market action

Chapter 36 Automated trendline: The Moving Average

Chapter 37 The same old patterns

Chapter 38 Balanced and diversified

September 28,1985: an oversold market

Chapter 39 Trial and error

Chapter 40 How much capital to use in trading

Chapter 41 Application of capital in practice

Chapter 43 Stick to your guns

Appendix A The Dow Theory in practice

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