Mage System

THE INTRODUCTION TO THE
MAGEE
SYSTEM
OF TECHNICAL
A N A LY S I S
SL302X FM frame Page ii Wednesday, January 16, 2002 10:36 AM
THE INTRODUCTION TO THE
MAGEE
SYSTEM
OF TECHNICAL
A N A LY S I S
JOHN MAGEE
in a new edition by W.H.C. Bassetti
St. Lucie Press

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AUTHORS
John Magee (1901–1987), a graduate of MIT and a leading expert on

technical analysis, was the founder of the well-known charting and advi-
sory firm of John Magee, Inc. Magee pioneered the concept of analyzing
the stock market from an engineering point of view and became known
as the Father of Technical Analysis. With Robert Edwards, he coauthored
the best selling book, Technical Analysis of Stock Trends. Now in its 8th
edition, it is considered the definitive work in the field and has more than
one million copies in print.
W. H. C. Bassetti, editor and co-author of this book and the 8th edition
of Technical Analysis of Stock Trends, is an honors graduate of Harvard.
His experience spans the modern history of the markets, beginning as a
student and client of John Magee in the 1960s through the electronic
markets of the present. He was formerly a principal in California’s first
licensed commodity advisor, CEO of Blair Hull’s Options Research, Inc.,
managing partner of a market maker, and president of an options arbitrage
manager. He is presently Adjunct Professor of Finance and Economics at
Golden Gate University, where he teaches technical analysis of stock
trends.
v
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A SPECIAL
ACKNOWLEDGMENT
Anyone who has engaged in research on issues long dead knows what
a nightmare it is to pursue data on the New Haven, or astoundingly(!)
IBM before 1968. In fact, if IBM has digital data on its stock prices prior
to 1968, I was unable to find it within that corporation (or anywhere else).
On the other hand a veritable treasure trove of old data is kept at M.C.
Horsey and Company Inc., P.O. Box 2597, Salisbury, MD 21802. On hand-
kept ledger cards. M.C. Horsey publishes this data on very long-ter m
monthly charts in “The Stock Picture.” I am most indebted to them for
use of their IBM data and recommend them to seekers after wisdom and
truth who can’t find it in real time data.
Special appreciation goes to makers of software packages utilized in
preparation of this and previous editions:
AIQ Systems Metastock

P.O. Box 7530 Equis International, Inc.
Incline Village, NV 89452 3950 S. 700 East, Suite 100
702-831-2999 Salt Lake City, UT 84107
www.AIQ.com 800-882-3040
www.equis.com
TradeStation
Omega Research
14257 SW 119th Avenue
Miami, FL 33186
305-485-7599
www.tradestation.com
vii
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ACKNOWLEDGMENTS
First of all, to that irrepressible Maine–iac and distinguished technical

analyst Richard McDermott; surfer of the markets, sometime president of
John Magee Inc., editor of the first edition of this book and delightful
raconteur.
To my invaluable research and editorial assistants, Don Carlos Bassetti y
Doyle and Don Pancho Samuelito Bassetti y Doyle who have contributed
significantly to this edition. Thanks for the Peaches. Also, the fish.
To my publisher at CRC Press, Drew Gierman and his production staff,
especially Pat Roberson, whose professionalism is exemplary, and Michele
Berman, who is an excellent, close reader.
To Blair Hull and his staff for generous and helpful support.
To Professor Hank Pruden of Golden Gate University for many favors
and kindnesses in the preparation of this and other books.
Members of the Market Technicians Association, especially Shelley, Ed
Polokoff, and Jon Knotts at Prophetfinance.com.
And as always, to that modest gentleman, tireless teacher, and master
of the craft, John Magee.
ix
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FOREWORD
To the uninitiated the field of technical analysis presents an aspect of

scientific (or perhaps, pseudo scientific) complexity. If it is not stochastics,
it is Bollinger Bands or RSIs or ADXRs or some other jar gon-ridden
description. Either this is intimidating or it leads the neophyte to expect
that if he masters this mélange of tools he will magically, or scientifically,
achieve investment success. I regret to inform the reader immediately that
there is no Philosopher’s Stone.
In reality mathematical or statistical sophistication is not necessary to
practice technical analysis in the markets. Any number of little old ladies
with a ruler and chart have outperformed any number of Nobel Laureates.
This book is for those just beginning the study of technical analysis, or
those conducting a concise review. Its purpose is to initiate the newcomer
to technical analysis, to furnish him with sufficient background and knowl-
edge to practice as a beginning and moderately competent technical inves-
tor/trader. In addition, it lays out a clear methodology and “system” for
trading for the general mid- to long-term investor, and it also lays out a
plan of study and self-education for the initiated neophyte who wants a
more thorough and detailed mastery of advanced techniques and concepts.
Make no mistake — the intelligent application of technical analysis
cannot help but lead to long-term success in investing. But be warned:
success involves more than the static use of cookie-cutter principles. It
requires, in addition to an intelligent methodology and technique, the
ability to see markets clearly and accept immediate realities, and the
character and maturity to formulate a plan and then to stick with it when
it would appear doomed. Thus, there is not just a rational or consciously
intelligent side to investing and trading, there is also, perhaps more
important, a psychological, mental side. The best systems in the world
are of no use to the investor without the patience to see them through
and the discipline to implement them.
xi
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xii The Introduction to the Magee System of Technical Analysis
WHAT THIS BOOK DOES NOT DO

This book is not a blueprint to riches or infallible investment success.
Speaking in general, and speaking specifically, this book does not explain
in laborious detail statistical and number-driven systems. Nor does it go
into great detail on systems and methods of interest to short-term traders
(e.g., day trading methods). Options and futures are introduced but not
explored in detail. Background and perspective are offered on all of these
subjects and indications are given for more advanced study.
What this book will do is give the newcomer a thorough grasp of
chart-oriented technical analysis and the basics of investing following
technical methods. And it also offers basic perspective on other important
areas of technical analysis (e.g., number-driven techniques) if not advanced
detail. With this foundation, readers should be able to manage a general
investment portfolio with some confidence and competence. And they
should also be able to proceed to further study if they want to continue
to develop their capabilities and activities.
THE PLAN OF THE BOOK

This book opens with a concise statement of the principles and basics of
technical analysis by the most important master of the craft, John Magee.
He expounds on the history of technical analysis, on its most important
concepts, such as support/resistance and trends and the patterns that
occur over and over in all charts. Then the editor/co-author summarizes
and abstracts Magee’s work to prepare the reader for the continued study
of concepts and tools developed in large part after Magee practiced.
Included is material on Magee’s methods for managing portfolios and
controlling risk, including a description of his stop systems. To my knowl-
edge there are no better stop systems extant.
Then this book presents a brief survey of number-driven technical
methods, along with descriptions of Candlestick charting and Point and
Figure charting. Magee follows with a semantical discussion of his method,
calculated to give readers a rational confidence in the process.
PURPOSE OF THE BOOK

My intention is that the conscientious reader should emerge from the
book with a well-rounded grasp of Magee-type analysis and be able
profitably to manage a mid- to long-term investment portfolio — without,
of course, attempting anything fancy or clever.
Not to discriminate against the fancy and clever (that being my history),
racy traders will find here the indispensable perspective and foundation
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Foreword xiii
on which to rest further studies. And the direction these studies should
take will be pointed out to them. Traders need to know the same thing
investors need to know. They also must know other things which the
investor will profit from knowing. Some of this is presented here.
To this end, this book includes appendices on Directed Further Study
as well as on Resources for all types of investors. Included also is material
on suggested trading plans for all different types of investors — plungers
to the somnolent.
EDITORIAL METHODS AND ORGANIZATION

OF THE BOOK
The basic material of this book was written by John Magee, some was
written by the redoubtable and distinguished technician Richard McDer-
mott, and the modernized parts were written by myself as Magee’s diligent
student. I consider my thought and methods to be essentially extensions
of what I learned from Magee, supplemented by experience with many
developments in statistics, markets, and technology. I have called these
various ideas about risk, portfolio, and trading systems Pragmatic Portfolio
Theory, as it seems to me that Magee was the essence of pragmatic. These
ideas are introduced and briefly covered here and should be sufficient
for the average general investor. The theory is more fully discussed in the
8th edition of Edwards and Magee’s classic work on the subject, Technical
Analysis of Stock Trends.
In view of the fact that this volume is a relaxed and informal presen-
tation of ideas more fully expressed in Edwards and Magee’s classic, I
have not been overly rigorous academically in the changes and additions
I have made to this book. Readers will, in general, readily distinguish my
work from Magee’s. I have used italics where I have directly intruded on
his text. I have also made moderate changes in the organization of Magee’s
text to fit a pedagogical plan I have found effective in teaching technical
analysis seminars at Golden Gate University and the University of Califor-
nia, Berkeley, Extension.
ABOUT GENDER
Female readers will note that the usage of “her system,” “she will,” and
so on does not appear in this book and perhaps think Magee and me
chauvinist pigs. Quite the contrary. I quote here from my foreword to the
2nd edition of Magee’s General Semantics of Wall Street (charmingly
renamed according to the current fashions, Winning the Mental Game on
Wall Street):
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xiv The Introduction to the Magee System of Technical Analysis
“About Gender in Grammar
“Ich bin ein feminist. How could any modern man, son of a beloved
woman, husband of an adored woman and father of a joyful and
delightful daughter not be? I am also a traditionalist and purist in
matters of usage, grammar and style. So where does that leave me
and my cogenerationalists, enlightened literary (sigh) men (and
women) with regards to the use of the masculine pronoun when
used in the general sense to apply to the neuter situation?
“In Dictionary of Modern American Usage, Garner notes: ‘English

has a number of common-sex general words, such as person, anyone,
everyone, and no one, but it has no common-sex singular personal
pronouns. Instead we have he, she, and it. The traditional approach
has been to use the masculine pronouns he and him to cover all
persons, male and female alike. …The inadequacy of the English
language in this respect becomes apparent in many sentences in
which the generic masculine pronoun sits uneasily.’
“Inadequate or not it is preferable to s/he/it and other bastardizations

of the English language. (Is it not interesting that ‘bastard’ in common
usage is never used of a woman, even when she is illegitimate?) As
for the legitimacy of the usage of the masculine (actually neuter)
pronoun in the generic, I prefer to lean on Fowler, who says, ‘There
are three makeshifts: first as anybody can see for himself or herself;
second, as anybody can see for themselves; and third, as anybody
can see for himself. No one who can help it chooses the first; it is
correct, and is sometimes necessary, but it is so clumsy as to be
ridiculous except when explicitness is urgent, and it usually sounds
like a bit of pedantic humor. The second is the popular solution; it
sets the literary man’s (!) teeth on edge, and he exerts himself to
give the same meaning in some entirely different way if he is not
prepared to risk the third, which is here recommended. It involves
the convention (statutory in the interpretation of documents) that
where the matter of sex is not conspicuous or important the mas-
culine form shall be allowed to represent a person instead of a man,
or say a man (homo) instead of a man (vir).’
“Politically correct fanatics may rail, but so are my teeth set on edge;
thus I have generally preserved the authors’ usage of the masculine
for the generic case. This grammatical scourge will pass and be
forgotten and weak willed myn (by which I intend to indicate men
and women) who pander to grammatical terrorists will in the future
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Foreword xv
be seen to be stuck with malformed style and sentences no womyn

will buy. What would Jane Austen have done, after all?
“About Gender in Investors
“And, as long as we are on the subject of gender, we might as well

discuss, unscientifically, gender in investors. Within my wide expe-
rience as a trading advisor, teacher, and counselor it strikes me that
the women investors I have known have possessed certain innate
advantages over the men. I know there are women gamblers. I have
seen some. But I have never seen in the markets a woman plunger
(shooter, pyramider, pie eyed gambler). And I have known many
men who fit this description (and in fact have done some of it
myself). I have also noted among my students and clients that as a
group women seem to have more patience than men as a group. I
refer specifically to the patience that a wise investor must have to
allow the markets to do what they are going to do.”
I have found the previous edition of this marvelously concise little

book an ideal beginning textbook, a perfect first step to further study in
the bigger more complete, more complex Technical Analysis of Stock
Trends. The rearrangements I have made of the material fall naturally into
the teaching plan I use in seminars.
W.H.C. Bassetti
San Francisco
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CONTENTS
SECTION I: A BRIEF HISTORY OF DOW THEORY AND

THE FOUNDATIONS OF TECHNICAL ANALYSIS
Magee summarizes the basics of technical analysis, its origins in
Dow Theory, something of its philosophy, and the use of its primary
tool, the bar chart.
1 Basic Tenets of Technical Analysis as Evolved from
Dow-Jones Theory and the Bar Chart, Tool of Technical
Analysis .........................................................................................3
SECTION II: THE CENTRAL CONCEPTS AND

VOCABULARY OF TECHNICAL ANALYSIS
Magee concisely recounts the central concepts of technical
analysis — support/resistance and trends — and discusses some of
the important patterns that recur in normal market activity. Patterns
of both long-term and short-term importance are covered. In addi-
tion to the explanation of this basic market vocabulary, the Magee
system of stops is explained.
2 Important Practical Concepts: Support and Resistance .........19
3 The Central Concept: The Importance of Trends and
Trend Channels ..........................................................................27
4 Other Important Patterns of Short-Term Import: Gaps,
Spikes, Reversals ........................................................................61
5 When to Buy, When to Sell: Stops, Hair-Trigger Stops,
Progressive Stops .......................................................................73
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xviii The Introduction to the Magee System of Technical Analysis
SECTION III: MAGEE’S METHODOLOGY: RISK

MANAGEMENT, PORTFOLIO MANAGEMENT, AND
RHYTHMIC TRADING. PRAGMATIC PORTFOLIO
THEORY FROM BASSETTI
The Magee method is briefly summarized, and Bassetti develops and
articulates Magee’s ideas of rhythmic investing, portfolio manage-
ment, and risk management and control.
6 The Magee Method .....................................................................81
7 Further Developments to the Magee Method: Portfolio
Management, Risk Control, Including Rhythmic Trading
and Pragmatic Portfolio Theory ...............................................83
SECTION IV: OTHER TECHNICAL ANALYSIS TOOLS:

NUMBER-DRIVEN TECHNIQUES, CANDLESTICKS, AND
POINT-AND-FIGURE-CHARTING — ALGORITHMIC
TRADING
Charting is the original form of technical analysis, the basic disci-
pline. With the development of the computer, other forms of technical
analysis have evolved — number-driven (or statistical) analysis,
candlesticks, and point-and-figure analysis.
8 Other Important Technical Analysis Methods ........................91
1. Number-Driven Methods
2. Moving Averages
3. Candlesticks
4. Point-and-Figure Charting
SECTION V: CONSIDERATIONS FOR TRADERS/

INVESTORS OF WHATEVER STRIPE — DAY TRADERS
TO LONG-TERM INVESTORS
Implications of technical analysis are put in context for various
kinds of traders/investors, from short-term traders to long-term inves-
tors: What kind of analysis is appropriate for whom. Sample trading
plans for these various categories of traders are discussed.
9 Considerations for Short-Term Traders, Speculators, and
Mid- and Long-Term Investors................................................117
10 Some Hypothetical General Trading Plans ............................121
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Contents xix
SECTION VI: TRADING IS ONLY HALF SYSTEMS AND

METHODS — THE OTHER 90% IS MENTAL
Magee explores the philosophical and psychological aspects of stock
market trading and investing.
11 The Mental Side and the Philosophical Foundations ...........129
SECTION VII: APPENDICES

Market wisdom. After basic training and drill the army enters the
battle. How well does the theory and method hold up in the heat of
combat? Also, the necessities of manual Tekniplat charting. Indica-
tions for further study and resources for traders/investors.
Appendix A Some Selected John Magee Letters.........................143
Appendix B Tekniplat Charting...................................................199
Appendix C Continuing Study Plan ............................................211
Appendix D Resources..................................................................213
Glossary .............................................................................................217
Glossary of Patterns .........................................................................237
List of Diagrams................................................................................246
List of Charts.....................................................................................247
Index..................................................................................................249
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I
A BRIEF HISTORY
OF DOW THEORY AND
THE FOUNDATIONS OF
TECHNICAL ANALYSIS
Magee summarizes the basics of technical analysis, its origins

in Dow Theory, something of its philosophy, and a brief dis-
cussion of its primary tool, the bar chart.
Dow Theory, deriving from original editorials in the Wall Street

Journal by Charles Dow, stated that the near future of the
economy — and of the stock market in general, could be
forecast by observing the average behavior of 30 industrial
stocks and 20 transportation stocks. When these averages
advanced in concert a Bull Market was in effect and, conversely,
when they declined in concert a Bear Market was in effect.
Signals cast off by these two averages may be used as buy-
and-sell indicators and have been for 100 years. Buying and
selling on Dow signals would have netted $362,212.98 in 103 years
on an initial $100 investment as opposed to $39,685.03 realized
from a buy-and-hold plan.
1
2 The Introduction to the Magee System of Technical Analysis
Dow Theory is wholly a technical method. Technical analysts

saw that principles of Dow Theory could be applied to indi-
vidual stocks and, using bar charts, developed the theory and
have applied it productively for more than half a century. The
definitive statement of chart-based technical analysis is Edwards &
Magee’s Technical Analysis of Stock Trends (1st ed., 1948; 8th ed.,
2001). Contrary to the beliefs of academic random walkers,
trends occur in the markets and the most productive investment
methodology identifies and profits from these trends, using bar
charting as its basic tool.
1
BASIC TENETS OF TECHNICAL
ANALYSIS AS EVOLVED
FROM DOW-JONES THEORY
AND THE BAR CHART, TOOL
OF TECHNICAL ANALYSIS
John Magee’s Inc.’s objective has always been to forecast individual stock
prices — not the “overall” stock market. Investors buy individual stocks,
not the “market” — their profits (or losses) reflect how well those stocks
do. (Magee, of course, wrote this statement and practiced before it was
possible for the general investor to “buy the market” by purchasing ishares
or DJIA futures, instruments which effectively allow the investor to “buy
the market.” These instruments are explored later. The purposes and meth-
ods Magee discusses remain valid not only for individual stocks but also
for the averages themselves.) Although it is often the case that the vast
majority of stocks move in the same direction as the market, it is not
always so. Certain groups may lead a market move whereas others may
lag or not participate at all. And, even within a group of stocks such as
airlines or steel, for example, certain stocks may move ahead of, with, or
actually lag behind their own group.
The basic tenets of technical analysis were first put forth by Charles
Dow, editor of the Wall Street Journal and creator of the Dow-Jones
averages. By analyzing the behavior of the industrial and rail averages,
Dow developed a theory — the famous Dow Theory — by which he
sought to forecast the major direction of the stock market from the price
behavior of these indices.
3
THEORIES AND ASSUMPTIONS

The foundations for modern technical analysis of stock trends were laid
by Charles Henry Dow, a founder and the first editor of the Wall Street
Journal. During his tenure as editor, from July 8, 1889, until his death on
December 4, 1902, Dow published his observations on the market and
its likely future direction based on the interactions between the industrial
and railroad averages. These editorials constitute the solid core of present-
day Dow Theory. The industrials represent the strongest and biggest
companies, called “blue chips” or primary issues. These companies are
in goods and services. The transports are secondary issues that move
goods and people such as rails, trucks, barges, and airlines. The two basic
assumptions of Dow Theory technical analysis are as follows:
1. The averages, in their day-to-day fluctuations, discount everything

known, everything foreseeable, and every condition that can affect
the supply of or the demand for corporate securities; and
2. The market moves in trends, upward or downward, over time.
The fundamental premise of technical analysis is that it is possible to

identify and predict the continuations and turning points in market trends,
to evaluate relative strength or weakness in the market, and to profit from
the application of that analysis.
The central method of Dow Theory involves examining the co-move-
ments of two averages, such as the Dow-Jones industrials and the Dow-
Jones transportations, for “confirmations.” One average is usually regarded
as the primary one and the other as the confirming index. Confirmation
occurs when, for instance, the industrials reach a high above their previous
high, and the transportations do likewise around the same time. The trend
in the averages is held far more likely to continue when confirmation is
present than when it is absent.
In addition, technicians have used the Dow-Jones transportation aver-
age as a confirming indicator to the industrials since the days of Charles H.
Dow. (Confirmation — in other words if one average is going up, or
down, the other should be going in the same direction to confirm.) At
that time, the junior average consisted only of railroad stocks. The indus-
trials were considered an index of productive activity and the rails one
of distributive activity. Both of these should be sound in order to have a
healthy economy and, hence, a healthy stock market. Although the rails
do not “move the nation” now as they did then, today’s transportation
index still provides a supplementary barometer of speculation in the
market and, therefore, continues to be useful.
Basic Tenets of Technical Analysis 5
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Chart 1. Dow-Jones Averages Chart Showing Divergences and Confirmations of

Industries by Transportation. In May and June the industrials and the transportations
part ways, that is diverge — an ominous sign for the Dow, and also for the entire
market. The industrials continue merrily along waiting until the fateful month of
October to confirm the transportation move. Both averages react and the Dow
goes to its all-time high with the transportations once again diverging in November
and the joint downtrend reaching mutual confirmation in March 2000. The conse-
quences and reflections of this action in the averages may be seen in Chart 4.
The technician’s assumption is that if confirmation occurs between the

industrials and either of these supplementary indicators (or more strongly,
both), a trend under way would be likely to continue. If confirmation were
not present, the averages would be said to be “out of gear” (or divergent),
and the trend in the industrials would be less likely to continue. The
usefulness of this, if it were true, would not be confined to the narrow
Dow-Jones averages alone. Correlation among all the major averages is of
a high degree and well established historically. The technician’s assumption
about confirmations and trends appeared to us to be easy enough to test.
Confirmations are visible on charts, as are subsequent movements in the
averages. Robert D. Edwards and I, therefore, set out to test (in Technical
Analysis of Stock Trends) whether any statistically valid, identifiable connec-
tion exists between confirmations and subsequent continuations of trends.
Several of the basic principles of technical analysis extended from Dow
Theory of overall stock market behavior and applied to individual stocks,
however, deserve attention. These principles are, in brief, the foundations

of technical analysis, as explained below. Dow Theory, although not com-
pletely objective (i.e., reducible to an uncontested algorithm), shows con-
siderable power in practice. An investor following the long-term trading
signals of the Dow, from its inception in 1897 up to 2000, would have
realized $362,212.98 on an initial investment of $100, whereas an investor
who bought $100 of the average at its inception and held it to its high in
1999 would have realized $39,685.03.
BASIC TENETS OF TECHNICAL ANALYSIS

The first major principle of technical analysis is that the market action of
an individual stock reflects all the known factors affecting that stock’s
future. Among the factors, and expressed in its chart, are the general
market conditions which influence all stocks to a greater or lesser degree,
as well as the particular conditions applying to the particular stock,
including the trading of insiders. A basic tenet of the Dow Theory is that
the averages discount everything (except “Acts of God” — and Alan
Greenspan). In technical analysis, price and volume are the great “data
reducers of the stock market” — for individual stocks as well as for the
averages. By concentrating on the interpretation of price and volume
patterns only, and by disregarding the never-ending stream of corporate
information, advisors’ opinions, rumors, and tips and hunches from well-
meaning friends, the technical analyst approaches common stock selection
in a systematic manner, ideally suited for fast-moving markets in which
timely judgment and decisive action invariably spell the difference between
success and failure.
The second basic principle or premise is that stocks move in trends.
The third basic principle is that volume goes with the trend. In an
uptrend, volume rises as prices rise and declines as prices decline. Contrary
behavior by a stock in an uptrend may signal an important topping out,
or reversal, in the near future. For those who think this is obvious, we
would point out that it is frequently not the case. Price peaks and valleys
often occur during periods of low trading activity. This provides the
technician with a clear signal that buying or selling pressure is abating
and a new price trend is forming.
The fourth, and last, basic premise of technical analysis is that a trend,
once established, tends to continue. Until such time as its reversal has
been signaled, a trend is assumed to continue in effect. This proposition
is essentially stating an important probability — the likelihood that the
next move in a stock will be in the same direction as the previous one.
STOCK IN UPTREND
An uptrend is considered to be in force as long as each successive rally
reaches a higher price than the one before it, and each successive reaction
stops at a higher level than the previous reaction. A similar (reversed or
mirror image) definition holds for a downtrend.
We divide a trend into three subcategories:
1. The major trend usually lasts a year or more and results in appre-
ciation or depreciation of 20% or more.
2. The intermediate trend operates in the opposite direction of the
major trend, usually retracing one half or less of the prior movement
in the direction of the major trend. It is often referred to as an
intermediate reaction.
3. Minor trends consist of day-to-day fluctuations which are unim-
portant except as they combine to form larger trends.
For our purposes, it is more instructive to discuss some of the basic

assumptions a technician makes in interpreting a chart. This discussion
must begin with the relationship of volume and stock price. The rule of
thumb is that when stock price and volume rise together, there is sufficient
buying pressure to indicate an uptrend. Conversely, although not as
directly proportional, price declines will be accompanied by increasing
volume if there is sufficient selling pressure to indicate a downtrend. It
is, however, not necessary that volume increase on declines to definitively
indicate a downtrend. Price alone can indicate this.
Here are three charts of stocks (charts 2, 3, and 4) in normal trends,
such as those seen every day in the markets. One is an uptrend, one a
downtrend, and one a sideways trend.
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Chart 2. The Dow Industrials Uptrend. Here is the greatest uptrend in the history
of the U.S. markets — the Great Clinton–Gore bull market. A complex of factors
combined to produce the most important market in U.S. history. The benefits of
computer technology, the rush to the Internet, the incredible prosperity of the
people as a whole, and not least the fiscal responsibility of the Clinton–Gore
administration, which for the first time since the 1950s balanced the budget and
began to pay down the enervating debt produced in the Reagan years. Technicians
generally turn a deaf ear to analyses of this kind. And usually for the immediate
moment and for the short-term purposes of investing and trading they should.
But secular factors of this kind are worth noting, if not trading on. Trading and
investing takes place for most investors in a much more limited time frame.
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Chart 3. Xerox, in a Downtrend. Bull trends require labor and time and blood
sweat and tears. Bear trends are effortless and fall to earth, in many cases, like a
punctured hot-air balloon. Often it was hot air which created the bull trend. But
virtually always an important trend line is broken before the bear trend begins.
This is a common downtrend — after all a downtrend must begin from up. And
almost always will be ragged rather than regular, especially in modern markets
where investors are so quick to flee the least sign of weakness.
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Chart 4. Dow-Jones Industrials in a Sideways Trend, with a moving average line.

At the turn of the millennium as the great bull market topped, the Dow produced
a constellation of formations which all added up to the same thing — sideways
trend. A long-term moving average vividly illustrates the nature of a sideways
trend — the price see-saws back and forth across it effectively destroying any
trend following system which does not know to quit trading in sideways trends.
In these situations traders can make money shorting the top of the trading range,
covering and buying the bottom — as long as they know when to quit this tactic,
because eventually the price will fall out or break out and bite a trader who
overuses this tactic.
HOW TECHNICIANS USE BAR CHARTS

TO STUDY THE MARKETS
The purpose of this discussion is to explain the nature of the bar chart,
something of the history and development of the use of charts in the
evaluation of securities, and the philosophy and rationale of charting. In
later chapters we discuss some of the technical patterns seen on charts
and their use and interpretation, methods and details of application and
use, and comments and suggestions as to the setting up and maintaining
of daily charts.
What Is A Bar Chart?

A bar chart is one of the many methods of representing information in
graphic form. It consists of a rectilinear grid on which two variables can be
plotted. Thus, the vertical axis might be scaled to represent “miles per hour”
of a moving automobile and the horizontal axis, the “rate of gasoline
consumption.” The vertical axis might be “total number of employees” in
various industries and the horizontal axis “average wage of employees.” In
many kinds of engineering, sociological, and economic problems, the hori-
zontal axis represents time (hours, days, months, etc.), and the vertical axis
measures the magnitude of a second variable such as population, net income,
pressure, or whatever data are under examination. In the study of securities,
bar charts are widely used to show the record of price trends and fluctuations
over time. These charts can be adapted to any type of financial market:
stocks, bonds, warrants, debentures, commodities, etc. They can be used for
long periods, perhaps covering many years, or they may be focused down
to short-term trends on a daily or even hourly basis. (With today’s technology,
charts may be computer-generated on every tick of the market in real time.)
In charting security prices, the high and low prices for the day (if it
is a daily chart that is being run) are plotted on the line that represents
the particular day, and the high and low are connected by a vertical line.
Usually, the closing or last price for the day is shown as a cross-line on
this vertical range. It is also possible to show both the opening price and
the closing price, using a short line to the left of the vertical range for
the opening, and a short line to the right to indicate the close. The volume
of trading may be shown on a separate scale near the bottom of the sheet,
directly under the vertical lines showing the daily price range. For weekly
charts or monthly charts, the procedure is exactly the same except that
each horizontal interval represents a week or a month instead of a day.
Because the horizontal scale on the chart provides a “calendar,” it is
possible to enter any other data directly on the chart. This includes, of
course, dividend or ex-distribution dates, the dates of stock splits, any data
that might seem important as to earnings, mergers, and announcements of
new products, and so on. By noting on the proper date the purchase or
sale of a stock and the price paid or received, a record of these transactions
will be right on the chart — which will make it easy to check the status
of a transaction and the profit or loss on it. Moreover, this record will serve
as a valuable study later as to the degree of success of decisions.
The Uses and Applications of Charts

Before anyone can use any method in business, finance, science, or any
other field, and before he can judge properly the usefulness of the method,
he should have some background of theory and the goals he hopes to

reach. At this point we want to consider some of this important background.
We have already spoken of the use of charts simply as a record of
stock prices and trading volume — in other words, the market action of
the stock — and also of the convenience of recording other data on the
chart itself rather than in separate notebooks or tables. A more important
use of the chart is in backchecking the results of one’s judgment, building
up a body of firsthand experience in a form that can be consulted and
analyzed later, and in acquiring better perception — learning from both
one’s past successes and failures.
To many people, the stock market is a confusing and confused melee
in which prices move helter-skelter without rhyme or reason. But this
confusion is, to some extent, a confusion in their own minds, because
they do not understand the complicated forces and the detail of procedure
that actually cause stock prices to advance or decline. They might feel
the same sense of meaningless movement that a visitor to a textile mill
might feel the first time he saw the operation of an automatic loom. He
might not understand at first sight that the strange shifts of the jacquard
mechanism were not meaningless but were directed toward the orderly
creation of a definite pattern in the cloth which would have meaning to
anyone when he saw the finished product.
Groups of students in technical analysis of stock trends are often
skeptical as to the meaning or orderliness of the market at the first or
second lectures in a course. When they discover, as they do, that the
long-term trends of stocks, covering a period of a number of years, show
definite trends which often appear as straight-line channels on semiloga-
rithmic charting paper, they are likely to be overcome with enthusiasm.
Sometimes it is necessary to warn them that the existence of trends, though
true, is not the entire key to success in the stock market but merely one
of a number of important facts that appear in the study of charts. In this
field, “a little” knowledge can be a dangerous thing indeed.
The question, at this point, is, of course, whether the charts have
predictive value — whether they can be of help in planning the purchase
or sale of stocks with respect to the future movement of stock prices. As
to this we have a definite opinion that they do. But anyone planning to
use charts in his own financial planning should understand as thoroughly
as possible their theory and application. He should learn some of the
characteristic behaviors of charted stocks, check and verify what he has
read and heard by his own current observations, and have some idea of
what may be abstracted or surmised from a chart, and with what degree
of dependability.
THE BLOODLESS VERDICT OF THE MARKETPLACE

Following the line of reasoning in the preceding sections, especially that
part that touches on the difficulty of knowing all about a corporation or
about the market as a whole, we realize that the most dependable criterion
of value in the practical sense of what one must pay, or what one can
get for something (whether it should be shares of stock, bushels of wheat,
land, houses, automobiles, or whatever), is the free speculative auction
in which the bids and offers of prospective buyers and sellers determine
the price. Whether the reasons behind these bids and offers are sound,
reasonable, or wise has nothing to do with the fact that the price is
determined by them, and any investor is at liberty to take it or leave it.
There is an implication here that men who are putting their own hard-
earned cash on the line to support their opinions are likely to have serious
reasons for doing so; there is at least a presumption that the composite
of these opinions, the consensus as represented by the price at a given
moment, may be the most realistic expression of value we can hope to get.
Therefore, following this line of reasoning, we must assume that the
current price of the stock represents all that is known, or believed, or
hoped, or feared, in connection with the present value or future probable
value of that stock.
THE CHARTS SIMPLY REFLECT HUMAN EVALUATION

The question is sometimes raised as to whether a stock chart will reflect
unreasoning emotional states of mind on the part of investors. That is
surely true at times. There have been “crazy” booms in stocks, and there
have been equally “crazy” collapses and panics. But, the fact that these
market actions cannot always be supported by factual reports and statistics
does not make them any less important. When the price of a stock starts
to climb or when the bottom falls out of it, it is best to take appropriate
action, recognizing that an important move is taking place, rather than
trying to hold back the tide because it does not seem to make any sense.
In a surprising number of cases, the move eventually does prove to make
sense; the collective judgment of the market is extremely sensitive and
perceptive as to probable changes in production, earnings, dividends, and
other matters affecting the affairs of a company.
If a market move turns out to be premature or false, if the expected,
or hoped for, or feared, developments do not come about, it is still true
that one cannot argue with the tape. It is best, we feel, to accept the facts
regardless of the reasons, assuming that in most cases the reasoning behind
the move is sound.
One other question remains which we feel has always been given
more weight than it deserves, especially by those who have not studied
too long or too deeply. The question is whether the movement may
represent merely the manipulative operations of dishonest traders, or
whether, through false rumors or merely through the fact that something
seems to be happening, the movement snowballs and accelerates on its
own momentum.
As far as dishonest manipulation is concerned, this has never been an
entirely safe or easy thing, even in the “bad old days” when no punches
were barred. Today, with the various regulatory laws and the rules of
procedure in the important Exchanges, plus the self-protective, self-regu-
lation of the reputable brokerage houses, it is more difficult. Still, as the
various insider trading trials prove, there will always be a dishonest
element in the market.
Nor do we believe that the important market moves are merely the
result of rumor, collective hysteria, and emotional confusion. There are
too many hardheaded men, both individuals and traders for institutions,
who are prepared to check and counterbalance an entirely capricious or
irrational move. We would question whether the recommendations of
brokers or investment advisory services, or the statements of newspaper
writers or radio and TV analysts, or the self-reflexive action of technical
factors are major elements in important market moves. In all this, in all
the changes shown in the charts (which are a picture of what is actually
happening in the market and which are indirectly a portrayal of what the
collective investing public is perceiving), we are dealing with speculation.
In this connection, we are using the word in the particular sense in which
Webster’s Ninth New International Dictionary defines it, in the first defi-
nition of the word as in current use: “The faculty, act, or process of
intellectual examination or investigation.” This is the proper and legitimate
function of a market and in no way implies any dishonorable or unfair
practice. The word, as Webster here defines it, is merely synonymous with
evaluation, and it is in this sense that we use it in this treatise.
THE TECHNICAL PICTURE

We have spoken of the chart as a “picture,” a picture of the composite
evaluations going on in the minds of many people. We have spoken of the
chart as “a tool.” In spite of the possible effect of buying or selling by some
technicians who use charts, we do not believe that “the chart makes the
market go.” On the contrary, we believe that the market makes its own
complex evaluation, and the chart reflects this continually changing appraisal.
In general, as Charles H. Dow discovered before the turn of the century,
the market tends to anticipate expected conditions. Therefore (with Dow),
we assume that when the market or some particular stock is moving

strongly into higher ground, it is because people are anxious to buy it
and are willing to bid more for it. Conversely, when a stock is slumping
to new lows, it suggests that people are pessimistic about its future and
are prepared to take less for it in order to get it off their hands.
This, as we will see, appears to run somewhat counter to the ordinary
idea of buying something while it is cheap and selling it when it is dear.
We read so often of stocks that are overpriced. Yet the man who sells
these overpriced stocks, or sells them short, often finds that the upward
trend continues for months or years. Similarly, the investor who attempts
to buy at the bottom is often disappointed, because the stock which has
been in trouble for some time is quite likely to continue to slump.
Something else about the low-priced stocks should be mentioned here.
It seems reasonable to suppose that stock that once sold at $100 a share,
which has dropped to $10 a share, must be at or near its ultimate bottom.
An investor will sometimes argue that because it has already dropped 90
points from 100 to 10, it cannot drop more than 10 points at the most.
But this is a trap, and a dangerous one. Consider that you have $10,000
to invest. This would have bought you 100 shares of the stock at the
price of $100. When the stock dropped to 10, your accrued loss would
have been 90%, or $9,000. But if you should wait, and then buy the stock
at $10, and it should drop 9 points to $1, your loss would have once
again been 90%, and if you had used the same capital of $10,000 to buy
1,000 shares at $10, you would have suffered a loss of $9,000, the same
as in the first case. On a percentage basis (which is what the logarithmic
scales show clearly) there is no bottom to the chart, and no top — no
limit to what portion of your capital you could make or lose. ( For an
interesting practical lesson on this final point see Appendix A, Some Selected
John Magee Letters, page 144.)
II
THE CENTRAL
CONCEPTS AND
VOCABULARY OF
TECHNICAL ANALYSIS
Magee concisely recounts the central concepts of technical

analysis, support and resistance, trends, and some of the impor-
tant patterns that occur in normal market activity. Patterns of
both long-term and short-term importance are displayed. In
addition to an explanation of this basic “vocabulary,” the Magee
system of stops is briefly explained by Bassetti.
In any free-market auction marketplace, the item being traded

seeks a consensus price. If more people want to sell than want
to buy it, it will decline in price. And vice versa. The battle
between buyers and sellers will leave bodies on the field —
the buyer who bought at 100 and saw a price decline of
20 points and, smarting, seized the opportunity to get out when
the stock got back close to 100. Thus does resistance form. And
support forms when a majority of the traders believe that the
stock is underpriced at 90. The interplay between these levels
of support and resistance takes identifiable patterns (rectangles,
17
triangles, flags, etc.) depending on the strength of convictions

of the two sides. As one side or the other gains additional
adherents, resistance, for example, will be overcome, and a
trend, or the continued movement of prices in one direction,
will result.
In addition to patterns that form over weeks or months, markets

continually display short-term patterns of interest — gaps,
spikes, reversal days. These can have immediate importance as
well as importance for the longer term.
It is all very well to see one’s stocks go up. When do you sell?
The explanation of stops which is given in this section reveals
the best thinking of one of the most respected advisors in the
history of U.S. markets.
In view of the fact that frequent reference will be made to certain

terms definitions will be offered here. Basing points, which are explored
in depth in Chart 27, are reaction points in a trend used for drawing trend
lines and calculating progressive stops. The MEI, or Magee Evaluative
Index, is an index calculated by analyzing a sector or Average by decon-
structing it into strong neutral and weak percentages. Ishares are stock-
like instruments which represent a small percentage of a major index, for
example, the DIA is 10% of the Dow Jones Industrials.
2
IMPORTANT PRACTICAL
CONCEPTS: SUPPORT
AND RESISTANCE
For the purposes of this discussion, we may define support as buying —

actual or potential — sufficient in volume to halt a downtrend in prices
for an appreciable period. In other words, it is where the buying is.
Resistance is the antithesis of support. It is selling, actual or potential,
sufficient in volume to satisfy all bids and, hence, stop prices from going
higher for a time. Support and resistance, as they are defined, are nearly,
but not quite, synonymous with supply and demand, respectively.
A support level, or zone or band, is a price level at which sufficient
demand for a stock appears to halt a downtrend temporarily at least, and
possibly reverse it (i.e., start prices moving up again). A resistance level,
or zone or band, by the same token, is a price level at which sufficient
supply of a stock is forthcoming to stop, and possibly tur n back, its
uptrend. There is, theoretically and nearly always actually, a certain
amount of supply and a certain amount of demand at any given price
level. (The relative amount of each varies according to circumstances and
determines the trend.) But a support range represents a concentration of
demand, and a resistance range represents a concentration of supply.
According to the foregoing definitions, the top boundary of a horizontal
congestion pattern, such as a rectangle, is a resistance level, and its bottom
edge a support level (see Chart 5); the top line of an ascending triangle
is unmistakably a resistance level.
Pullbacks and throwbacks — the quick return moves we noted as
developing so often shortly after a breakout from head-and-shoulders
formations or other area patterns — exemplify the principles of support
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The Introduction to the Magee System of Technical Analysis
Chart 5. American Express, Support and Resistance Illustration. This chart of American Express vividly illustrates the phenomenon
of support and resistance, as marked by the horizontal lines. For months price bounces off the resistance at 110 and when repulsed
finds support around 99. An almost perfect bull trap is executed in July — almost perfect because the shrinkage in volume on the
breakout and top is a sharp warning sign of something amiss. Rising volume as price falls from the top is another warning sign.
Then the huge increase in volume in early August is the third strike. The exaggerated volume from August to October as disappointed
bulls liquidate their holdings allows the breakout in mid October, and then the stock goes happily back to its support/resistance range.
Important Practical Concepts: Support and Resistance 21
and resistance. When prices break down, for example, out of a descending
triangle, the horizontal lower boundary of the formation, which was
originally a demand line, promptly reverses its role and becomes a
resistance line. Any attempt to put prices back up through it after a decisive
breakout is stopped by supply at or near the line. By the same token,
the neckline of a head-and-shoulders top, which was a demand line,
becomes a resistance level after it has been broken. The top, or supply
line of the rectangle, becomes a support line after prices have pushed
above it on volume and by a decisive margin.
Major corrections or crashes, such as the ones in 1929, 1962, ( 1987,
1998, and 2001) can change supply and demand zones fast. Panics, once
they get under way, seem to sweep away all potential support in their
calamitous plunges until they exhaust themselves in a general market-
selling climax.
Another basic premise of technical analysis is that each stock has a
level of primary price support and resistance — in short, a price range
indicating an historical balance of buying and selling pressure. In stocks
with a record of volatile price activity, the range will be broader than that
of a stock whose price has not fluctuated dramatically. The primary support
and resistance levels are most obvious in stocks that have remained
inactive for lengthy periods. Technicians call this channeling. If a stock
price violates primary support or penetrates previous resistance, particu-
larly on an increase in trading volume, the technician assumes that a trend
is forming. In the case of inactive or channeling stocks, such a breakout
often indicates dramatic future price activity.
Technical analysis also reveals the existence of secondary price support
levels. Stock prices do not move in a straight line. Within an uptrend,
they advance, retreat, and then advance again. Conversely, during a
downtrend, the pattern is decline, partial rebound, and further decline.
Secondary price support levels are the price ranges to which stock prices
either rise or fall before resuming the dominant trend. They are not static
but, rather, move with the stock price. In the case of an uptrend, when
a stock price falls below the previous secondary support level, the tech-
nician is alerted to a potential change and, perhaps, reversal of the
dominant trend.
Overpage we illustrate the mechanics of support and resistance formation.
DIAGRAMS ILLUSTRATING MECHANICS OF SUPPORT

AND RESISTANCE
Diagram 1. How Resistance Forms. Here we see prices grind back and forth in
a congestion zone. We could give the pattern a number of different names, but
for the moment we will call it just a zone of contest between buyers and sellers.
When the price breaks definitively below the lows of this zone the lower reaches
(indeed all of it) become a resistance level. When prices return to this level we
will expect to see a supply of stock become available and constitute resistance.
Diagram 2. How Support Forms. As in Diagram 1, prices have been in a con-

gestion zone but have broken out on the upside. If and when reactions occur
there is the normal expectation that buying support will appear at the top of the
zone to prop up prices. These are the buyers who “missed the boat on the
breakout” and are glad to have a second chance to get on board.
Diagram 3. Old Resistance Becomes New Support. A resistance zone once over-
come becomes a source of future support. Here we see how the resistance zone
has offered a line of support to higher prices once overcome.
Diagram 4. Valid Support Levels. The top of a congestion zone will often serve
as a support zone when prices have broken out, but other valid levels may develop,
identifiable by volume behavior and the containment of prices within rational
boundaries.
Diagram 5. The Bull Trap. When prices break out of a congestion or trading
zone on the upside, even on good volume and conditions, bulls will rush to buy.
When further action nullifies the signal and the price drops through what previ-
ously looked like support, we say that a “bull trap” has been sprung. Quite often
the trade that develops after the trap is sprung turns out to be profitable (i.e.,
the trade on the short side). In fact, Schwager calls this subsequent signal one of
the most reliable of pattern trades.
Diagram 6. The Bear Trap. As in Diagram 5, the initial breakout, this time on
the downside, is a feint, trapping bears who jump too fast. The subsequent trade,
after the signal is canceled, can develop quite well.
TOP
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SECONDARY RESISTANCE
8 PRICE BREAKOUT
SECONDARY
SUPPORT
7 PRIMARY RESISTANCE
PRIMARY SUPPORT
BOTTOM
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VOLUME SPIKE
(SALES VOLUME SPIKE

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2000 INNACTIVE TRADING
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Diagram 7. Decoding a Bar Chart. Now we may look at the foregoing diagram
with some understanding and identify zones of resistance and support, of price
breakout, of tops and sell-offs. This chart is EveryMan’s EveryStock. Here we have
some support and resistance and some rectangles or battle zones and some tops
and bottoms. In fine, EveryStock. Primary support and resistance develop along
the horizontal trend lines of the rectangle. When price breaks out and encounters
secondary resistance, it returns to the top of the rectangle and finds there the
secondary support we expect to build up in normal times out of a zone such as
this. After the top, the secondary support line holds the price up until those
holders become discouraged after their second attempt at a breakout in July. And
then sellers drive the price lower to the bottom. These are discouraged bulls.
Notice the low volume on the downtrend. These fair-weather friends being out
of the way, true believers can take control of the stock in August, driving it back
up and causing acid indigestion in those who (probably rightly) sold out. Our
cunning technical analysts bailed out in July (perhaps even going short) and bailed
back in when the downtrend line was broken on eye-catching volume. See
Diagram 1, How Resistance Forms.
Diagram 8. Kilroy Bottom, Diagram of a More Persuasive Pattern to Rename

Head-and-Shoulders Bottom. As may easily be seen in this amusing World War II
graffito, the term “head-and-shoulders bottom” is innately disturbing. Much more
logical and descriptive to call it what it is, a Kilroy bottom. In fact, there is much
more accuracy in the nomenclature as complex formations might be said to have
multiple fingers instead of multiple shoulders (of which the human model only
has one of the left, etc.). The correspondence is obvious but I will gild the lily.
Left hand equals left (upside down) shoulder. Nose equals (upside down) head.
Right hand equals (upside down) right shoulder. Doesn’t that make more sense
than calling it an upside down head-and-shoulders bottom?
3
THE CENTRAL CONCEPT: THE
IMPORTANCE OF TRENDS
AND TREND CHANNELS
TRENDS
It almost always surprises novices to discover that on logarithmic charts
the price moves so frequently lie along straight lines, forming “trend
channels” that may run for months, or years. For example, the long-term
uptrend in International Business Machines ran from the end of 1953 to
the beginning of 1962 (see Chart 6 ), over 8 years, in one straight trend
channel so precise you could lay a steel ruler along it and it would not
violate the upward sloping trends at any point. Incidentally, when it did
break this trend, in January 1962, the price dropped precipitously from
over 600 to 300 in less than 6 months (see Chart 10). The trends of stocks
normally move down faster than they move up.
It is easy to verify the existence of these straight-line trends. It is easy
to see that stocks do not ordinarily jump around in completely random
fluctuations but move in more or less orderly progression for considerable
periods. However, knowing this does not automatically, and by itself,
solve all problems. As a matter of fact, though it is worth knowing, it
solves no problems. Before one can buy or sell a stock, it is necessary
to have some clear idea of what constitutes a change in the trend, so that
as far as possible one will not linger on the wrong side of the major
trend. This is a matter calling for the most intense observation and study.
It may require auxiliary studies. (For example, the volume of trading times
the price of a stock represents the number of dollars involved in the
market action on a particular day. It makes a great difference whether
the total trading amounted to $10,000 or $10 million.) As we said before,
27
Chart 6. IBM. Straight Trend from 1953 to 1962 and subsequent recovery. Cour-
tesy of M.C. Horsey & Co. Inc. With permission.
the chart is merely a tool, a means of setting down graphically some data
about the market action.
HINDSIGHT AS A WORKING TOOL

Many investors and traders focus on what is going on now in the market —
not only in the market but as to corporate affairs, national politics, inter-
national affairs, monetary conditions, and so on. They are trying to interpret
the present and estimate the probable future, but they are not well prepared
to do this unless and until they have acquired some knowledge of the
past. One of the most valuable study aids a technician can have is his file
of stock charts for previous years. By studying how stocks have acted in
the past, the typical action during booms and busts, the bottom formations
and top patterns, the extent and duration of trends, and so on, he will be
better prepared to evaluate a new situation. In fact, his intuition, his
understanding of the market (which is in his mind, not in the chart), will
develop as he acquires more experience, more understanding of what has
happened in the past. The times may be different, the conditions may be
different, the particular stock may be different from others that have been
studied. And yet, although history does not exactly repeat itself, one learns
what seems most likely to happen under certain circumstances.
The Central Concept: The Importance of Trends and Trend Channels 29
This is like learning in any field. The surgeon, the lawyer, the musician,
and the executive must continually face new problems not precisely like
any encountered before. But they must have had the experience of analyzing
other problems from the past that are in some significant ways similar. Thus,
when the technician is confronted with an entirely new problem, he can
draw on this storehouse of experience and, by “playing it by ear,” put to
use the intuitive knowledge he has gained from these past events.
We cannot make the point too strongly that chart interpretation and
technical market wisdom is not learned overnight. We cannot stress too
much the importance of looking back, and if the technician has noted
his past opinions and evaluations on the charts (as he should, to get the
most value from them), of checking these out and seeing where his
judgments were good, where they failed, and, if they failed, whether it
seemed to be because of some correctable error in judgment or whether
it was because of an unexpected and unpredictable change of conditions.
TRENDS, REVERSALS, CORRECTIONS,

AND CONSOLIDATIONS
If we agree that the chart is a valid representation of the daily price and
volume action in the market, and if we agree that it is primarily the market
that makes the charts go and not the chart that makes the market go, we
can regard the chart as a map of conditions that exist in the market.
As long as we keep it clearly in mind that our map, though accurate
and correct in what it shows, does not show everything (no map shows
everything in the territory it represents), we can deal with the chart (or
map) in many ways as if it were the territory itself.
We will look for relations, but we must be careful not to attribute
causes too freely. Quite often it is not necessary or possible to know the
cause or causes of a market condition, even though we know very well
that there must be causes. It can be dangerous to pin causes on things.
If, for example, we were to say the birds return in the spring and the
leaves get green in the spring, then the leaves get green because the birds
come back, we would be quite wrong. And we might dangerously confuse
ourselves in giving weight to a cause-and-effect relationship between drug
addicts and inferior abilities. One might assume that because inferior
behavior and drug addiction are frequently found in association, the drug
addiction was the cause or reason for the inferior behavior in work, social
relations, and so on. Or, vice versa, we might assume that general
incompetence and inferior abilities were the cause of addiction. This might
indeed be a false lead that could confuse understanding of the problem.
Better to treat relationships simply as relationships, without continually
trying to pin a cause-and-effect label on the relations.
If we can take the chart as an abstraction, leaving causes and effects

out of it, we can see some relations that might otherwise be overlooked.
For example, the chart of a utility stock may show a definite technical
pattern, let us say a rectangular horizontal channel from which the price
breaks away sharply upward or downward on increased volume. We may,
in fact we do, see other charts with almost identical patterns and behavior —
steel stocks, oil stocks, motors, rubbers, and so on. In fact, this particular
type of market pattern may turn up in any type of stock at some time or
other; for that matter, it may appear in bond charts, commodity charts, or
in the charts of anything traded in a free competitive market (see Chart 7 ).
The Constant Recurrence of Similar Patterns

Because the same type of pattern, with the same sort of breakout and
similar consequences after the breakout, shows up again and again in
many different kinds of market charts, we must conclude that the chart
pattern is not a particular characteristic of railroads or steel companies,
for example, but is more likely related to the dynamics of markets generally
or, to be more specific, to the perceptive habits of people. In a sense,
we are looking much more at the operation of men’s minds than at the
conditions affecting a corporation. Or, shall we say, if we are looking at
the affairs of the corporation, we are seeing them “as perceived” by the
buyers and sellers in the market, and it is that perception and evaluation
that are recorded on the chart. The underlying reasons could be many.
It is not actually necessary to inquire in detail what they are.
Again, we find the same trends and chart patterns on charts represent-
ing market action in 2001 as those of 1979, or 1929, or 1889 (see Chart 8
for the tops of three historic bull markets). An experienced technical trader
today could be taken back in time 30 years; he could be confronted with
stocks in a foreign market, and, if he were familiar with the typical behavior
of stocks generally, as it is shown on the daily charts, he could draw
some useful information from the charts. He might even operate better
in such an unfamiliar market than some who are so close to it they “could
not see the forest for the trees.”
Let us consider a stock that has been selling in a dull sort of way, for
a considerable time, at or near a certain price range. Suddenly, it comes
to life. It advances sharply and on much increased volume. It is possible
that such a breakout may come about through a false rumor, a piece of
gossip about the stock, or perhaps a premature “guess” that something is
about to happen. If the trader felt that there was a good chance that such-
and-such a company would get the big aircraft contract next month, or
might be merged on favorable terms with one of its competitors, or was
about to win an important lawsuit, he might well buy some of the stock,
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The Central Concept: The Importance of Trends and Trend Channels
Chart 7. Ebay, Largely Horizontal at this Moment in Time. The sideways channel is probably as common as, or perhaps even more
common than, uptrend or downtrend channels. Here once again illustrating support and resistance, and also the failure of support,

Ebay also offers good short-term trading opportunities. It is a common technique for traders to sell the top of a trading range or
horizontal channel and buy the bottom. In this chart the arrows illustrate this technique, taking key reversal days as the signal.
31
The August volume is probably mutual fund managers running for the exits. At the least it is unhappy bulls helping to create a bottom.
32
Chart 8. Dow-Jones Industrials. Three Bull Market Tops: 1929, 1987, 1998. The reader will note the common element to all these
bull market tops: an important trendline has been broken. Continuing price action under the trendline (especially in Magee’s
opinion if by 2% in the case of the Dow) is an escalating warning. An investor might be justified in setting his stop line at or
under the forming rectangle or pattern if the market were not of such long duration — but at the end of bull markets of these
durations extreme caution is a sign of market wisdom, not paranoia or cowardice. At the very least hedging is in order.
and if some others felt as he did, they might well be willing to pay a little
more than the market price to get their shares. If there were enough eager
buyers, this could use up all the available stock offered at the prices at
which this stock had been selling and eventually force the bids considerably
higher in order to attract sellers willing to part with some of their holdings.
Whether or not a particular breakout of this sort will be the beginning
of a long and profitable advance depends on whether the original infor-
mation was correct and whether the expected action takes place and other
factors. But, when a big move in a stock does take place, it is likely to
emerge from just this kind of situation. If the trader is not too impetuous,
does not jump in too heavily and risk too much, and if he is prepared
to get out again, often with a loss in case the move fails, he is likely to
pick up one of the important instances in which a new major trend is
getting under way.
No One Ever Went Broke Taking a Profit. True or False?

However, it is all too common for an inexperienced trader to become
nervous as his stock advances. Sometimes it seems he will suffer more
when a stock is going his way than when it is moving against him. There
seems to be a temptation to get out too soon, to “take profits,” and, in
fact, one of the oldest (and most misleading) market maxims is, “No man
ever went broke taking a profit.” Although the statement is true, the
implications of it are deceptive, for unless a man can stick with a strong
stock as long as it remains strong, his losses may outweigh his gains.
It is best not to be too urgently anxious to get out of a profitable stock.
Checking the records of some dozens or hundreds of stocks, as shown on
long-term monthly charts, we find that the major trends do not switch from
strong to weak and weak to strong every week or so. We will see plainly
that usually a well-established trend in a stock continues for some time,
that is, for months, sometimes for years. The upmoving stock is likely to
continue to move up. The downmoving stock continues to slide.
Therefore, once we have determined or decided that a stock is in a
major trend, if we have a position in that stock in line with the trend, we
should stay with it until there is some evidence that the stock is no longer
moving in that trend.
A Method Is Required to Avoid Premature Profit Taking

This is easier said than done, of course, because every stock has its daily
fluctuations and is also subject to the general dips and rallies of the market
as a whole. Nevertheless, it is possible to make some observations, to set
up some rules of procedure, and, in time, to acquire a “method” based
on observation and experience which will help in getting into stocks in

line with their major trends and in getting out of these positions only when
the trend seems seriously threatened. Not only will the investor acquire a
set of principles or rules of operation, but, more important, he will gradually
get a feeling or intuition of the action of stocks as a result of having
followed, observed, and tentatively judged many such actions in the past.
It is not possible to make a simple set of maxims or directives that
can be used as a formula and that will absolutely prevent loss and ensure
profits. The market is not that easy. Furthermore, each investor has his
own objectives and philosophy. Some are interested only in short-term
gains; they are temperamental in-and-outers and do not feel at ease in a
long-time holding. If they understand clearly that the problems of the
short-time market trader are complicated by high costs to cover the
frequent commissions, transfer taxes, miscellaneous fees, and unavoidable
execution losses, and if they are prepared for the nerve-wracking, tense
battle all day and every day, they may be able to hold their own in that
small group of short-term traders who are successful on balance.
For most of us, the more profitable course lies in holding a stock
position as long as it looks good and closing it out just as soon as it no
longer seems tenable. This also requires courage and constant study, and,
in addition, it requires the most difficult quality of all — the ability to sit
and wait, sometimes for weeks or months. It calls for patience.
Whether the plan is short-term trading or long-term, the investor must
be prepared to accept losses, to forget what he paid for the stock, and
to deal with it according to its current action only, regardless of whether
it shows him an accrued gain or loss at a given time.
CHANGES IN TREND CALL FOR CHANGES OF POSITION

Suppose we have taken a long position in a stock which has broken out
of dormancy, as we described previously. We will assume that the stock
has entered a major uptrend, and this trend will be considered in effect
until such time as there are indications that convince us that the trend
has been broken decisively.
This, of course, is easy to say and much harder to do. The whole
science or art of technical analysis of stock trends is involved here, and
it depends a great deal on the individual skill, experience, and perception
of the investor as to how well he will do. It also depends on whether he
has the conviction and courage to follow and carry out with determination
the decisions his method lead to.
Finally, it calls for a realistic understanding that in spite of the most
careful, most intelligent study of a stock situation, there is still a consid-
erable area of uncertainty. No one can make predictions with anything
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Chart 9. Microsoft. How a Historic Bull Market Ended. At the top of the Microsoft
bull market is a fine rectangle that advertises itself as a consolidation, especially
with the runaway days on breakout. But the short cap after the runaways and the
return to their base are ominous signs. Beneath the surface the general bull market
is ending, and Microsoft is locked in a death struggle with the Justice Department
and assumes that like all its other struggles it will prevail here also. As a further sign
that its day in the sun is done (for the moment), the Dow-Jones Company adds
Microsoft to the Dow-Jones Industrials. Spectacularly bad timing for all involved.
No technical analyst would have held the stock in spite of its long glorious record
when the medium and then the long-term trend lines were broken. That is what
technical analysis is for, to make obvious the unbelievable, that Microsoft could fall.
All stocks eventually suffer intermediate- or long-term decline. Nothing lasts forever.
like absolute certainty. If the investor is satisfied his method and original
basis of decision were correct, if the situation changes greatly, he must
be prepared to face the fact that some new conditions have arisen, and
he must act accordingly. It is no reflection on his method that he should
have to revise his opinion or reverse his decision in light of new facts.
One of the most damaging, sometimes ruinous, points of view is that of
the man who is so “wedded” to his original conclusion that he cannot
face the fact that the situation is different this month from what it may
have been 3 months ago.
FOLLOWING THE TREND

There are almost as many definitions of a trend as there are investors to
make them. Normally, the trend of a stock is a more or less irregular
affair, with bursts of high volume as new peaks are reached and then
periods of a few days or a few weeks with shrinking volume of trading,
followed by another advance on increasing volume. Some setbacks may
be short and of limited extent — a few days or a week, perhaps. Others,
especially after a series of minor advances, may be of greater extent and
may last for a number of weeks or several months. Yet all these may fit
into the category of major uptrend.
No method of determining whether or not the major trend is still in
effect is infallible. However, there are a number of methods of estimating
whether or not an important change of trend has occurred.
The simplest of these is to draw a trendline — that is, a line which
touches the bottoms of two or more reactions if the major trend is up
(see Diagram 9). (In the case of downmoving stocks, the trendline would
be drawn across the tops of two or more rallies.) In many cases the trend
follows a straight line, especially on logarithmically scaled charts, and a
sharp breakdown through the trendline dramatically underscores the
change of the trend.
A case in point would be the long-term trend in International Business
Machines (IBM). After more than 8 years of following a perfectly straight
trendline, IBM broke through that line in January 1962 and by the end of
May had dropped several hundred points. However, after that 1962 cor-
rection, IBM resumed the long-term trendline through 1989 (see Chart 10).
In spite of the clear evidence that trends do exist and that they follow
straight lines on logarithmic charts, the simple trendline is not by any
means the whole answer to stock analysis — far from it. It is not always
easy or possible to find clear points of reference through which to draw
the trendline. Quite frequently, the chart shows a sideways movement
that will penetrate the trendline without volume or any substantial decline.
It is necessary to understand that the way in which the trendline is broken
may be as important as, or more important than, the fact it is broken (see
Chart 11).
Alternatives to the Simple Trendline

To get around the difficulties of dealing with simple trendlines, various
refinements and alternatives have been developed. Some technicians
require a breakdown that penetrates the line by a definite minimum
amount, say 3% or 5% of the price of the stock. Others use double
trendlines, forming a channel that includes a warning area between a
slight penetration and a full-scale signal. Some use, instead of the ordinary
trendline, a moving average, which may be based on the performance
over any preceding period; we have 10-day moving averages, 30-day
moving averages, 100-day and 200-day moving averages, and so on. This
Chart 10. IBM. January 1962, End of Another Historic Bull Market. Courtesy of
M.C. Horsey & Co. Inc. With permission.
tends to stabilize the picture and eliminate certain types of false or trivial
moves, but it also introduces some other problems peculiar to moving
averages. There have been methods in which two moving averages, a
short-term and a longer-term one, are used together to give indications
of change of trend when they cross (see Chart 35). There are a number
of other methods using trendlines, moving averages, and some other
devices to catch early signs of a major turn.
Although none of these methods is entirely satisfactory, any of them
is better than no method at all. They may not catch the exact or optimum
point at which a decision could best be made, but they will at least ensure
that an investor who follows them will not allow himself indefinitely to
hold a stock that is piling up losses for him after a major reversal.
There are other indications of turn and some suggest a continuation
of the major trend. The latter we have called consolidation patterns. The
former we call reversal patterns.
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Chart 11. Advanced Micro Devices, Inc. Stocks tend to make straight-line trends,
either up, down, or horizontally. The trends do not necessarily move in the same
direction as “the Dow Jones Average” or “the general market.” Here, for example,
we see a strong downtrend in a particular stock at a time when the “general
market” was moving sideways to higher. From June to December, AMD declined
by nearly 50% in the face of a generally bullish market. Although this issue did
enjoy a rally back to 11 during the first half of 1989, the downtrend resumed the
following June while the “averages” were challenging old highs. You will find
some issues moving sharply higher in bear markets and others, like AMD, moving
down in bull markets. This type of action does not strike us as “random.” Appar-
ently, some economic or psychological factors were operating to affect public
opinion. But it is not necessary for the market technician to know what these
factors may have been. The chart speaks for itself.
Behavior at the End of Trends

In many cases, the consolidation patterns in their early stages look exactly
like the reversal patterns in their early stages (see Chart 12). In fact, they
probably arise from the same cause. When a stock has advanced in a strongly
bullish move for a time (or declined in a bearish move), there will come a
day when traders decide to take profits (if they are on the right side of the
stock), and what frequently occurs after a rapid price move is a great increase
of activity culminating in a burst of tremendously increased volume.
In the final day of a fast advance, the price may open on a “gap,”
higher than the top price of the day before, and may go into entirely new
high ground in the morning but then slump off as the day wears on, closing
Chart 12. B.F. Goodrich Company. Not only can chart patterns be described in
several ways, many can be either reversal or continuation patterns. The Goodrich
chart shows two unusually good examples, quite close together, of the dual nature
of some chart patterns. After moving steadily higher in 1986 and early 1987, this
issue turned sideways. From April through July, we see a series of advances and
declines which all together add up to a narrowing symmetrical triangle. In mid-
July, on sharply higher volume, Goodrich broke out of the pattern to resume its
previous uptrend. Using the width of the pattern as a measure, you would have
anticipated a move to the 63 area and not been disappointed when Goodrich
peaked in early September around 64½. This is a symmetrical triangle as a
continuation pattern. Following the September peak, another series of fluctuations
emerged, also taking the shape of a symmetrical triangle. This time the decisive
breakout was contra to the prevailing uptrend, illustrating a reversal symmetrical
triangle. Notice the excellent double bottom that formed on the December test
of the October low. The late December rally through 37, on rising volume, was
a clear signal that the downtrend was over. During the next two years, Goodrich
rallied to 70.
at or near the low for the day’s trading. Such a climax day or one-day
reversal is quite commonly the peak, the end of the advance for the time
being. Following it, there may be a few days, a week or so, or a number
of weeks, of decline or at least of inconsequential sideways movement,
and this period is usually marked by irregularly shrinking volume.
Whether or not the one-day reversal will prove to be of more than minor
importance or not, we cannot tell at this stage, although many high-water
marks preceding a severe Bear Market have been made on exactly this
sort of day.
What seems more important here is that the one-day reversal, or, at
any rate, a climax day of high volume, quite often marks the end of one
phase of an advance.
Corrections and Consolidations Occur Frequently

In any stock that is moving up (and what we say here would apply in
reverse for downmoving stocks, of course), there are likely to be fairly
frequent periods of correction or consolidation, not necessarily, however,
marking the ultimate end of the major trend (see Chart 13).
A common type of consolidation occurs when the stock goes into a
narrow horizontal range, moving, for example, from 32 to 36, and fluc-
tuating back and forth within these limits in moves that may last a few
days to a week or so. Ordinarily, as this rectangle forms on the chart, the
volume tends to shrink, although in a bullish trend, the peaks of the
rallies may be marked by somewhat increased volume. In time, the stock
will emerge from the rectangle, and if this is an upside breakout, it will
almost certainly be on greatly increased volume and will be quite unmis-
takable. Such a breakout suggests that (1) the major uptrend is still in
effect and that further advances are probable, and (2) there is likely to
be an influx of support (buying) on any reaction to the neighborhood of
the top of the rectangle. In a major downtrend we also see rectangles
with similar characteristics except that volume on the downside moves or
breakouts may not be so emphatically marked.
Rectangles (see Diagram 13 and Chart 13) are among the most beau-
tiful and most interesting of the technical formations that appear on charts.
They may be either consolidations (or continuation patterns) or the mark
of an important turn (reversal pattern). During their formation, it is not
possible to say whether they mark a consolidation or a reversal, but, on
the basis that a major trend must be assumed to be in effect until there
is clear evidence of reversal, the presumption is that they are consolida-
tions until there is a contrary breakout. As a matter of fact, the majority
of rectangles, symmetrical triangles, and so on do turn out to be consol-
idations.
A good example of a rectangle as shown on a chart is to be seen in
the 1988–1989 BankAmerica chart (see Chart 13). The Glossary of Patterns
includes a conceptual diagram.
One could regard rectangles as “horizontal trend channels,” with ten-
tative trendlines drawn across the tops and bottoms.
Chart 13. Bankamerica Corporation. There are those who will tell us that the
movements of stocks are as completely random as the stumblings of a drunk in
a public square late at night, or as meaningless as the scores of a blindfolded
dart player. Anyone who has kept daily charts of stocks knows that the charts do
not provide “all the answers,” nor do they infallibly “predict the future.” But it
is hard to believe that the trends such as the uptrend shown here in BankAmerica
or the uptrend and downtrend in Advanced Micro Devices could be the result of
the gyrations of a drunk or the scores of a blindfolded dart player. In the Bank-
America chart you will also notice two other typical patterns, the falling wedge
and rectangle. The first is considered a bullish pattern, and confirmation is given
when the upper boundary line is decisively broken on increasing volume. Rect-
angles, on the other hand, can be continuation or reversal patterns, depending
on which way they break out of the formation. Generally speaking, rectangles
define a tug of war between two groups of approximately equal strength. The
stock will bounce back and forth, trading within two horizontal boundary lines,
until one side or the other is exhausted. The measuring implication of this pattern
(i.e., the expected minimum movement after the breakout) is the width of the
rectangle. A rectangle 2 points wide, for example, should move at least 2 points
beyond its breakout point.
When a breakout from such a pattern occurs, it is quite common to

see the move run a few days and then return to approximately the breakout
level before resuming the primary move.
This raises the interesting point of support and resistance phenomena.
When a stock has made a dynamic breakout move, this move is likely to
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Chart 14. Qualcomm, Symmetrical Triangles. The handwriting is already on the

wall for Qualcomm when this symmetrical triangle appears in its chart, perhaps
bringing a moment of hope to bulls that it might be a continuation pattern. But
the church spire top and the air pocket gap formed at the beginning of the triangle
have already forecast its fate. Would the long trader be justified in holding out
for the second cruel joke, the false upside breakout? No. All the trendlines are
pointing the wrong way. Denial is not just a river in Egypt. It is also refusing to
recognize the end of the party, the passing of all good things, the boats beating
backward against the current, the end of the millennium, etc.
be followed by some quick profit taking, and a reaction sets in. However,
many observers believe that prospective buyers who may have missed
the original breakout may then come into the market on the reaction. It
is this buying that constitutes the support that so frequently appears at
or near the bottoms of rectangles (or in bearish moves, the resistance that
appears at or near the bottom of rectangles).
There is another type of market action that is somewhat similar to the
rectangle. This type has the form of a more or less symmetrical triangle,
and we call it by that name (see Chart 14).
It is marked, usually, by a heavy volume climax as it goes into its first
turning point, which is followed by a series of declines and rallies that,
instead of forming two parallel lines, as is the case of the rectangles, tend
to narrow, so that the lines drawn across the turning points make a
downsloping and upsloping side to the triangle. It is a “narr owing”
formation, ordinarily accompanied by shrinking volume. The triangle may
eventually turn into a rectangle. More often it breaks out decisively at

some point well before it reaches the apex or intersection of its two
bounding trendlines. The symmetrical triangles often mark important
consolidations and sometimes important reversals. They are more subject
to false moves than are rectangles, as when the price makes an “end run”
entirely around the apex of the triangle and reverses the move entirely.
An interesting feature of the symmetrical triangle is the market tendency
of reactions after an emphatic breakout to return to the point of intersection
of the two sides of the triangle — the “cradle point” as Robert D. Edwards
has called it.
Uncertainty of Direction of Breakouts from Rectangles and Triangles

With both the rectangles and symmetrical triangles there is little indication
of which way the breakout will occur. There is, however, another family
of triangles that carries a definite indication of the probable move to come.
These triangles are known as ascending triangles (in which the successive
minor peaks are at substantially the same price level and the successive
bottoms are at continually higher levels) and descending triangles (in
which the minor bottoms come at about the same price level but successive
rallies top out at continually lower levels) (see Charts 15 and 16).
The ascending triangle (see Chart 16) apparently corresponds to a
resistance level (or supply level), and the successively rising bottoms show
the tendency of investors to be willing to pay more for the stock on its
declines. The reverse would be true of the descending triangle ( see
Chart 15). Thus, these types of triangle patterns can generally be regarded
as bullish (for the ascending type) and normally bearish (for the descend-
ing type). In some cases, these patterns, like all chart patterns, fail, and
even when they do not completely fail they are often prone to turning
into rectangles as time goes on. But all in all, the ascending and descending
triangles are among the most dependable of chart patterns.
Measuring Price Moves — Or Estimating Potential Price Activity

The question of measurement is bound to come up in connection with
chart formations. It is not possible to make very accurate estimates as to
how far a move will go. At best, one can state a minimum probable move,
but we would not consider that a stock that has made such a minimum
probable move and has reached its estimated objective should be sold.
If the move is part of a major trend, the advance may continue far beyond
the objective and there is no guarantee, in any case, that a particular
target will be reached. We would use any measuring formulas as guides
or auxiliary information, but we would not hold to them as to a religion.
44
Chart 15. Lucent, Descending Triangle. This top of Lucent is marked by a particularly vicious descending triangle, particularly
vicious because it contains a false breakout, a bull trap which would have left the impatient or inexperienced bull long just in time
for the air pocket and given him firsthand experience with catastrophic risk. Lucent is, of course, psychotic. But at least it makes
a bottom after the plunge in the form of a symmetrical triangle, which is tradable but which, when it returns to the cradle of the
triangle, is offering a hint to the wise: go find another stock to trade. Was crashing with the stock a necessity? Not really. A 3-month
trendline was decisively broken well before the plunge, and the use of the basing-points procedure would also have taken out a
systematic technician. Perhaps an even more elemental procedure would have avoided the whole situation in the first place —
that is, the careful choice of stocks that make up the portfolio. On the other hand, the bungee trader using very sensitive tactics
might be delighted with Lucent.
Chart 16. American Airlines, Ascending Triangle. Making an ascending triangle

against a resistance line American Airlines makes a good breakaway gap through
the top boundary of the triangle, but late in development of the pattern, and with
no follow-through. A key reversal day follows a few days later, the gap is closed,
and the handwriting is on the wall. Given that the entire range from 63 to 70 is
a heavy resistance zone, it is not surprising that the breakaway is a bull trap.
Once again the observation that a failed signal on one side is a good signal on
the other is demonstrated, but there is probably an even more fundamental
question about American Airlines to begin with — namely, does it have enough
up and down range to be a good investment vehicle? Investment vehicle in the
sense that is there a likelihood of long fruitful trends?
In general, we assume that the probable move out of a pattern, such

as the rectangles, symmetrical triangles, and ascending and descending
triangles will be at least equal to the measurement of the pattern on its
first “leg.” In the case of the rectangles, this would mean the measurement
from top to bottom. With the triangles, it would be the same distance as
the “open side” of the triangle.
Flags and Pennants and Their Implications

There is another type of continuation pattern that should be mentioned
here. Generally, it is a consolidation or continuation pattern, and it is
frequently found in the charts of stocks that are making a large and rapid
move either up or down. We will speak here of the upmoving case, but
the downmoving is quite similar, in reverse.
Chart 17. Comdisco, Inc. It is not always possible to make an “overperfect”

picture of a technical situation. There may be premature and/or false breakouts
to cloud the picture. End runs are also a hazard. This, of course, is why we employ
stop-loss protection. Here, we see several examples of false breakouts, and an
end run, on the same chart. Beginning in April, CDO began to fluctuate sideways
in a narrowing but slightly downward-slanting pattern. Initially, several formations
were possible. But, as the consolidation stretched out into July, it took the shape
of a falling wedge. This is a bullish pattern, so an upside breakout would be
expected. Notice that in late July, however, support was broken. This would have
called for some special attention, but it did not go far outside the boundary of
the wedge before pulling back into the formation. It happened in early August
as well, but, again, the break was not decisive and the close in both cases was
basically on the boundary line. These two breakouts were false. The true breakout
came shortly thereafter on a high-volume rally through the upper boundary line.
CDO turned sideways again, forming an excellent symmetrical triangle on dimin-
ishing volume. In late September, it broke out of the triangle on the upside. The
rally stalled a week later, and prices plunged back through triangle support on
heavy volume, a clear failure of the breakout which “has aptly been termed an
end run around the line.” CDO formed a large symmetrical triangle after the
crash and broke to the upside in early December, retracing most of its October
loss over the next 2 years.
The patterns we are speaking of occur after a rapid, almost vertical

advance, oftentimes a move that may “gap” from day to day and which
may cover many points in a week or in 2 weeks’ time. There may be a
one-day reversal at the end of such a “leg” in a move, or there may not.
But the stock is quite likely, in any case, to “stall,” to decline, and then,
Chart 18. Gap, Inc. GPS was a spectacular performer in the decade of the 1980s.
From under 1 in 1980, this issue exceeded 76 at its 1987 peak. Along the way,
it also suffered some substantial setbacks. To look at a long-term chart (monthly),
these downturns look as if they materialized out of thin air. Although it is true
that stocks can reverse dramatically when some sort of fundamental news hits
everyone by surprise, like a particularly disguised takeover attempt, or a disaster
like the gas leak in Bhopal, India, which hurt Union Carbide, more often than
not, signs of a change of direction will show up in the daily chart. In GPS, for
example, it was hard to miss the deteriorating technical position which occurred
through the summer of 1987. Oscillating higher, on generally weakening volume,
(note that each high from June on occurred on lower volume), GPS formed a fine
rising wedge pattern. Just opposite of the falling wedge (see Comdisco chart),
this pattern has bearish implications. Well before the rest of the market collapsed,
Comdisco (CDO) had fallen through support and was heading sharply lower. An
excellent bear flag, evident at the end of September, was also completed before
the October crash in the general market.
with volume shrinking sharply, to go into a tight, narrow pattern as seen

on the chart, such as a flag or pennant which may be flying horizontally
or may be drooping somewhat. If anyone seeks an explanation of this
sudden halt and consolidation, he may well regard this as a period of
profit taking by quick-turn speculators or the rather premature selling out
of investors who are overeager to take profits. It will, undoubtedly,
represent, too, the trading of those who hope to sell the stock near a
temporary top and then buy in on the first reaction (see Chart 18).
In any case, such a pattern is not to be regarded as bearish. It normally
suggests the likelihood of a powerful resumption of the move in the near
future. Although, as with all market phenomena, this is not a certainty,

the rewards of patience during the flag-and-pennant-type corrections are
often richly worth exercising that patience.
Schabacker has stated that flags and pennants carry a rather definite
measuring implication, namely, that the continuation of the move after a
breakout from the flag or pennant is likely to measure about as much as
the original fast move leading into the pattern, or, as he put it, “The flag
flies at half-mast.” It is extraordinary how often this particular measurement
is completed. But, in such a case, we would not feel that after the attainment
of the objective the stock should be sold. For it can go into another
continuation pattern and then break out again for still further advances.
There are a number of other technical patterns, trend actions, support
and resistance phenomena, and so on, which might be studied but would
require an entire book to deal with adequately. (In fact, see Technical
Analysis of Stock Trends, 8th ed.)
However, there is one particular chart picture that is of such prime
importance that we have saved discussion of it for the last.
This is the head-and-shoulders pattern which can appear at both tops
and bottoms, and which is a major indication of reversal, which has
appeared in the charts of dozens or hundreds of stocks during every
important market top or bottom (see Chart 20).
This pattern was observed and discussed in connection with stock
averages by Charles H. Dow and William Peter Hamilton over half a
century ago. It was studied extensively by Richard W. Schabacker and
was explained in considerable detail by Rollo Tape (alias Richard Wyckoff)
in his fine book, Studies in Tape Reading in 1910.
The head-and-shoulders top (see Diagram 23) in its simplest form
consists of the next-to-last and the final rallies in a major uptrend, the
first (failing) rally of a major downtrend, and the penetration of the
“neckline” marking the bottoms between the rallies.
Typically, a stock, and often an average, follows a major trend in a
series of waves (i.e., advances interrupted by corrective reactions). This
movement has been compared to the advance of the incoming tide on a
beach, not steadily but in a series of advancing high-water points as the
breakers wash higher and higher up the sands. When the succession of
large waves begins to fall short of a high-water mark, and the intervening
ebb runs back to a lower point, one can infer that “the tide has turned.”
It is a good analogy.
The head-and-shoulders top is normally marked, like most technical
patterns, by unusually high volume on the “left shoulder.” The “head,”
which goes to a new high on the price scale, will ordinarily have less
volume accompanying it. The (lower) “right shoulder” is usually made on
relatively lower volume.
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Chart 19. Nike Kilroy (or as it is sometimes known, head-and-shoulders) Bottom.

The Kilroy bottom like its opposite number is marked by an effort to find a level
unsuccessfully — that is, the left hand or shoulder and then another effort in the
same direction which exhausts the power of that side. Buyers in the case of the
head-and-shoulders top, sellers in the case of the Kilroy bottom. Retreating from
the head (or nose) the sellers make one last attempt and then the other side
begins to achieve dominance. As illustrated here, the pattern may be part of a
larger bottom finding which is one reason that seeing the pattern as possessing
fingers as well as hands, or shoulders, makes taxonomic sense. As in the chart
reproduced here, the hands may be abrupt and of short duration. And the pattern
may be of a complex sort which requires some analysis. The one thing which will
be true is that among the various hands, fingers, and noses, there will be a
definable neckline. Otherwise what is at first suspected to be a Kilroy bottom
will peter out and become a long rectangle or other complex form.
The neckline of such a pattern appears to represent good support,

and, until and unless it is broken, it is probably best not to try to jump
the gun by assuming the head and shoulders will be completed by such
a breakthrough. When a neckline breakdown happens, it may be on
increased volume or it may not. However, such a break, even though it
merely drifts through the neckline on small volume, should not be taken
lightly. If it has substantially broken the neckline (say by 3% of the price
of the stock), it is likely to indicate a serious situation.
After such a break, there may be a rally. Although there is no promise
or certainty of such a rally, it does occur in many, and, perhaps, a majority
of cases. But this rally usually gets no farther than the general level of
Chart 20. Dillard Department Stores Inc. This is a head-and-shoulders top. The
head-and-shoulders patterns, top and bottom, are the most well-known of the
classical charts; they are also the most reliable of the major reversal patterns.
Here, the price action traces the head-and-shoulders very clearly, breaking away
on the downside with an open gap. During what proved to be the 1987 peak in
the “averages” in August and September, a significant number of individual stocks,
such as DDS, were clearly showing topping activity. The actual breakdown in the
stock market in October, therefore, was not surprising; only the speed and the
depth of the collapse were. It should be noted, however, that stocks almost always
go down faster than they go up. Except for takeover situations, you will make
money quicker on the short side of the market than on the long side. Indeed, it
took Dillard 4 months to drop from roughly 58 to 24; it took 17 months to recoup
the loss. This head-and-shoulders top exhibits the typical volume characteristics
of the pattern — higher trading volume on the left shoulder than the head, and
relatively flat volume on the right shoulder. The penetration of the neckline
showed higher volume but would also be valid on low volume as long as it were
broken by 3%.
the neckline, and the dropoff from here is likely to be precipitous and
on greater volume.
Measuring Implications of the Head and Shoulders

The question can be asked, “How much of a decline might one expect after
a definite head-and-shoulders break?” The most that one can be fairly definite
of expecting is a decline amounting to the height of the pattern itself; that
is, the height from the top of the head to the neckline will represent the
minimum expected drop from the point of penetration of the neckline.
The comment may well be made that this is not such a great drop,
and that if this is all there is to it, it might be best to hold the stock or
even buy it on the decline. This, however, is not the whole story. When
a major uptrend has been in effect for a long time, say, 6 months or a
year or more, and then a pattern of this sort appears, either a head-and-
shoulders, a large descending triangle, or a long rectangle broken on the
downside, it may indicate a change in the major tr end. There is a
presumption, or at least a suspicion, that the successive rallies will come
lower and lower and that the stock may plunge in a series of drops that
may far exceed the minimum implications of the original top formation.
We would never disregard a clearly formed and definitely broken head-
and-shoulders top or any other typical top pattern.
We have spoken about the simple head-and-shoulders top, but there
are many minor variations of this pattern. There may be a double head;
there may be two or more left shoulders at about the same height, or
two or more right shoulders. In the case of slow-moving, large-issue
investment stocks, this type of pattern may become a rounding top (see
Chart 21), having few, if any, definite rallies and declines but with the
general picture of heavy upside volume gradually petering out and then
increasing again as the stock “rounds over” and starts its downtrend.
In the case of head-and-shoulders (or Kilroy) bottoms (see Diagram 8
and Chart 19), the situation is similar but reversed. The formation is
“upside down” and some writers have referred to it as a pendant bottom.
Here, we have the heavy volume on the left shoulder, a rally, then a
further drop to a new low (the head), and a recovery move that is likely
to be marked by somewhat more volume than we have seen on a rally
for some time. A corrective reaction on low volume takes the stock part
way down again (right shoulder), and then a sharp advance occurs (which
must be on heavy volume), smashing through the neckline defined by
the two previous minor rallies.
The main differences between the head-and-shoulders tops and bot-
toms are that (1) the top formations are often completed in a few weeks,
whereas a major bottom of any sort usually takes longer, and, in some
cases, may cover from several months to a year and a half; and (2) the
breakout move from head-and-shoulders top formations may not be
marked by much increase in volume, whereas, the breakout from the
head-and-shoulders bottom must have volume confirmation.
In concluding this discussion of daily charts and their use, we would
once more like to emphasize that the chart is merely a map of what the
market is doing and the market action is a composite of what people are
thinking about a stock or about the market. There is no magic to a chart
Citicorp (56.8750, 57.7500, 54.1875, 54.7500, -1.5625)

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Chart 21. Citicorp, Rounding Top. In all likelihood the technician would have (or
should have) been long before the breakaway gap and runaway gap in May. The
rounding pattern does not become obvious until August, but what might be a
neckline or a trendline constructed across the lows of the top should take the
trader out before or around the gap. Basing-point stops would also have preserved
the major part of profits. A short position might well have been established, in
fact, especially on the symmetrical triangle from which prices plunge in September.
Courtesy of Metastock, www.equis.com.
picture. It is a visual aid to the investor’s thinking. In the final analysis,

his success will depend in large part on his own powers of abstraction,
observation, and ability to follow in practice the decisions he has arrived
at in his mind. Continual study and review, backchecking on previous
decisions and their consequences, experimentation and trial and error
cannot help but build confidence, eliminate mistakes in trading, and
improve one’s practical ability to cope with the market.
TREND CHANNELS
At the start of this trend study, we applied the term “basic trendline” to
the line that slopes up across the wave bottoms in an advance, and to
the line that slopes down across the wave tops in a decline. And we
noted that the opposite reversal points (i.e., the wave crests in an advance
and the wave troughs in a decline), were, as a rule, less clearly delimited.
That is one of the reasons that our discussion up to this point has been
devoted to basic trendlines. Another reason is, of course, that the technician’s
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Chart 22. Oracle with Trend Channel and Earnings Gap. Oracle habitually forms
nice smooth trend channels often consolidated by rectangles and sideways chan-
nels. It also frequently hits air pockets, usually caused by news or earnings
announcements. Frequently enough that a clever technician might hedge all or
part before earnings announcements. Oracle seems sufficiently known and regular
to offer a good investment vehicle, but the frequent gaps and air pockets should
be programmed into the trading strategy — for example, the long-term investor
might disregard them, but that would involve a different kind of vigilance — say,
a long-term moving average as a warning, or an ear to the wind as to the
fundamental prospects of the company, say, by checking Value Line. Also secondary
and intermediate trends should not be ignored. Courtesy of AIQ, www.aiq.com.
most urgent task is to determine when a trend has run out, and, for that
purpose, the basic line is all-important.
In a fair share of normal trends, however, the minor waves are suffi-
ciently regular to be defined at their other extremes by another line. That
is, the tops of the rallies composing an intermediate advance sometimes
develop along a line which is approximately parallel to the basic trendline
projected along their bottoms. This parallel might be called the return line
because it marks the zone where reactions (return moves against the
prevailing trend) originate. The area between basic trendline and return
line is the trend channel.
Nicely defined trend channels appear most often in actively traded
stocks of large outstanding issues and least often in the less popular and
the relatively thin equities which receive only sporadic attention from
investors. The value of the trend channel concept for the technical trader
would hardly seem to require extended comment.
Its greatest utility, however, is not what usually appeals to the beginner
when he first makes its acquaintance, namely, the determination of good
profit-taking levels. Experienced technicians, rather, find it more helpfu1
in a negative sense. Thus, once a trend channel appears to have become
well established, any failure of a rally to reach the return line (top parallel
of the channel in an intermediate advance) is taken as a sign of deterioration
of the trend. Further, the margin by which a rally fails to reach the return
line (before turning down) frequently equals the margin by which the
basic trendline is penetrated by the ensuing decline before a halt or
throwback in the latter occurs.
By the same token, given an established trend channel, when a reaction
from the return line fails to carry prices all the way back to the basic
trendline but bottoms out somewhere above it, the advance from that
bottom will usually push up out of the channel on the top side (through
the return line) by a margin approximately equal to the margin by which
the reaction failed to reach the bottom of the channel (basic trendline).
ILLUSTRATIONS OF TREND FORMATION

AND TREND LINE DRAWING
Diagram 9. Construction of Uptrend Line — the Bullish Trendline. Even before

drawing a trendline an uptrend may be distinguished by a continuing pattern of
higher highs and lower lows. The trendline is then drawn through the lows of two
or more reactions. Old chartists find this process so natural they may become
inarticulate when asked by young chartists to explain the process and mutely
point to a chart or two or hundreds. Just find two lows and lay a ruler across it.
This is easy in retrospect, when the whole chart is before us. In real time it may
be a different matter for the beginner. And, in fact, in real life, it is a process of
recognizing a pattern formation — a rectangle, say — and marking it, and when
the breakout has occurred taking the last logical down point of the rectangle, or
the first reaction thereafter, to construct an experimental trendline which hangs
out in the air as real trading takes place until one finds basing points on which
to anchor the line. Basing points are used advisedly. In fact, the basing-points
procedure discussed in the caption of Chart 27 can be used, as can other clear
reactions that have clearly run their course. In real trading a constant process of
drawing and redrawing takes place. For example, each time a consolidation takes
place in a trend the trendline changes. The reader will see how the process has
occurred in many of the charts in this book.
Diagram 10. Construction of Downtrend Line — the Bearish Line. The comments
on construction of an uptrend line could almost be turned on their head to
describe the construction of the downtrend line. The line pictured is the ideal
theoretical calm drifting downtrend: lower highs, lower lows, a continuing pro-
cess. The process is unmistakable though, and one should begin to see prices
cross previously drawn uptrend lines and lines drawn from support and resistance
from previous time in the chart. As with the uptrend line, basing points may be
established and used, and often prices will fall away from the line entirely.
Alternatively, rallies in the bear trend may be used to construct a line, always
keeping in mind that one wants clear points on the chart and patience must be
exercised in allowing the chart to develop — like a photograph coming clear in
developing fluid.
Diagram 11. Construction of Sideways Trendlines. A Mulish Trend? One could

easily confound random walkers by semantical tricks — that is, by saying that
prices are always in one kind of trend or the other — up, down, or sideways,
which is, in fact, true. Sideways trendline construction is that time when prices
stubbornly, like a mule, refuse to go up or down but drift horizontal or near
horizontal, offering the analyst two or more points to draw a line near level across
the chart. This may be described, of course, as a rectangle, or in Dow Theory as
a “line.” The nature of these sideways trends depends to a certain extent on the
broader market mood. For example, in the volatile irrationally exuberant markets
of the fin de siecle, it was common to see spikes up and down out of the otherwise
easily definable sideways pattern. In these cases it is necessary to draw more than
one line to define the sideways trend, picking the various lows at various levels.
The longer these sideways trends persist, the greater their import. For example,
from 1965 to 1982 the Dow was in a broad swinging sideways trend, then marched
from 1000 to 11700 from 1982 to 2000. See Charts 4 and 51.
Diagram 12. Formation of Downtrend Channel. The downtrend channel pictured here is
a nice orderly retreat without panic on one side or enthusiasm on the other. This kind of
emotion produces an orderly, easily defined trend channel. It’s a nice coherent picture of
price deterioration. Obviously the technician will be short. Anyone long at this point is
not an experienced technician. The experienced practitioner will be short and watching
the lines defining the channel because it is unlikely that it will last forever. Failure to touch
the return line — in other words, an acceleration of the trend for the aggressive trader —
might be a signal to pyramid, or, more conservatively put, to position build, although
whichever you call it, pyramiding is less dangerous on the short side than on the long.
(Except at market tops when selling strength.) The channel is important only as long as it
continues, but its mere existence allows the analyst to get the rhythm and state of the
particular issue involved.
Diagram 13. Formation of Sideways Channel. Like the up and down channels, the side-
ways channel represents an understandable, manageable, situation. As the downtrend
pictures an orderly preponderance of sellers over buyers, and the uptrend presents an
orderly preponderance of buying over selling, the sideways trend channel pictures a balance
between the forces. Like all trends it should be expected to continue, and like all trends
the longer it continues the less probable is its continuation. It is true that the longer it
continues the farther it will go when it breaks out and finds its valid direction.
Diagram 14. Formation of Uptrend Channel. Many of the comments made of the down-
trend channel might also be made of the uptrend channel. This uptrend channel represents
the orderly advance of prices with only enough stock being offered to satisfy but not
quench demand, and reasonable supplies are called forth by higher prices. There are, of
course, less orderly channels, meaning broader and more difficult to confine within two
lines, and when the channel becomes completely disorderly it has lost its usefulness and
other interpretations must be called on. It is worth noting, in regard to this point, that
when the pattern or situation does not lend itself to any understanding on the part of the
technician, he should either abandon the issue in question or trade it with a high/low
system or a moving average. The important matter about the trend channel, up or down,
is that it gives the analyst a firm handle on what is happening at the time. It also gives
him a firm handle on what can be expected to happen. First, the trend itself should continue,
even if the channel becomes disorderly. If price falls short of the return line it is a yellow
light, and if it then breaks the uptrend line a selling decision may soon be involved,
depending on the stop methodology the trader is using. Alternatively, if price soars through
the return line a different blow-off strategy may be called for, or near progressive stops.
4
OTHER IMPORTANT
PATTERNS OF
SHORT-TERM IMPORT:
GAPS, SPIKES, REVERSALS
GAPS
A gap in the language of the chart technician represents a price range at
which (at the time it occurred) no shares changed hands. This is a useful
concept to keep in mind because it helps to explain some of the technical
consequences of gaps.
Gaps on daily charts are produced when the lowest price at which a
certain stock is traded on any one day is higher than the highest price at
which it was traded on the preceding day, or when the highest price of
one day is lower than the lowest price of the preceding day. When the
ranges of any two such days are plotted they will not overlap or touch
the same horizontal level on the chart. There will be a price gap between
them. For a gap to develop on a weekly chart it is necessary that the
lowest price recorded at any time in one week be higher than the highest
recorded during any day of the preceding week. This can happen, of
course, and does, but, for obvious reasons, not as often as daily gaps.
Monthly chart gaps are rare in actively traded issues; their occurrence is
confined almost entirely to those few instances in which a panic decline
commences just before the end of a month and continues through the
first part of the succeeding month.
61
Gaps Exhaustion
Gap
Runaway
Gap
Common
Gap Breakaway
Gap
Diagram 15. Diagram Illustrating Different Kinds of Gaps. There is more than one lesson
to be learned in studying gaps. The first and obvious lesson is the specific, about gaps qua
gaps. That is, there are common gaps, breakaway gaps, runaway gaps, and exhaustion gaps.
Common gaps occur within patterns or formations or trading ranges and have little if any
significance. In fact, it might be said their main significance is to confirm the fact that
price is confined to a congestion area. Breakaway gaps are generally pretty obvious as they
occur after a congestion area and break away from its upper or lower boundary on
noticeable volume. There cannot be a runaway gap without a breakaway gap, so by
definition the second gap after a breakaway should be a runaway gap. It is possible that
the second gap will be an exhaustion gap, and this would be explainable on analyzing the
post gap action and the nature of the pattern and breakaway gap that proceeded it.
Ordinarily though, a runaway gap will be the second gap and mark the power of buyers
over sellers. It is also common for the runaway gap to be followed by price continuation
as far as price has come from the breakout. In other words, if symmetry reigns, the
breakaway will be halfway of the move. Then as the move peters out another gap appears
which would seem to be even more buyer enthusiasm; and in fact it may be yet another
runaway gap. (This is not unusual in commodities.) If this subsequent gap is an exhaustion
gap, it will soon be covered and price will lose its steam. The exhaustion gap may be
prelude to a blowoff, in which case it will appear to be another runaway gap, but a short
time will reveal the truth.
The second lesson to be learned from the study of gaps is a general lesson which is not
just about gaps but about all market phenomena. That lesson is about context and situation.
In other words, the importance and significance of any pattern, formation, or market action
lies not in itself alone. It must be interpreted in context. Context means the general
condition of the market, the broad trend, the secondary trend, and market volatility. In
addition, the same factors must be evaluated for the specific issue.
Thus a gap occurring within the obvious context of a rectangle is a common gap, but a
gap leaping out of the rectangle on volume is a breakaway. Similarly, a key reversal day
occurring after a 5% advance in conditions of average volatility will not have the same
importance as a key reversal day occurring after a 100% advance, surging volatility, and
irrational exuberance. The pattern and the gestalt. Not a knee-jerk reaction. That is what
is important.
Other Important Patterns of Short-Term Import: Gaps, Spikes, Reversals 63
The Common or Area Gap

This type of gap gets its name from its tendency to occur within a trading
area or price congestion pattern. All the congestion formations we have
studied in the preceding chapters — both reversal and consolidation types —
are attended by a diminution in trading turnover. The more strictly defined
sorts — the triangles and rectangles — show this characteristic most
conspicuously. Moreover, activity in these patterns tends to be concen-
trated at or near the top and bottom edges, their support and resistance
lines, while the area in between is a sort of “no-man’s land.” It is easy to
see, therefore, why gaps develop frequently within such areas. The charts
show many good examples of pattern gaps.
Such pattern gaps are usually closed within a few days, and, for obvious
reasons, before the congestion formation in which they have appeared is
completed and prices break away from it. But not always. Sometimes a
gap develops in the last traverse of prices across the pattern area just
before a breakout, and in such cases it is not likely to be closed for a
long time, nor is there any reason why it should be.
The forecasting significance of common or pattern gaps is practically
nil. They have some use to the technician simply because they help him
recognize an area pattern — that is, their appearance implies that a
congestion formation is in process of construction. If, for example, a stock
moves up from 10 to 20, drops back to 17, and then returns to 20 making
a gap in the course of that rally, it is a fair assumption that further pattern
development will take place between approximately 17 and 20. This is a
convenient thing to know and may, on occasion, be turned to profit in
short-term trading.
Pattern gaps are more apt to develop in consolidation than in reversal
formations. Thus, the appearance of many gaps within an evolving rect-
angle or symmetrical triangle reinforces the normal expectation that the
pattern in question will turn out to be a consolidation rather than a reversal
area.
Breakaway Gaps
The breakaway type of gap also appears in connection with a price
congestion formation, but it develops at the completion of the formation
in the move that breaks prices away. Any breakout through a horizontal
pattern boundary, such as the top of an ascending triangle, is likely to
be attended by a gap. In fact, it is safe to say that most of them ar e
attended by a gap. And, if we consider what goes on in the market to
create a flat-topped price formation, it is easy to see why breakaway gaps
should be expected. An ascending triangle, for example, is produced by
persistent demand for a stock meeting a large supply of it for sale at a
fixed price. Suppose that supply is being distributed at 40. Other holders
of the stock who may have intended originally to liquidate at 40½ or 41
see quotations come up to 40 time after time, stop there, and turn back.
They tend, in consequence, either to join the crowd selling at 40, or else
to figure that, once through 40, prices will go much higher; they may
either lower or raise their selling price. The result is a “vacuum” on the
books, a dearth of offerings in the price range immediately above the
pattern. Hence, when the supply at 40 in our ascending triangle example
is finally all absorbed, the next buyer of the stock finds none offered at
40⅛ or 40¼, and he has to bid up a point or more to get his shares, thus
creating a breakaway gap.
Continuation or Runaway Gaps

Less frequent in their appearance than either of the two forms we discussed
previously, gaps of the continuation or runaway type are of far greater
technical significance because they afford a rough indication of the prob-
able extent of the move in which they occur. For that reason, they are
sometimes called measuring gaps.
Both the common or pattern gap and the breakaway gap develop in
association with price formations of the area or congestion type, the former
within the formation and the latter as prices move out of it. The runaway
gap, on the other hand, as well as the exhaustion gap, which is discussed
later, is not associated with area patterns but occurs in the course of rapid,
straight-line advances or declines.
When a dynamic move starts from an area of accumulation, the upward
trend of prices often seems to gather “steam,” to accelerate for a few days,
perhaps a week or more, and then begins to lose momentum as supply
increases when the extent of the advance invites more and more profit
taking. Trading volume jumps to a peak on the initial breakout, tapers
off somewhat in the middle of the advance, and then leaps up again to
a terrific turnover as the move is finally halted. In such moves — and in
rapid declines of corresponding character — a wide gap is quite likely
to appear when the runaway is at its most intense, when quotations are
moving most rapidly and easily with relation to the volume of transactions.
That period comes normally at just about the halfway point between the
breakout that inaugurated the move and the reversal day or congestion
pattern that calls an end to it.
Exhaustion Gaps
The breakout gap signals the start of a move; the runaway gap marks its
rapid continuation at or near its halfway point; the exhaustion gap comes
IBM (118.188, 118.438, 114.812, 115.625, -1.5000)

140
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March April May June July August September November 2000 February
Chart 23. IBM, Double Top in a Relatively Complex Situation. IBM tells an interesting
and instructive story in this chart, beginning with a breakaway gap, a large breakaway
gap on impressive volume. A trade on the breakout day would have been completely
justifiable technically. The second gap, which should be a runaway gap, is quickly
covered, but until this reaction there has been no point on which to place a trendline.
Subsequent reactions give other points for even tighter trendlines. If a trader were
trading a multilevel (or multiunit) position, the liquidation of a unit on the gap through
the trendline in July would be indicated. Another unit might be taken off with the
breaking of the trendline in August. The failure of the advance in September is ominous
and one might immediately begin to suspect a double top. The drop through the neckline
at 117 is ample notice to abandon hope, a propitious warning in view of the plunge in
October. It is interesting but not coincidental that the price drop is arrested around the
support level of 94. Among the other interesting lessons here is the rectangle that makes
the bottom in October and November.
at the end. The first two of these are easily distinguished as to type by
their location with respect to the preceding price pattern, but the last is
not always immediately distinguishable from the second.
Exhaustion gaps, like runaway gaps, are associated with rapid, exten-
sive advances or declines. We have described the runaway type as the
sort that occurs in the midst of a move, that accelerates to high velocity,
then slows down again, and finally stops as increasing resistance over-
comes its momentum.
Chart 24. Consolidated Edison. If we take the history from early 1965, when it reached
its all-time high of 49¼, we find that like almost all of the other electric utilities, ED
had declined more than 50% by 1973. And, like most other utilities, the dividends were
steady, and the earnings good. But, at 18, the stock did not look healthy as you can
see. And then on Tuesday, April 23, the bottom fell out completely, and, within 4 weeks,
it was down to 7, later to 6. The stock was not showing strength at any point in 1974.
It did not look like “a bargain” at 18. And it most certainly did not look like a bargain
at any time after the great downside gap. ED is unusual only in that the breakdown was
so spectacular. Actually, other stocks in the group have also looked unattractive to buy
or sell. And rather than considering these as “bargains,” we would be asking why, if
they are so good, should they be passed over by the important institutions in Wall Street?
It would take some solid evidence of assertive, eager buying to make these utilities look
good. In a situation like this, it would seem best to stay out or sell short.
AAPL LAST-Weekly 12/01/2000

70
60
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1997 1998 1999 2000
Chart 25. Apple, Brought Low by Earnings Hysteria. The infamous earnings gaps from
the turn of the millennium. As the Great Clinton–Gore bull market began to top in 1999
and 2000 it became obvious that shorting stocks that had soon to report earnings was
a profitable tactic. As almost all stocks were overbought and selling at very high price
earnings ratios there was little risk in a company’s reporting surprising earnings. On the
other hand, the least disappointment in earnings figures resulted in breathtaking pun-
ishment by traders. Earnings gaps of 6% — even up to 43% — occurred. Easy money
for the alert trader.
Diagram 16. Diagram of Island Reversal. The island reversal has been chosen here
because its meaning is so clear and obvious. Even the novice should have no difficulty
reading the message. It is like an exclamation mark at the end of a long sentence. Note
that it should be at the end of a long sentence. Just as we discussed in the case of gaps,
the context must be evaluated.
And what is the other important matter about the island reversal, the general matter
which it has in common with all market phenomena? That, like all market phenomena,
you do not know definitively the nature of the pattern until it is complete. As in all
technical analysis, patience is required to allow the market to complete the message.
That is why, besides intelligence, patience is the most important attribute of a trader.
The Island Reversal

The island pattern is not common and it is not, in itself, of major
significance, in the sense of denoting a long-term top or bottom, but it
does, as a rule, send prices back for a complete retracement of the minor
move that preceded it.
An island reversal might be described as a compact trading range
separated from the move that led to it (and which was usually fast) by
an exhaustion gap, and from the move in the opposite direction that
follows it (and which is also equally fast, as a rule) by a breakaway gap.
The trading range may consist of only a single day, in which event it
normally develops as a one-day reversal, or it may be made up of several
days to a week or so of minor fluctuations within a compact price zone.
It is characterized, as might be expected, by relatively high volume. The
gaps at either end occur at approximately the same price level (they
should overlap to some extent) so that the whole area stands out as an
island on the chart, isolated by the gaps from the rest of the price path.
We have said that an island does not of itself appear as a major reversal
formation, but islands frequently develop within the larger patterns at
turning points of primary or important intermediate consequence, as, for
example, in the head of a dynamic head-and-shoulders top. By the same
token, they appear occasionally at the extremes of the minor swings that
compose a triangle or a rectangle (in which event, of course, the gaps
that set them off are really better classified as common or pattern gaps).
The reasons islands can and do develop — in other words, why gaps
can and do repeat at the same price level — become more apparent
when we think back on the general subject of support and resistance (see
Chapter 2). Suffice it to repeat, at this point, that prices can move most
rapidly and easily, either up or down, through a range where little or no
stock changed hands in the past, in other words, where previous owners
have no “vested interest.”
Sometimes, the second gap — the breakaway that completes the
island — is closed a few days later by a quick pullback or reaction. More
often it is not. Rarely, the first gap — the exhaustion gap that starts the
island — is covered in a few days before the second gap appears, in
which event the island congestion takes on a sort of V-shape (if it is a
top), and there is no clear “open water” across the chart horizontally
between the island and the trends preceding and following it. In any of
these variations, however, the interpretation remains the same: The pre-
ceding minor move should be practically retraced.
OTHER DAILY PATTERNS OF POTENTIAL SIGNIFICANCE:

SPIKES, RUNAWAY DAYS, REVERSAL DAYS,
KEY REVERSAL DAYS
Daily patterns obviously have less importance than, say, a long-term head-
and-shoulders or a massive reversal formation. But they often occur at
critical junctures and sometimes give trading signals worth paying attention
to. They also appear in circumstances in which they have little importance.
Being able to tell the difference comes from experience and study. And
there is always the chance to be wrong when taking action based on
their appearance.
Spikes
A spike is a day whose bar on the chart protrudes markedly above the
previous and succeeding days. Clearly at the time it occurs the trader does
not know whether it is a runaway day (see below) or a spike. The Errol
Flynn (or Indiana Jones) type trader though, if possessed of exquisite
timing and judgment and luck, might catch a market top by correctly
identifying the day as a spike at the moment, thus selling short at the
top. The gold markets of the 1980s ended with just such a spike. And
one of my associates sold it short at $1000 an ounce: a nice trade. When
making this trade the trader must be prepared to experience subsequent
run days (runaway days) against his position.
Reversal Days
Sometimes a spike is also a reversal day — that is, a day on which the
price opens strong, takes off like a rocket, pierces new highs, and then
reverses and closes on the low. If long, this is not a pleasant sign and is
worth close watching — and, perhaps, depending on the status of the
market, may justify a hasty exit.
Runaway, or Run Days

A day on which the price opens strong and pushes up (or down) all day
long and ends on strength, transversing a range notably greater than
average days is a run day or runaway day. Such days tend to occur in
the latter stages of bull markets, perhaps with a gap involved. Of a lesser
magnitude they may occur on breakouts (see Chart 26).
75 LU LAST-Daily 09/20/2000
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Chart 26. Lucent, Illustrating Key Reversal Days. As the great Clinton–Gore bull market
expired, many high-flying stocks developed long rectangles and congested trading pat-
terns, offering easy low-risk opportunities for short scalps on key reversal day patterns.
Some stocks are better for this than others, and study of the stock itself is advised before
this or any other trading strategy like this is implemented.
Key Reversal Days

At the turn of the millennium, key reversal days appeared frequently in
the charts of tech issues offering good trading opportunities. A key reversal
day occurs when today’s high is higher than yesterday’s, and today’s close
is lower than yesterday’s.
For the agile trader these patterns can afford good trading signals if
evaluated properly. For the longer-term investor they can be yellow
caution lights, blinking red lights, or even stop signs.
5
WHEN TO BUY, WHEN TO
SELL: STOPS, HAIR-TRIGGER
STOPS, PROGRESSIVE STOPS
STOPS
Stop orders, or as everyone refers to them, stops, are the instructions
given to the broker or the market or the computer to buy or sell a security
depending on specific criteria. For example, “Sell my 100 shares of IBM
if the market price declines to 99.” Or, “Buy 100 shares of IBM if the price
rises to 101.” Stops may be used as indicated for buying and selling. Here
in this discussion we are concerned only with the use of stops for
protective purposes, that is, to stop a loss from running, or to protect an
accumulated profit.
First, no stop system is perfect. Regardless of the way stops are
calculated, and there are myriad ways, losses will occur, profits will not
be efficiently seized, money will be left on the table. It is unfortunately
an imperfect world. But almost any stop system is better than indecision,
confusion, and doubt. John Magee developed a number of stop systems,
all of them good. Their use often depends on the particular market
situation and can be relatively complex (consult Technical Analysis of
Stock Trends, 8th ed.), but here we cover the basics.
Two situations exist in which stops should be calculated and used:
entry and profit protection.
INITIAL STOP LOSS CALCULATION

When we make an initiating trade, buying or shorting a stock, we must,
even before completing the transaction, compute a stop to limit the loss
73
if the market moves against our position. Such a move is almost guaranteed
to occur in trend trading. The way we deal with counter moves is to plan
the trade so as to limit the loss up front. There are two ways to set the
initial stop — using a money management rule or finding a technically
analyzed point.
In the first case the trader would determine the percentage risk to be
taken from the entry price and set the stop that distance below the entry
(e.g., entry price 100; percentage risk 8%; stop price 92). Or, on the same
trade the analyst might have found a support level at 95 — the bottom
of a rectangle or a triangle support line — and set his stop there. Or, he
might find the support level and add a fudge factor — 2% or 3% to the
support level. Say, 95 plus 2 or 93. In either case the sum at risk is called
(by this author) the Operational Risk.
It is entirely possible that the market will take out this stop. It is also
entirely possible that IBM will decline to 20, making the stop at 93 look
like an act of genius. For the wisdom of this kind of policy see the “Best
and Brightest Case” (Appendix A, page 149).
PROTECTING AN ACCUMULATING PROFIT

WITH ADVANCING STOPS
A happier situation exists when our trade has worked out well and over
time has accumulated paper profits. Paper profits are real profits. They
are not illusory. It is as improvident to allow paper profits to dissolve as
it is to allow a loss to run for not having a stop entered (see Case 21,
Appendix A, pg. 190). Experiences of this kind are warning signals to an
investor, warning signals which may be a notice that further education is
necessary, or that an investment psychiatrist should be consulted. (Start
by reading Winning the Mental Game on Wall Street by John Magee.)
THE ANALYZED STOP, COMPUTED FROM THE CHART

As our stock advances it performs all the gyrations described in this book.
It proceeds in a straight line up. Profit taking occurs and it falls back,
perhaps as much as 50% of its run, or it drifts sideways into a rectangle,
or a triangle as buyers and sellers contest the ground. It breaks out,
perhaps in a gap, runs and returns to the breakout line, then battles for
a few points. In short it is EveryMan’s EveryStock. The reader of this book
should have by now some idea of how to deal with these situations. He
is looking for support and resistance levels, for trading and congestion
zones, for trendlines and trend channels. He is learning to recognize
changes of trend, signs of strength, and signs of weakness. He is also
defining his personal trading style and philosophy.
When to Buy, When to Sell: Stops, Hair-Trigger Stops, Progressive Stops 75
Perhaps he operates on the basis of support/resistance levels, or only

on trendlines. I have known successful traders who used both, or only
one. Nevertheless, he finds the line significant to him, and uses it, or it
plus a filter such as 2% or 3%. So when price breaks the chosen line by
2% it finds his stop and he takes the rest of the money to the bank.
Naturally, he gave some of it back. If he did not give some back he is
not letting his profits run until a definite change of trend is proven to
have occurred. I call this the Bridge Rule, after a comment by Goren that
if a declarer didn’t get set on at least 20% of his contracts he was
underbidding.
PROGRESSIVE STOPS, OR THE 3-DAYS-AWAY PROCEDURE

Another way of advancing stops is from a procedure developed by Magee
called awkwardly the 3-days-away procedure, or, sometimes, the basing-
points procedure.
Using this procedure the analyst determines basing points as follows:
1. He observes low price points on reactions.

2. He watches the market until 3 days of price activity outside the
range of the low day have occurred.
3. This price low is then marked as the basing point.
4. The stop is then computed based on this point. The stop might
be the point itself, or a close below it, or the point plus a filter
which might range from 2% to 8%.
This is a summary of the process. It is actually more complex and

more clever than this brief description would imply, but the procedure
described here is certainly sufficient for the purposes of the general
investor and considerably more sophisticated than any process used by
the average unenlightened investor.
Let me emphasize that this brief discussion only scratches the surface
of the subject of stop setting — and it is sufficient for the general long-
term investor. Chapter 8, on moving averages, discusses other methods.

Chart 27. Microsoft, Illustrating Stop-Setting with 3-Days-Away-Procedure. This is, perhaps, the most important chart in this
book. Illustrated is a stop-setting procedure Magee called progressive stops using basing points. In using this procedure the trader
finds the low of a reaction against the trend. To become a basing point the price must spend a minimum of 3 days above the
range of the basing-point day. Once that has occurred the stop is set at the basing point less the filter. The filter is a percentage
figure which may vary according to the volatility of the stock. As a rough rule of thumb the filter would range for most stops
from 5% to 8%; 5% has been used on this chart of Microsoft. (Please note that prices are rough-cut on this chart.) Thus, at
1 where the low is 68 the stop is set at 64.60. When the low at 2 occurs and prices move 3 days out of range above, the stop
is raised to 70.12, 5% below 73.81. x now occurs between 3 and 4, appearing to be a potential basing point. However the price
comes back before it has closed 3 days out of range, and higher. This makes 4 the next basing point which meets our criteria,
and at 75 the stop is raised to 71.25. 5 is the next basing point at 76.625 with a stop at 72.79. No sufficient reaction occurs
between 5 and 6 (generally speaking we want to see a reaction that brings price back about half way or more). The top between
5 and 6 definitely heightens attention, looking like a spike. Following the procedure of hair-trigger or near progressive stops,
some traders might set a stop ⅛ under the spike day and be taken out shortly. The longer-term trader would have found a new
basing point at 6 (81.625 and 77.54). A rectangle develops with 7 as one of its points and also as a basing point (85.063 and
80.80). Between 7 and 8, price comes back as might well be expected but, because of the filter of 5%, leaves the position intact.
The reaction cannot be taken as a basing point because that would cause a lowering of the stop which is against the rules. The
reaction at 8, though small, offers another point, perhaps more judgmental, moving the stop to 86.87 in relation to the point at
91.438. Between 8 and 9 the x indicates a point which does not see 3 days of action away from the price on the upside, but
9 does (94.875 and 90.13). Then in an interesting development the trade is terminated in late February by the basing point stop,
and, coincidentally(?) the 14-month-long trendline is broken. Note the horizontal resistance/support line at 96 which is also
penetrated at the same time. This is, of course, the top of the Microsoft bull market, and the breakout in December 1999 is of
course a cruel joke — sometimes known as a bull trap. The technical analyst has numerous tools to exercise here — the trendline,
the basing points, the runaway days (which might be answered with the hair-trigger stop as discussed for the spike between 5 and
6), the round over after the runaway days and the return to the base of the runaway days (which might be taken as a throwback,
When to Buy, When to Sell: Stops, Hair-Trigger Stops, Progressive Stops
but certainly not after the relative high after 9), and the failure of the support line at 96. In the markets of the millennium, these

runaway days occurred many times and the result was almost always dismaying.
77
III
MAGEE’S METHODOLOGY:
RISK MANAGEMENT,
PORTFOLIO MANAGEMENT,
AND RHYTHMIC TRADING.
PRAGMATIC PORTFOLIO
THEORY FROM
PROFESSOR BASSETTI.
The Magee method is briefly summarized, and Bassetti develops

and articulates Magee’s ideas of rhythmic investing, portfolio
management, and risk management and control.
To manage and control the risks associated with stock trading,

investors must observe a variety of common sense procedures.
A portfolio should be diversified and balanced. It should attune
itself to the nature of the market — that is, it should do as the
market does: trade some longs and trade some shorts. The
Magee Evaluative Index (MEI) offers a way to allocate assets
according to the character of the market. Observing the prin-
ciples of this Index (which is a stratification of the market into
79
longs’ shorts and neutrals) leads to rhythmic trading. Rhythmic

trading is the liquidation of positions as the markets move,
mature, and change and the initiation of new positions in the
direction indicated by the MEI. Thus as a bull market tops out,
longs would be closed and shorts would be put on in a natural
rhythmic process.
Pragmatic Portfolio Theory offers investors a coherent simple

way to assess and control the risk of their trades and portfolio.
6
THE MAGEE METHOD
John Magee Inc.’s method of portfolio strategy for technical investing is

diversification by industry, geographic diversification, diversification by
type of investment, and a systematic strategy for minimizing losses and
maximizing gains known as the trailing (or progressive) stop method of
trend following. For purposes of this discussion, however, we are only
referring to the common stock position of one’s portfolio. Protective stops
are used for both long and short positions. After a purchase has been
made, a price is selected below which the stock will be sold at the market.
This price is defined as the protective limit. It fixes (with rare exceptions)
in advance how much we are willing to lose on a position. As a position
moves higher, the limit is advanced. As long as a trend “goes our way,”
we hold the stock and advance the limit. As soon as the trend is broken,
and the protective limit violated, we sell at the market.
PORTFOLIO STRATEGIES: LIQUIDITY,

INDUSTRY SELECTION, AND NUMBER OF POSITIONS
How many stock positions should an investor own at one time? Which
stocks should be included once the “ideal” number of positions has been
determined? The answers to these seemingly straightforward questions
are, in fact, quite complex because portfolio strategy depends in part on
the needs and characteristics of each individual investor. The range of
possible outcomes is extremely wide. Perhaps the most common mistake
we have observed is the investor is buying small positions in so many
stocks that he has trouble following them all (see Case 9, Appendix A).
Moreover, each position tends to be such a small part of the whole that
even a good job of managing a holding has little impact on the investor’s
total holdings.
81
The opposite extreme, that of “putting all one’s eggs in one basket
and then watching the basket closely,” carries the obvious risk that a
single “bad” investment could wipe out a significant portion of one’s assets.
Our experience suggests that portfolio diversification and managerial
efficiency combine usefully when the number of positions varies from
2 to 10 and funds available for investment vary from $10,000 to $200,000.
For example, if an investor has $10,000 to invest initially, we would
recommend the selection of two positions of $5000 and $5000 each. A
$100,000 investor might begin with 6 or 7 positions of $15,000 each. While
at $200,000, approximately 10 positions averaging $20,000 each would be
appropriate. The benefits of diversification decline sharply as the number
of positions held rises above 10; thus, for even a $1 million account, we
would recommend holding no more than 10 to 12 positions. (As the reader
will see, the Editor feels these ideas were later refined by Magee more in
the directions recommended in the next chapter. In addition it is my feeling
that a $10,000 portfolio is probably better off in ishares than in individual
stocks; see Case 24, Appendix A.)
Additional diversification criteria that we have found useful include
industry and liquidity. For a theoretical $120,000 portfolio of eight $15,000
positions, we certainly would not want all eight positions to be in steel,
or oil, or electronics, or any other single industry. Thus, we suggest a
policy of individual stock selection that provides industry diversification.
For our theoretical $120,000 portfolio, a “concentration limitation” of two
holdings in any one industry (25% of total portfolio) is desirable, with
one position per industry being ideal.
To the extent that one’s stock positions become sizable (1000 shares
and up of a stock), we add “liquidity.” As a stock position totals 100
shares or even a few hundred shares of a nationally listed company, a
high degree of liquidity can be assumed. But when it is time to head for
the exits with larger positions, one’s ability to sell and move quickly may
be sharply reduced in many of the “thinner,” less actively traded stocks
that may be found on the exchanges. Our rule is that no more than half
the issues in any individual industry should be illiquid.
7
FURTHER DEVELOPMENTS
TO THE MAGEE METHOD:
PORTFOLIO MANAGEMENT,
RISK CONTROL,
INCLUDING RHYTHMIC
TRADING AND PRAGMATIC
PORTFOLIO THEORY
THE ELEMENTS OF THE MAGEE METHOD

The Magee method is a complete and well-rounded expression of a
philosophy and methodology regarding long-term success in the markets.
This method might be described as midterm technical trend following,
regulated by prudent diversification and disciplined risk control (including
hedged portfolios) managed with unemotional realistic patience. This long
sentence demands an entire book for its complete explication. The book
in fact exists, and is, of course, Technical Analysis of Stock Trends, now
in its eighth edition, with more than 1 million copies in print. Repeating
the entire book here would be awkward, but we can attempt a summa-
rization of Magee’s method.
The essence of the Magee method is moderation. The foundations of
the method may be described as follows: (1) technical analysis, (2) portfolio
83
construction, (3) risk measurement and control, and (4) personal psycho-
logical management.
Technical Analysis
By technical analysis Magee meant the bar charting and dispassionate
analysis of objective data from the markets — primarily price and volume.
Charting the markets and acting on hard data alone not only mean the
choice of objective data as the input to analaysis. They also mean the
deliberate shunning of fundamental analysis, that is, the study of earnings,
cash flow, sales figures, and on and on — that is all the data that can be
manipulated and misrepresented or cooked by creative accountants. The
Wall Street Journal does not misreport the data for trading on the New
York Stock Exchange. Like the sports scores, that is not permitted in our
society. But earnings reports are only as good as the integrity of the
people who make them. Technical analysis also means ignoring the din
of touts, brokerage house recommendations, tips from barbers and taxi
drivers, and, worse, television talking heads (except for the coauthor).
This choice of an analytical method is complemented by the observa-
tion that the most efficient trading horizon or term is the mid- to long-
term trend. Mid- to long-term trends, in general, last at the extreme several
years but might be only months in duration, as opposed to a secular trend
which might last many years — as in the case of the great bull market
of the late 20th century which began in 1982 and lasted until 2000. Trading
on the Dow Theory certainly was rewarding over the last century. The
mid-term analyst should have done even better, not being constrained by
the long periods necessary to generate signals.
Thus, in detail, Magee gathers data from the market that is uncontested —
price and volume rather than hypothetical earnings. He presents these
data in bar charts. From long experience and investigation he analyzes
the chart and identifies situations in which the probabilities are in his
favor. For example, he finds a trading range defined as a rectangle, and
when price breaks out of the rectangle he commits a portion of his capital
to it. At the same time, he sets a stop beneath his trade in case his
experiment is unprofitable. If the market moves in his favor he system-
atically raises his stops to protect his profits. He pursues this policy until
the trend proves to have definitively changed.
Portfolio Construction and Management

No one thinks of Magee particularly as a portfolio theor etician, and
compared to present-day practitioners he might appear (appear only) a
little primitive. Modern-day theorists will not have examined his work on
Further Developments to the Magee Method 85
sensitivity and composite leverage, which precede the academics’ creation

of modern portfolio theory. Modern-day portfolio theorists will bend
themselves into pretzels computing correlations, constructing variance-co-
variance matrices, investigating volatilities, and calculating portfolio Monte
Carlo simulations. I think the general investor will probably find Modern
Portfolio Theory a little sticky and prefer Pragmatic Portfolio Theory, as
briefly summarized below.
In actuality there is much to be said for Magee’s latter practice and
philosophy, which might be described as rhythmic and natural, hedged
and simple, and which I have further articulated and called Pragmatic
Portfolio Theory. Pragmatic Portfolio Theory is comprehensively described
in Technical Analysis of Stock Trends (8th ed.).
Rhythmic and Natural

I call Magee’s trading approach rhythmic and natural. Natural, because it
observes what the market says without intervening algorithms and takes
action based on an interpretation of market activity. Rhythmic, because,
for example, in a bull market turning to bear, the trader has been following
the market with long positions which are liquidated as the market turns.
Observing the measurements of the MEI (as explained later and in Case 24,
Appendix A), as well as trading opportunities, the trader begins to turn
his portfolio to the short side, putting on his new trades as shorts.
Hedged
As refers to hedged, Magee thought that a portfolio should be biased in
the direction of the general market, and the percentage it should be biased
in the direction of the broad market was determined by the analysis of the
market, the MEI. The MEI is constructed by analyzing the market or market
segment and classifying it into strong, weak, and neutral layers. This creates
a kind of oscillator with which one may find broad market tops and bottoms.
And one may also use it to allocate the portfolio to longs and shorts. If the
MEI is 60% bull, then the portfolio is 60% long or thereabouts (thereabouts —
is close enough; only in professional trading do teenies really matter). The
rest of the portfolio is allocated to shorts and sidelines.
Simple
Magee thought, in general, leaving aside considerations of extremely large
and extremely small capital, that 8 to 10 issues were sufficient diversifi-
cation. His mind may have been constrained on this number because of
the difficulty and distraction of managing larger more complex portfolios
by manual means, but the point is at least sustainable. And, in view of

comments I make later concerning present-day portfolio construction, this
number is moot. We must also remember that during the mature part of
his career, Magee did not have the incredible array of investment instru-
ments available to the modern trader.
Risk Measurement and Control

Magee practiced what I call Operational Risk Control, never entering a
position without a technically analyzed stop. If there is an essence to his
philosophy and method beyond that expressed by the term “technical
analysis” it is risk control. Starting with diversification, buttressed by trend
following, adding probable behavior, concluding with stop calculation,
Magee’s method is a wholly articulated and an integral system for man-
aging risk. It is, in fact, better than that practiced by the majority of
professional portfolio managers who seem to be incapable of recognizing
the escalating risk of being long a stock in a downtrend (see Case 1,
Appendix A).
A firm understanding of these concepts is necessary because the
management of risk is the one indispensable element necessary to invest-
ment success (aside from dumb luck). One of the most amusing and
mysterious facts of the universe is that the best trader I know personally
for risk management also is possessed of more dumb luck than any other
trader I know of. Perhaps it is the Jack Nicklaus phenomenon. Jack said,
“The harder I work the luckier I get.”
Trend Following
The trend follower diminishes his risk by intending to take the middle
third of a trend. He does not enter his position until the market has in
all probability signaled its intentions. He does not exit his position until
the market signals that it has reversed its direction. Bottom fishers and
top pickers clearly and obviously run the greatest risks. They also, inci-
dentally, in the short run reap the greatest profits.
Trend traders are willing to let them have those greater profits, pre-
ferring to take the least risky part of a trend — the middle third.
Diversification
If all a trader’s capital is concentrated in one issue, the destruction of that
issue lets him experience that most painful of trading experiences: gam-
bler’s ruin — that is, being wiped out, and not being able to play anymore,
which is more distressing than losing all one’s money. Magee thought
Further Developments to the Magee Method 87
8 to 10 issues were good diversification. I think this is sufficient, and, or

but, I also think that the ballast of a portfolio should be in the important
averages — the Dow and the Standard & Poor’s primarily, with the
speculative portion in the NASDAQ. This is easily accomplished by invest-
ing in ishares, the SPY, DIA, and QQQ as traded at the AMEX.
Profit Goals and Trade Management

Attempting to make, say, spectacular profits, exposes one to spectacular
risks. As Magee points out in Chapter 11, investors can take a lot of hits
of their capital of 3% to 8%, but a few hits of 40% or 50% will send them
back to the pinochle table. In a word, when an investor puts his trades
on, he calibrates them so that his risk represents a tolerable amount of
his capital.
A HINT TO THE WISE

I think it was Malraux who said, “Smart men learn from their mistakes.
Wise men learn from the mistakes of others.” Even in a primer the reader
should learn that he must calaibrate the size loss he must plan to take
on his total capital when he puts on a trade, so that instead of putting
on 1000 shares of Microsoft, which represents 75% of his capital to risk,
he puts on 100 shares with a planned loss of 5% of his capital, if that
occurs. And, according to the MEI, it does not require a Nobel Laureate
to stratify a portfolio into some longs and some shorts, or to hedge when
the market is screaming “overbought!” In fact, judging from Long-Term
Capital Management, one might be better off without a Nobel Laureate.
By computing and aggregating operational risk for the entire portfolio the
investor may see at any point in time what his risk is — a risk which will
be diminished if it is somewhat hedged. If any portion of the operational
risk is out of balance with the rest of the portfolio it may be recognized
and sold down. Pragmatic Portfolio Theory is just what it says, practical
as an old MIT engineer with only a slide rule for a sidekick.
IV
OTHER TECHNICAL
ANALYSIS TOOLS: NUMBER-
DRIVEN TECHNIQUES,
CANDLESTICKS, AND POINT-
AND-FIGURE CHARTING —
ALGORITHMIC TRADING
Charting is the original form of technical analysis, the basic

discipline. With the development of the computer and the
Internet, other forms of technical analysis have proliferated —
number-driven (or statistical) analysis, an ancient Japanese form,
candlesticks, and point-and-figure analysis.
A Chacun son gout, as Andre Malraux is said to have remarked.

Each to his own. Although charting is the original for m of
technical analysis, other forms have flourished over the last half
century, especially with the advent of the computer. The com-
puter has allowed analysts to construct and test more and more
complex algorithms and to use these objective systems in the
markets. Many of these number-driven methods have produced
astounding profits. Some have also, after having produced
astounding profits, shredded their capital: a prescient warning
89
that nothing lasts forever, and that the market learns about
successful systems and works to defeat them.
Nonetheless, number-driven tools fit the style and character of

many analysts and serve them well. The neophyte would do
well to know something about them. As an example, nothing
more vividly illustrates a sideways market than a moving aver-
age line wandering through it.
In addition to statistical systems, two “natural” methods deserve

some attention — candlesticks and point-and-figure charting
(P&F). (P&F is not purely natural but close enough for govern-
ment work.) Both are graphic ways of looking at the markets
and may be the tool of choice for some traders. I have seen
traders have success with these methods, in some cases quite
notable success. These natural and “unnatural” methods are
explored exhaustively in Technical Analysis: Natural and
Unnatural Methods, Bassetti and Bassetti. (See Appendix C.)
8
OTHER IMPORTANT
TECHNICAL ANALYSIS
METHODS
A BEWILDERING ARRAY OF TOOLS AND INDICATORS

The newcomer to technical analysis will quickly be confronted with a
bewildering array of tools, gadgets, and widgets. There are probably 30
or 40 such tools with some popularity, and new ones are being developed
daily. These tools are well implemented in the commercially available
software packages (e.g., Metastock, AIQ and TradeStation, and Wall Street
Investor, which is for the Macintosh). Metastock has included in its standard
tool chest six categories of technical indicators, among them indicators for
trends, volatility, momentum, cycles, market strength, and support/resis-
tance. Within these categories they include upwards of 100 separate entries.
AIQ has in the neighborhood of 49. Omega TradeStation has similar
numbers of studies and indicators. I cite these numbers only to indicate
to the newcomer some degree of the potential richness and complexity of
the field. The software packages mentioned should not be compared on
this basis. Any one of them represents a challenge for the beginner. In
fact, an excellent way to achieve an in-depth education in the area of
number-driven systems would be to paper trade the technical indicators
in any of these packages. Money trading them would be an expensive
way to get an education. One should not run before walking, or walk
before crawling — unless, of course, bungee jumping is one’s favorite sport.
I habitually get a laugh from my technical analysis seminars by asking
the rhetorical question, Why are there so many number-driven techniques?
The answer, of course, is because none of them work all the time, and
some work only for their inventors, or only worked very well at some
91
given point in the past. I should not be so irreverent. Number-driven

systems have often scored astounding successes. And, for those who
cannot relate to graphic chart analysis, number-driven methods may be
the only way to trade technically. It is also true that numbers do not
change their complexion according to the amount of hope and fear
inspired by the markets at any given moment.
And, also, it is my casual observation that many more traders use
number-driven systems than use chart analysis — or use some combina-
tion. The reason usually given for this is that number-driven signals do
not admit of misinterpretation due to terror or greed. This is a powerful
factor in their favor.
These tools are here given the name “number driven (or statistical)”
because they use results derived from market action to arrive at their
conclusions — namely, price and volume data. Of course, all technical
analysis uses these basic data, but chart-based analysis uses it in a
qualitative way, whereas number-driven analysis uses it as determinative.
I make no attempt here to explore every tool in detail — I am not
even persuaded that every tool is worth it. But I do attempt to give the
reader a brief outline of what are, in my opinion, the most interesting.
PHILOSOPHER’S STONE FOUND

Just as chart interpretation varies from analyst to analyst, different users
reach different conclusions from many of the statistical tools. It is my
suspicion that when these techniques are successful, more is involved
than the objective technique. In other words, the inventor (or adroit user)
is unconsciously employing some unrecognized experience and judgment
behind the use of the tool. How otherwise to explain the success of Larry
Williams (inventor of %R, which is defined later)? On at least two occasions
(that I know of) Williams has taken spectacular profits out of the markets.
If %R is so good why hasn’t Williams taken spectacular profits year after
year? (Maybe he has. Maybe I just don’t know about it.) In fact, the
coincidence of market, trader, and tool creates the illusion of the philos-
opher’s stone — found at last.
Sadly, no stone — even those not left unturned. With these words of
cynicism, we will briefly examine the box of statistical tools as purely an
introduction so that the novice is aware of the richness and complexity
of the discipline.
WHAT DO THESE TOOLS ATTEMPT TO DO?

I habitually divide these tools into three categories: trading tools, trending
tools, and volume analysis. Remember that trend systems buy strength
Other Important Technical Analysis Methods 93
and sell weakness, and trading systems sell strength and buy weakness.
Volume analysis attempts to quantify the assessment that the chart analyst
makes of the importance of volume. Although some traders employ
exclusively one or the other trading or trending tool, there is no inherent
conflict in using trading tools within a trend-following system in attempting
to determine when to take profits or hedge. In fact, for all but the longest-
term investors I believe in a diversity of tactics. The markets after all are
infinite in their diversity. Why shouldn’t tactics adjust continuously to
them, depending, of course, on the time frame of the investor?
In fact, let me emphasize, the adjustment of technique to the market
rhythm may be the most important factor in trading success. This adjust-
ment occurs naturally for the chart-based trader.
To teach a mechanical number-driven system to make this adjustment
requires more than a little mathematical and systems-building sophistication.
TRADING TOOLS THAT WILL BE DISCUSSED

“Momentum” is the term given to the direction and velocity of price
movement. (Clearly the analysis hopes to measure momentum of the price
and its likelihood of continuing.) Measurement and analytical tools of
interest examined here are Wilder’s RSI, Lane’s Stochastic’s, Bollinger’s
Bands, Rate of Change (ROC), Relative Strength, and Moving Average
Convergence Divergence (MACD).
TREND IDENTIFICATION TOOLS COVERED

Primarily, I discuss moving averages here, as I believe that it is the best
number-driven tool for trend identification.
VOLUME ANALYSIS CONSIDERED

Volume indicators proliferate also. On-balance volume is one of the better.
Moving averages and oscillators can also be run on volume.
NATURAL METHODS
Candlestick Charting and Point and Figure charting will be illustrated and
placed in perspective.
TRADING AND MOMENTUM TOOLS

The Relative Strength Index
Like diseases identified by doctors, technical tools are often linked to their
creators. J. Welles Wilder invented the RSI to identify overbought and
oversold conditions. The RSI attempts to measure average upmovement
against average downmovement. Relative strength is charted on a vertical
scale from 0 to 100. Conventionally, a reading over 70 indicates overbought
and a reading under 30 oversold. These measures are computed using a
weighted moving average. Other forms of this indicator sometimes use
an exponential moving average. This indicator is sometimes confused with
relative strength analysis which refers to the comparison of one issue with
another (e.g., S&P 500 vs. the Dow). (See Chart 28 for an illustration of
RSI.)
120 MSFT LAST-Daily 04/14/2000

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Chart 28. Welles Wilder RSI Illustration.


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Chart 29. George Lane Stochastic Illustration.
Stochastic Indicator
Why George Lane called the stochastic indicator “stochastic” is a mystery.
The word as understood by lexicographers means “a naturally occurring
random process.” What Lane meant, and as the business understands it, is
the relating of the closing price to the range in prices for a prior time
period — usually 21 days for Lane’s purposes. The idea is based on the
observation or belief that in rising markets closing prices have a tendency
to cluster near the top of the range, the reverse being true in downmoving
markets.
The 21-day stochastic relates today’s close to the price range from the
previous 21-day period. The price range is the difference between the
highest price and the lowest price. Expressed as a percentage, the point
is plotted on a scale of 0 to 100. Above 80% is taken as overbought and
below 20% is taken as oversold. Generally this tool may work well in a
trading market and less well or not at all in a strongly trending market
(see Chart 29).

Bollinger Bands with %R
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Chart 30. Bollinger Band Illustration.
Bollinger Bands
Bollinger Bands were created by John Bollinger. Rather than an outright
trading indicator, they are more a tool used in conjunction with other tools
and techniques. Bollinger bands are calculated based on standard deviation
from price — usually 2 standard deviations. This is charted as an envelope,
above and below the price line. This means that the envelope expands
and contracts about the price plot. Unusual shrinking of the envelope is
usually associated with potential for price breakout (see Chart 30).

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Chart 31. Rate of Change Illustration.
Rate of Change
ROC is a simple indicator, simply constructed. The present price is compared
to the price n days ago. As an example, if the ROC were 10 days, today’s
price would be compared to today minus 10 days (and tomorrow’s price
compared with tomorrow minus 9 days). The result, plotted as a continuous
series, then oscillates about an equilibrium line to give one a measure of
overbought and oversold conditions. Chart 31 is a representative chart.
A ROC indicator is not a definitive or totally dependable measure of
overbought and oversold conditions. A stock can go from being over-
bought to being very overbought. And then to very, very overbought.
And then to unbelievably overbought as those who measured it over-
bought shorted it, only to see it become even more overbought. Then be
caught in the boa constrictor of short squeeze. In the reverse situation,
the oversold becomes very oversold, and so on.
Microsoft (104.375, 108.000, 104.141, 106.562, +2.9370), Relative Strength Index (52.7618)
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Chart 32. Relative Strength Index Illustration.
Relative Strength Index

A potential confusion exists between the RSI and the concept of relative
strength. To determine relative strength, one measurement is divided by
another, but RSI is the comparison of an instrument’s present status to its
past behavior. As illustrated in Chart 32, it is constructed to show absolute
levels of 100 and 0 with overbought conventionally set at 70 and oversold
at 30. RSI exhibits the same problems of interpretation as ROC. Overbought
can go to very overbought and the trader who depends on it can be left
with foreshortened profits or, worse, short a rising issue. Chart created
with AIQ, www.aiq.com.

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Chart 33. Moving Average Convergence/Divergence and Bollinger Bands.
Moving Average Convergence/Divergence

MACD has two elements based on exponential moving averages. The
averages are computed for two different periods, commonly 12 days and
25 days. A difference is taken of these averages from which a price phase
line is constructed. The second element is called a signal line, which is
an exponential average of the price phase line. The common default value
of the signal line is 9. Buy and sell signals are generated by the signal
line crossing the price phase line (see Chart 36). Although this indicator
appears gimmicky, some traders use it effectively at the end of bear trends
and in the study of overbought and oversold conditions.
TREND IDENTIFICATION TOOLS

Moving Averages — The “Dynamic Trendline”
Of all the number-driven techniques, the moving average is, in my
experience, the simplest and the most effective.
The Simple Moving Average

A moving average is computed by taking the number of days involved,
say, 10, adding them together and dividing by length (in this case 10).
The resulting point is plotted on the chart on today’s date. On today plus
one, the most distant day (i.e., day 1) is subtracted and the new day is
added and the new sum is once again divided by 10. For example, each
number representing a day and also the value of that day 1 2 3 4 5 6 7
8 9 10 = 55/10 = 5.5 is the average of the 10-day prices for today.
For the next day’s price we can drop off day one and add day 11: 2
3 4 5 6 7 8 9 10 11 = 65/10 = 6.5 is the average of the 10-day prices for
today plus 1.
This simple process smooths the data. As is readily seen, the difference
between price 10 and price 1 is quite large. By smoothing these data we
get a continuous line that is easier to see and interpret than a jagged line
which may be confusing at times (see Chart 34 ).
INDU LAST-Daily 11/30/2000

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Chart 34. The Dow, Circa 2000. A Broadening Top and Moving Average.
The Weighted Moving Average and the Exponential Moving Average

As the reader will quickly realize, a simple moving average lags price
action. There are pluses and minuses to this. If the trader desires to give
more weight to the most recent action he can use a weighted moving
average, which will turn more quickly than the simple. To construct a
weighted moving average the analyst multiplies as follows: 1st-day price
by 1, 2nd-day by 2, 3rd-day by 3, and so on. Then sum and divide by
the sum of the weights: 1 + 2 + 3 = 6. In the exponential variant of the
moving average, the weight of the older data declines exponentially. Thus
even more importance is given to recent data. This method is best
examined by experimentation with a software package.
Perspective on Moving Average Methods

A moving average line has sometimes been called a “dynamic trendline,”
and there is some truth in this. The hand-drawn qualitative or judgmental
trendline is a relatively subjective thing and depends for its validity on
the experience and emotional coolness of the chartist. The moving average
is totally objective. If the markets were number driven it would be a
perfect tool for trading.
But, as we know by now, the markets are not number driven, and so
this, like all number-driven tools, has its drawbacks as well as its strengths.
Still, in my experience, moving average systems have on occasions been
quite successful. And in other cases they have been a hindrance and

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Chart 35. Microsoft with Two Moving Average Systems.

unprofitable. Before we examine the conditions that produce success or

frustration, let us examine the context of the method and its relationship
to Magee charting.
How Moving Averages Are Used

The moving average is a basic concept, and it may be used in a number of
different ways. The simplest way is to buy the issue when the price crosses
above the moving average and to sell the issue when the price falls below
it. In a trending market this can be a powerful method. But in a sideways
market it can result in numerous whipsaws depending on the length of the
moving average and the rhythm of the sideways trend. A vivid illustration
of this is the major market indexes at the turn of the century (see Chart 36 ).
Consequently numerous complementary methods have been developed
to deal with these problems. Other tools may be used to confirm a trade.
A filter may be used — that is, one does not trade until the price has moved
3% (or x%) over the moving average line. Or, price must stay above the line
for x days, or must make a minimum percentage move for the trade to be
taken. The more conditions put on the system the fewer trades will be taken.
This will result in fewer losses and smaller profits. It is tradeoffs such
as this that drive my graduate students crazy. On the one hand this; on
the other hand that, which is reminiscent of Jack Kennedy, who said that
he was looking for a one-handed economist so that adviser would not
be able to say, “On this hand this, … but then on the other hand.”
I examine some other aspects of moving averages further along in this
chapter, but first it would be advisable to return to that old bug-a-boo:
how long term is an investor? In the case of moving averages, that means
how long a moving average is the investor going to use. The shorter the
term, the more active the investor, until, at a certain point, he is not an
investor at all but a speculator, or a trader, or even a scalper.
It is worth emphasizing here that Jorion (a superlative source on risk)
in Value at Risk computed the following figures: mean return and probability
of loss over a 1-year period, mean return: 11.1% and probability of loss:
23.6%; over an hour period, 0.0055 and 49.4%. So much for day trading.
Short, Medium, and Long-Term Moving Averages

Just as in bar charting, the trader or investor can choose a time frame that
fits his character and method — short, medium, or long term. There is some
consensus among technical analysts as to the parameters used for these
periods which one will find embedded in the software packages, but be
aware that there is nothing sacrosanct about these parameters, and further-
more the blind acceptance of these numbers makes one a member of the
herd. This can sometimes be an advantage and other times a disadvantage.
One would like to be more or less at the middle of the herd and able to
Other Important Technical Analysis Methods

Chart 36. A 200-Day Moving Average on the Dow-Jones at the Turn of the Century. A market which slithers back and forth across
a moving average is the definition of a trading range. In this case a very long-term moving average. When this occurs after the
greatest bull market in history its message is clear to those who look and listen: The yellow caution light is blinking and the alarm
103
is ringing. This behavior suspends trend trading operations, and also leads to hedging, and if so inclined, to short-term trading tactics.
stop if the herd turned out to be lemmings pouring over a cliff. And one
would also like to know if it were a herd of bulls in firm control of the market.
A 10-day moving average will result in frequent trading regardless of
permutations introduced. A 200-day moving average results in much
slower trading. Some futures traders use 4- and 7-day moving averages,
and some use these lengths as crossover signals (i.e., trading when the
4-day crosses the 7-day).
The Dow and the 150-Day Moving Average

Using a 150-day moving average on the Dow-Jones Industrials from 1897
to 1986 resulted in a 7% annual advantage over a buy-and-hold strategy.
This advantage is gained using the simplest rule — buying and selling on
price crossover of the average. In 1986, this strategy stopped working. It
will be remembered that it was in the 1980s that Ronald Reagan, the great
communicator and voodoo economist, tripled the national debt and pur-
sued improvident fiscal policies. Whatever the reason, this simple strategy
no longer works. But it might be modified for the future if one were
willing to do the research and give it the thought necessary. In fact, many
commentators consider a 200-day moving average a sort of proxy for the
Dow Theory. The fact that many so consider it is a point against it in my
opinion, but that does not mean I ignore it.
Pluses and Minuses

Thus moving averages work very well in trending markets and not so
well in sideways markets. Chartists have an advantage in dealing with
moving averages as they can see when sideways markets develop without
dependence on some blind numerical algorithm. The refinement of moving
average systems is an advanced topic and further study on the subject is
addressed in the Appendix on Further Study.
VOLUME ANALYSIS TOOLS

On-Balance Volume
On-balance volume (OBV) relates volume to price change. To get the figure,
we add the day’s volume to a cumulative total when the price closes up
and subtract the day’s volume from the total when the price closes down.
The theoretical assumption is that OBV changes precede price changes,
and that the indicator measures capital flowing into and out of an issue.
Other Volume Studies

Moving averages of volume may be constructed. A volume oscillator my be
constructed by calculating a short-term and long-term moving average. When
the short term rises above the long term, we would expect to see rising
prices following the conventional theory of volume — that rising prices and
rising volume are bullish, and rising prices and falling volume are bearish
signs. Moderately declining prices with declining volume can be a bullish
sign. Increasing volume and falling prices are ominous signs. However, it
should be noted that volume interpretation can sometimes be a mysterious
process and judgment must be exercised before believing any indicator.
Equivolume
Invented by Richard W. Arms, Equivolume is a clever graphic way of
looking at volume.
Top of the box is volume high, the bottom the volume low. The width
of the box is the normalized volume, which is obtained by dividing the
volume for the period under consideration by total volume on the chart.
The idea behind this indicator is that shares are more important than time
in determining future direction. Arms says, “If the market wore a wrist-
watch, it would be divided into shares, not hours.”
Diagram 17. Equivolume Graphic. Equivolume presents an interesting way of

representing volume, as illustrated in this Equivolume chart of the ubiquitous
Microsoft in yet another guise. If the market wore a wristwatch it would be ticking
down to zero for Microsoft in this chart. This graphic form highlights the fact
that after high-volume periods in Microsoft the price had a tendency to decline,
a vivid lesson that Bill Gates has an infinite supply of stock to sell to his willing
Windows fans. This might be called distribution under the cover of strength, as
they used to talk about in the old days about X.
CANDLESTICKS
There are more techniques in the technical analysis tool kit than bar charting
and number-driven tools. Two other techniques of great interest are used
by many analysts: candlestick charting and point-and-figure charting.
Candlestick charting is an ancient Japanese way of representing the
standard price data. Because of its particular graphic characteristics and
long experience with the method, candlestick chartists feel they ar e
enabled to interpret graphic patterns to forecast prices. Since its introduc-
tion to American traders in the 1990s, it has attracted numerous followers
and is in my opinion well worth study.
Briefly, a candlestick is formed by taking the standard price data —
open high, low close — and drawing a graphic which has a body
composed of the difference between the open and close prices (the real
body) and a stick (or bar) (the upper or lower shadow) marking the high
and low of price action (see Diagram 18 for an illustration). With the real
body colored according to the direction of prices (white for up, black for
down) interesting new dimensions are added to graphic analysis. Just as
by the mere act of bar charting prices we bring order to price analysis,
candlestick charting adds color and formations to our graphic analysis.
Based on the observations of generations of Japanese traders, certain
patterns and formations are taken to indicate vital information about the
nature of the market under study.
As an illustration of these concepts, see Chart 37, from Microsoft, using
conventional bar charting, followed immediately by a candlestick chart
(Chart 38) of the same data.
Numerous candlestick patterns and formations are recognized and
purport to have predictive value. But the method is not discussed exten-
sively here. Rather, the reader should be advised that candlestick charting
is not the philosopher’s stone either. It requires experience and judgment
and use within a sound and balanced practice. Further study of this
interesting method might start with Japanese Candlestick Charting Tech-
niques by Steve Nison (New York: Merrill Lynch).
Diagram 18. Illustration of Candlestick Method. This fascinating method of

charting and analysis recently arrived (10 or 15 years ago) in the United States
but dates to ancient markets in Japan. Another thing we have to learn from the
Japanese. Bullish sticks are white, resulting from a market that opens on a low
price and closes higher. The bearish stick is the opposite and is black. The “shadow”
is the line above or below the “body.” Patterns, or combinations of these basic
designs, are presumed by candlestick chartists to have diagnostic power in ana-
lyzing the markets. The bullish engulfing line and or hammer are bullish if found
Diagram 18. (continued) after an extended downtrend. The morning star signi-
fies a potential bottom and may be white or black. The piercing line is bullish
and is the opposite number to the dark cloud cover. It is the relationship of one
day’s close to the next which determines their significance. More than halfway
into the body carries meaning for the candlestick analyst. The ominously named
hanging man lines are bearish found after a significant uptrend. As may be seen,
they quite graphically (pun intended) represent the tight range of open and close
and dramatize the long range traversed by prices outside of the narrow open/close
relationship. This selection of candlestick patterns is necessarily limited here and
the interested reader should pursue the subject in Nison’s work and other refer-
ences at www.johnmageeta.com.
POINT-AND-FIGURE CHARTING
One school of chartists who have on occasion had marked success in the
markets is the point-and-figure group. P&F charting (see Chart 42) is quite
a different animal from other charting techniques. The horizontal axis is
not used for time periods as on other charts. It does, however, mark
changes in the direction of price with each new column noting a reversal
of prices. The reader will note that Chart 39 provides a new representation
of the information in Charts 37 and 38.
The P&F chart is constructed as a series of Xs and Os, each entry
being a box and box size (i.e., price value) being a critical factor in
construction of the chart. The X represents upward price movement, and
the next up box is not marked until price has moved equal to or more
than the value of the box. For example, if the box size is 1 point the box
will not be marked on a half-point move. In addition to box size, a reversal
value must be specified. Reversal will indicate the number of points of
movement in the opposite direction to start a new column. If, for example,
the reversal value is set to 3, then price must move 3 points in the opposite
direction to start a new column, which, again by definition, will have
three boxes immediately filled.
P&F chartists identify formations considered to be of predictive impor-
tance, as do other chartists. In Diagram 19, some top and bottom forma-
tions and triangle formation are produced. Numerous other formations
are recognized by P&F chartists and the reader may pursue study of this
important school with references found in the Appendix on Further Study.
Most popular technical analysis software packages switch easily among
the various charting methods — from bar charting to candlestick or P&F
among their other capabilities. An excellent way of learning the nuts and
bolts of these methods is by taking a market with which the student is
well acquainted in bar-charting format and studying the case in different
graphic and number-driven formats (candlesticks, P&F, moving averages,
etc.).
Diagram 19. Point-and-Figure Patterns. Variously reported to have been invented

by Charles Dow and the Russians, point-and-figure (P&F) charting has its adher-
ents, and it has been my experience that it can be an effective analytical method
as I have known traders who were quite successful with it. The traders in question
averred that they “optimized” the box size (i.e., studied the markets and adjusted
the size of the box to fit the market, using, for example, 1.5 points or some such).
This is, of course, the central question of P&F charting and makes it a quasi-
natural rather than a pure “natural” system. Nonetheless, as is illustrated here,
P&F analysts identify patterns in their data, just as chartists do. Double tops and
double bottoms are illustrated, and the reader of this book by now will have no
difficulty seeing in his mind’s eye the pattern on a bar chart. The same is true for
the symmetrical bullish and bearish triangles. There is much to be said for this
method, whether or not boxes are optimized by sophisticated research. For those
who have difficulty making sense of the bar chart, it might be a good alternative.
The patterns illustrated here are, as might be imagined, the tip of the iceberg,
and the interested reader is referred to Cohen, and Bassetti and Bassetti.
120
Bull Trap
110
115
110
105 Runaway days

Department of Justice gap
100
95
90
85
Runaway gap
80
75
8/1999 9/1999 10/1999 11/1999 12/1999 00 2/2000 3/2000 4/2000
Chart 37. Microsoft, once more, to continue the case. See Charts 9 and 27. Here once again we see Microsoft at the top. Having
considered the previous charts as well as the lessons we have learned through the entire book, we are ready to look at the same
thing. But to see it differently. Now we know the end of the story, so this situation may be looked at with special perspective.
Having examined the previous lessons on stop systems and methods we know that it was possible not to go down with Microsoft.
If only we can separate ourselves from belief. In this chart and the two following charts we see the same data represented in three
different modes: the bar chart, which should by now be second nature to us, and which should allow us to extend our knowledge
to other forms of representation — that is, to candlesticks and point-and-figure.
Chart 38. Microsoft, Same Data, Charted With Candlestick Method.

Chart 39. Microsoft, Same Data, Charted with Point-and-Figure Method.

WRAP-UP OF NUMBER-DRIVEN INDICATORS

Following, by necessity brief, is a summary of number-driven methods.
But it will introduce the newcomer to the area and give him some idea
of the possibilities and problems of this area of technical analysis. The
reader will not have much difficulty in drawing the conclusion that the
authors of this book prefer a qualitative experienced analysis to surren-
dering control of their trading to numbers. This prejudice should not
unduly influence the reader. Each analyst or trader must find the tools
and methods that work for him.
Trending tools worked marvelously well in the bull markets of the
1990s — trending tools of every nature, trend lines, support and resistance
analysis, and moving averages. Studying this period once again reveals
that old truth that anything including darts works in a huge bull market.
Moving averages worked especially well for the Averages and, for example,
Microsoft. In almost any kind of market, actually, I like to see a moving
average line in addition to my own ruler drawn analysis. When the price
begins to see saw back and forth across the moving average line, it forces
me (if nothing else) to acknowledge a change in the nature of the trend.
As an example, look at the Dow chart at the top of the bull market,
Chart 34. This change of character then makes other number-driven tools
more effective. Now tools which measur e momentum and over-
bought/oversold conditions become more effective. I personally would
use stochastics and Billings Bands to complement a chart analysis in
sideways markets, and there are those who do the opposite. Others hew
to a strictly objective use of the tools. Many methods can be effective if
combined with disciplined risk control.
For Larry Williams, a known trader in the commodities markets, %R
has been a useful tool. (%R is a tool that measures overbought/oversold
conditions.) Wilder is said to have done well with his tools. As I have
said often, the inventor is the best user of his tool.
Generally it is my observation that a spectacular success in the market
results from the felicitous combinations of trader, method, and market.
Over the long term, smoother success is achieved by the robust method
of Magee-type trend following, whether implemented with a ruler or a
computer.
Fortunately, my readers are probably not well enough acquainted with
the field to demand, “Where is the write up on Elliott Wave?! Where is
the write up on Gann Angles?!” My easy answer is that those are advanced
subjects — as well as being unnecessary for the general investor. Fasci-
nating subjects for investigation and well worth it for the truly dedicated
amateur or semi-pro, but out of place here.
V
CONSIDERATIONS FOR
TRADERS/INVESTORS
OF WHATEVER STRIPE —
DAY TRADERS TO
LONG-TERM INVESTORS
Implications of technical analysis are put in context for various kinds of

traders/investors, from short-term traders to long-term investors: what kind
of analysis is appropriate for whom. Sample trading plans for these various
categories of traders are discussed.
There are the Marc Antony investors, sleek and well fed, who sleep
well at night, and there are the Cassius traders, lean and hungry men
who like a lot of action. To each his own, as Cato the Elder observed. It
behooves the individual to know himself and conduct his investment
affairs accordingly. Technical analysis has sufficient flexibility to be applied
at any scale, from tick by tick real-time trading to dozing gents who wake
up only when they get the call that the Dow has signaled a change of trend.
115
But. And. An awareness of the state of the market, its present rhythm,
its direction and nature are indispensable to the survival and prosperity
of the great majority of investors. In 1972, a group of the “best and
brightest” Wall Street analysts chose a group of stocks that they said the
investor could buy, throw in a drawer, and forget. Read further to see the
results of this kind of fundamental analysis and “buy and hold” investing.
Keeping in mind several kinds of investors, Bassetti has proposed some
sample trading plans for various investment types, which if followed might
avoid long-term busts. No guarantees are ventured for day traders. Gam-
blers are directed to the nearest casino. Or, actually, Las Vegas is a
happening place.
9
CONSIDERATIONS FOR
SHORT-TERM TRADERS,
SPECULATORS, AND MID-
AND LONG-TERM INVESTORS
One of the more important aspects of self-knowledge is an individual’s

ability to recognize what kind of investor — or trader — he is. There is,
as there is in most human activities, a spectrum of investment types.
Diagram 20 is a little graphic that illustrates this spectrum.
An individual determines his character as an investor by his reaction
to the seminal questions. How much risk do I want to take? How great
a return do I want to make? How much activity does my personality need
to stay interested? What sort of time frame is important to me? Once these
questions have been answered he can look for the style of trading or
investing that meets his financial and personality needs. In this process
he should be aware of some interesting data from a table prepared by
Professor Philippe Jorion from his book Value at Risk, which relates the
probabilities of loss to the time money is invested in the market. Relating
probable returns and probability of loss to time in the market, we observe
the following: for an hour, the likely mean return is 0.0055% return and
the probability of loss is 49.4%. For a year, the mean return is 11.1% and
the probability of loss is 23.6%. The shorter term that one is in the market,
the quicker the rhythm, the greater the quantity of transactions — the
greater the likelihood of loss — from transaction expenses even if profits
are realized on operations.
There is an exception to this rule. Market makers and stock market
specialists make hundreds if not thousands of transactions in a day. They,
117
Annual
Mean Return = 11.1000
Probability of loss = 23.6
Hourly
Mean return = .0055
Probability of loss = 49.4
1 2 3 4 5 6 7
Diagram 20. A Spectrum of Investors (Nonprofessional). 1. Gambler. 2. Day

Trader. 3. Interweek Trader. 4. Midterm Speculator. 5. Mutual Fund Investor.
6. Trend Speculator. 7. Annual Investor. With this clever graphic I attempt to
represent the spectrum of human experience in approach to the markets and
investing. As the cone expands, so the probability of success increases. I see this
spectrum as running from those with little or no chance of success to those
virtually assured of success. This spectrum runs from the compulsive gambler at
the narrow end to the long-term investor at the broad end. But, “What price
glory, Captain?” or, perhaps, what is success? First of all, survival is success, as
Gerald Loeb implied in his classic book, The Battle for Investment Survival. We
have a counterpoint to this philosophy in the term “gambler’s ruin,” meaning the
total loss of capital ending the ability to play. But is there a benchmark or measure
for quantifying success? Indeed there is. The average return over 1 year in the
stock market is 11.1%. Not much of a return the average speculator will say, and
the inexperienced newcomer will sniff and point out the 90% returns achieved
by mutual funds in the late 1990s. After the turn of the century and the millennium
those same funds gave back much if not all of that profit. And anyway, only about
20% of mutual funds consistently beat the market averages.
But let us take the extreme long term: $100 invested in the Dow in 1897 would
have been worth $39,685.03 at the top of the market in 2000. (Note: this is
capital appreciation only. Dividends not included.) Not much of a return one
would think, 6.017% compound interest rate annualized. Of course, that was
the pathologically somnolent investor. The Dow Theory investor had, instead,
$362,212.97 (no dividends). A bit better, or 8.366% compound interest rate
annualized. Not bad. During that time how many “long-term investors” with
short-term vision put all their money in the New Haven and lost it all? Meanwhile
Magee, the mid-term speculator was realizing even greater percentage gains.
Considerations for Short-Term Traders, Speculators, and Investors 119
however, enjoy advantages the off-floor trader/investor does not have.

That is, they buy on the bid and sell on the ask, the opposite from the
nonprivileged investor, and they also pay negligible transaction costs —
not to mention numerous other advantages not listed here. In addition,
they are actually more businessmen than investors. They are turning over
their inventory. Also, they are, in general, preternaturally skilled at their
trade.
Lurking over all Magee’s writings is the leftover Victorian idea of that
old clubman smoking his cigar and telling his heirs “not to sell the New
Haven” — the solid man who “bought good stocks” and required that “a
good dividend be paid,” and who tied up the New Haven in a trust which
his heirs could not break after his death until the New Haven stock became
worthless.
There are today’s investors, like Warren Buffet, whose time frame is
decades and who placidly take 50 or 60% market moves against their
positions. Probably not all their positions. They are of course not strictly
stock traders, but financiers who instead of buying the stock buy the
company. Also, they are concerned with the value of their companies,
not the value of the stock. Two different animals, “stock” and “company,”
as Magee has pointed out.
INVESTMENT CHARACTER AND NATURE

OF MARKET OPERATIONS
Investors and traders will define themselves along several criteria: their
choice of time frame, the rhythm and frequency of their trading, their
profit goals, their risk constraints, their methodology, and their choice of
trading instrument.
It behooves the newcomer to know himself well enough that he does
not buy Palm on the IPO day thinking that he is a conservative investor.
Nor will the speculator buy utilities. He might short them, seeing the mess
Diagram 20. (continued) Each person must place himself on this spectrum,
either through deliberate discipline and choice or as a matter of natural temper-
ament. Identity is style, or vice versa. And the individual must recognize his
nature — day trader or long-term investor — and fit that nature to the markets
in terms of the instruments he trades, the rhythm he follows, and the tools he
uses. The obvious prejudice of the authors of this book is for the midterm
speculator, as Magee called himself, but each person must find his own identity —
not just in life, but in the markets.
that the utility companies have made of energy deregulation and their
feckless investments in nuclear energy. Conservative investors will not
speculate in pork bellies, and their use of options and futures will be of
an insurance hedging nature.
In the next chapter I suggest some hypothetical trading plans for
different species of traders/investors.
10
SOME HYPOTHETICAL
GENERAL TRADING PLANS
Here are some potential trading plans for various types, from gamblers
to the long-term investor.
GAMBLERS
There is no satisfactory trading plan for gamblers. They are, in fact, best
off in casinos where they can lose their money in a stimulating atmosphere
with good music and amusing comedians and cheap food. Professional
gamblers are not really gamblers. They are businessmen who like to take
easy money from gamblers.
TRADERS AND DAY TRADERS

This is the fast lane of trading, actually not quite as fast as market making
but fast enough for most people. Successful day-trading programs, if such
exist, are primarily built on recognizing and instantly reacting to market
developments. For example, one might see a stock open with unusual
volume on a gap and jump on it, watching it in real time and stopping
it just as we have discussed in Chapter 5. I have not previously discussed
another type of stop, nor do I here. I will mention, however, for the
reader’s future investigation target stops and stopping on strength, so my
reader who is a potential day trader will at least know of the existence
of this kind of stop. Thus, day trading, or short-term trading, is primarily
a matter of recognizing momentum and being on the right side of it.
121
I think there is a better way to day trade. If I were a short-term trader,

I would recognize and trade the important daily patterns. An associate of
mine does this profitably with key reversal patterns (see Chart 26 ). Also,
at the top of the Clinton–Gore bull market, it was possible to lay a trap
for stocks that were shortly to report earnings by going short and profiting
from the exaggerated drops that occurred when they missed their earnings
by a penny (see Chart 25).
Of all the aspects of long-term trading or investing we have discussed,
risk control and diversification should be observed by the short-term trader
or he will quickly be in a different occupation.
SHORT- AND MEDIUM-TERM SPECULATORS

The mid-term speculator will weight his portfolio more to the explosive
issues — at the millennium the Internets and techs — following the mid-
term trend-following techniques discussed in this book. He will also
dedicate a part of his portfolio to the short-term trading opportunities
discussed for traders. He will, of course, be trading long and short. The
NASDAQ at the turn of the century was the primary medium for the
speculator and could be played long and short, based on an MEI type of
analysis. As this book goes to press, it is not yet clear what the next great
speculative bubble will be — perhaps biotechs — but the alert speculator
should be watching, and he should also be tracking carefully the NASDAQ
so as to get long when all the blood has been squeezed from it. This can
be determined by computing an MEI for the NASDAQ and buying when
the percent strong stocks is below 8%, or, to be even more conservative,
at 5%. (See Case 24, Appendix A.)
It was also, for example, merely a matter of common sense in
2000–2001 that the European Currency Unit — the Euro, which nose-
dived from $1.15 to $.82 after its introduction — would come back to
parity with the dollar. Those students in my graduate seminars who did
not listen to this analysis are still paying their tuition with their own
money. So currencies will always be good trading vehicles for speculators.
In fact, currencies are one of the best trading vehicles, but that is the
subject of a different lecture, for we are talking here about stocks.
LONG-TERM INVESTORS
A Simple Plan Following the Dow Theory
The simplest of all trading plans for the long-term investor might be to go
with the Dow Theory. Buy the Dow on bull market signals; sell it on bear
market signals. If a sporting type, sell it short on bear market signals.
Some Hypothetical General Trading Plans 123
Actually it is usually a good idea to confine shorts to a portfolio of individual

issues, just as it is a good idea to buy the averages for long-term purposes.
An average will hold up better than an individual stock, making the
average better for buying purposes and the individual issue better for the
short. How often, for example, do we see the Dow or S&P take a 1-day
hit of 18% or 40%? Rare indeed, but at the turn of the millennium daily
gaps of this type seemed amazingly frequent in stocks that reported a
hiccup in their earnings.
This simple strategy may be endlessly varied. The more it is varied
the less it becomes a long-term plan.
The Dow Theory plan was probably followed to some extent by those
old-time investors who had the capital to buy the Dow. Today there is
an easier way, namely, the Dow and the other major indices can be
bought in small bites by buying the Amex ishares (symbols: DIA, SPY,
QQQ). These unit shares in the Amex trusts allow the small investor (or
even the big one) to trade the Dow like a stock for reasonable transaction
costs. The development of these trading instruments is, in my opinion,
one of the truly important events in modern markets.
Trading these instruments gives the investor instant diversification; par-
ticipation in the most widely watched averages; downside protection as
they and their components are in the portfolios of most important managers
in the world; insulation against long-term deterioration (any buggy whip
manufacturers will be ostracized from the index in good time by the index
creators); high visibility (the most distracted investor cannot miss the
highway and skyscraper tickers); and, as Magee would say, etc., etc., etc.
A Relatively Simple Plan for the Present-Day Mid-

to Long-Term Investor
A perhaps more modern and practical plan for the present-day investor
might be as follows:
1. Buy the ishares (Dow, S&P, NASDAQ) on breakouts, at the bottom

of trading ranges on readings of the MEI in the 5% to 8% range.
2. Hedge using the stop methods described in Chapter 5 or when
markets are blowing off or when 150-day moving average is violated.
3. Lift hedge when selling climax occurs or when long-term trend
shows to have resumed or at bottom of trading range.
4. Never liquidate longs. Avoid taxes at all reasonable cost. Pay taxes
on hedge profits when they occur.
5. When losses occur, take the maximum that can be charged off for
tax purposes. Of course, take losses anytime rational methodology
dictates, regardless of the tax situation.
OPTIONS AND FUTURES

An option is an instrument that gives the buyer of it the right to buy (a
call) or sell (a put) the underlying security. For example, one may buy a
call on IBM (or numerous other securities futures, indices, real estate,
etc.). The buyer specifies a time frame and price at which he wishes to
have this alternative and pays a premium to the seller. Or, for example,
he might hedge his portfolio by buying a put. Thus, if he owned 100 shares
of IBM at 100 and bought a put at 100 and IBM declined to 90, or 80,
he could “put the shares” to the seller for 100, thus effectively insuring
his portfolio against declines in the market.
If he owned ishares, he could do the same thing by selling a Dow-
Jones Futures Contract on the Chicago Board of Trade (CBOT) to hedge
his portfolio. A futures contract, unlike an option, obligates the buyer/seller
to perform on the contract. If the price declines, he must, day to day,
pay any losses incurred. On the option the entire risk is the premium paid.
The beginner must know of these markets and their possibilities, and
he must also know that the options and futures markets are subjects for
postgraduate study. Careless forays into these areas can be fatally expen-
sive. For the investor who has done his homework, these are invaluable
mechanisms. The Appendix on Further Study will direct the interested
investor to the appropriate education.
ELEMENTS OF A TRADING PLAN

Regardless of where a trader/investor falls on the spectrum of time and
risk, he should have an explicit and written trading plan. This plan should
include the following elements. Specific numbers, securities, and percent-
ages are for illustration only. Each investor should fill in the blanks for
himself.
1. Risk management rules. For example, no more than 3% of capital

may be risked on any one trade and, therefore, trade size must
be adjusted up or down according to price and number of shares.
No more than x% of capital will be at operational risk at any one
time.
2. Trade entry and exit rules. Enter on breakouts, or on the first
secondary reaction after a breakout, and exit on trendline break
of greater than 3%.
3. Capital management rules. Portfolio will be diversified among 8
to 10 issues, or between S&P 500 and Dow; will be hedged by
shorting weak stocks. No more than x% of capital will be allocated
Some Hypothetical General Trading Plans 125
to one issue, or capital will be allotted evenly to each issue (i.e.,

risk balanced).
4. Trading instruments sought and permitted. Being a long-term inves-
tor, trading vehicle of choice will be ishares, DIA, SPY, and QQQ for
spice.
5. Time frame intentions. Time horizon of investment is 5 years,
hedging on breaks of 3-month trendlines.
6. Goals. Profit goals are to track market performance on the upside
and neutralize market performance on the downside.
7. Portfolio analysis and review procedures. Periodically (3 month,
6 month), the portfolio will be evaluated compiling statistics for
profit per trade, loss per trade, volatility of instruments, etc.
8. Tax plan. Taxes will be paid on hedge profits. Long investments
in ishares will be held indefinitely. Short-term needs for cash will
be met by borrowing against the portfolio.
9. Procedures to implement the foregoing. Simply enough, the written
rules for the foregoing — brokers, accounts, and so on.
10. Shut-down procedures. If the account declines by 50%, the accounts
will be shut down and the capital turned over to an advisor or a
mutual fund.
VI
TRADING IS ONLY HALF
SYSTEMS AND METHODS —
THE OTHER 90% IS MENTAL
Magee explores the philosophical and psychological aspects of

stock market trading and investing.
A former staff member of Options Research Inc. was chosen

as a trader in an elite commodity trading program (the Turtles).
When he was trained by the principals only half of his training
time was spent on systems. The other half was spent on
psychological preparation.
In this section Magee establishes a firm philosophical and

psychological basis for the practice of technical analysis.
The best system or methodology in the world is worthless if

its user has no confidence in it. Thus the rational analysis of
Magee’s methodology and system is of primary importance.
Beyond that, the cultivation of calm, poise, and, above all,
planning for all eventualities prepares the investor for success
in a viciously competitive area.
127
11
THE MENTAL SIDE
AND THE PHILOSOPHICAL
FOUNDATIONS*
Before anyone can use any method in business, or finance, or science,

or any other field, and before he can judge properly the usefulness of
the method, he should have some background of theory and the goals
he hopes to reach. At this point we want to consider some of this important
background.
We have already spoken of the use of charts simply as a record of
stock prices and trading volume — in other words, the market action of
the stock — and also of the convenience of recording other data on the
chart itself rather than in separate notebooks or tables.
A more important use of the chart is in backchecking the results of
one’s judgment, building up a body of firsthand experience in a form that
can be consulted and analyzed later, and in acquiring better perception —
learning from both one’s past successes and failures.
To many people the stock market is a confusing and confused melee
in which prices move helter-skelter without rhyme or reason. But this
confusion is, to some extent, a confusion in their own minds because
they do not understand the complicated forces and the detail of procedure
that actually cause stock prices to advance or decline. They might feel
the same sense of meaningless movement that a visitor to a textile mill
might feel the first time he saw the operation of an automatic loom. He
might not understand at first sight that the strange shifts of the jacquard
* The alert reader will note here that some material has been repeated from earlier
in the book. This is not an accident.
129
mechanism were not meaningless but were directed toward the orderly
creation of a definite pattern in the cloth which would have meaning to
anyone when he saw the finished product.
At the first or second lectures in a course, groups of students in
technical analysis of stock trends are often skeptical as to the meaning
or orderliness of the market. When they discover, as they do, that the
long-term trends of stocks, covering a period of a number of years, show
definite trends which often appear as straight-line channels on semiloga-
rithmic charting paper, they are likely to be overcome with enthusiasm,
sometimes to the point at which it is necessary to warn them that the
existence of trends, though true, is not the entire key to success in the
stock market but merely one of a number of important facts that appear
in the study of charts. In this field, “a little” knowledge can be a dangerous
thing indeed.
THE PREDICTIVE VALUE OF CHARTS

The question, at this point, is, of course, whether the charts have predictive
value — whether they can be of help in planning the purchase or sale
of stocks with respect to the future movement of stock prices. We have
a definite opinion that they do. But any investor planning to use charts
in his own financial planning should understand as thoroughly as possible
their theory and application. He should learn some of the characteristic
behaviors of stock charts, check and verify what he has read and heard
by his own current observations, and have some idea of what may be
abstracted or surmised from a chart and with what degree of dependability.
Remember the gypsy shops set up in vacant stores along the second-
or third-rate business streets of many of our cities. Today there is an
empty store with a “For Rent” sign pasted in the window. Tomorrow the
windows will be hung with printed cotton fabric; there will be displays
in the window of the signs of the zodiac and various arcane symbols,
and somewhere there is a display card announcing that Madame Zoloft
or Princess Osira will read your character and that she sees the past, the
present, and the future, clearly. If Madame Zoloft reveals the future to
you, tells you that you will meet a dark woman, that you will come into
a large sum of money, that you will travel across the water, this is
prediction of the future. But not a very good prediction.
EVERYDAY PREDICTION
On the other hand, every one of us makes predictions involving the future
every day of our lives. In fact, we depend on our ability to predict; we
could not live or work without it. Whenever a man tells his wife he will
The Mental Side and the Philosophical Foundations 131
be home for dinner at 6:30, he is predicting the future. Whenever he

writes down the date of a convention, or trip, or theater party, he makes
a prediction of the future. Whenever he enters into a business transaction,
gets married, buys a home, purchases stock, he makes predictions; that
is, he considers certain known facts, weighs and evaluates them, and
arrives at some conclusions as to the probable (future) consequences of
his decisions.
There is nothing mystical about the predicting process; there is nothing
that automatically ensures that a man’s predictions (or, as we say, judg-
ments and evaluations) are wise or valid. They can be foolish, they can
be based on false data or inadequate data, or obsolete data; the conclusions
may not follow validly from the facts at hand.
But, the degree of a man’s success will depend on his ability to abstract
the relevant facts, to weigh them and determine their importance, and to
arrive at the best decisions possible from the data available. The results of
his past experiments and experience, if he relates these to future problems
as they arise, constitute the background of understanding that we call
intuition. If he is observant and uses each new experience to correct and
add to the body of knowledge he has already, he will have, in effect, a
cybernetic machine, a perceptual ability to continue learning and to correct
his own methods, to improve accuracy, to update the basis of his premises,
and to modify his predictions in line with changing conditions.
All this can be said in a single paragraph. But sound judgment, good
intuition, foresight, and wisdom do not come about overnight by reading
a book or adopting a method or discovering a formula. These invaluable
assets on which our vital predictive processes in life are based constitute a
whole lifelong process of self-education. It is not easy, but it is the only way.
THE LIMITATIONS OF PREDICTIVE METHODS

Not only is good predictive ability difficult, it is also not “absolute.” When
we choose a mate, or build a business, or buy a stock, we are making
the best decisions we know how to with the best current evidence we
can get. All we can hope for is to make the best choice of several in the
light of the present situation. All we have to go on is what we have learned
in the past. Our experiences with women will aid us in choosing the right
wife. What we have learned about business will help in choosing the right
products, the right location, the right kind of organization. And what we
have learned from past experience about stocks will be our best guide as
to buying the right stocks now. This is what is meant by good prediction.
If the conditions change, if new facts appear, it will be necessary to
overhaul the prediction and alter it accordingly, or, in some cases, to reject
it entirely and make a fresh start. Nothing in any prediction of the future
is absolute or guarantees the outcome. But there is a vast difference in

the degree of probability between Madame Zoloft’s prediction of coming
into a large sum of money and the weather bureau’s prediction of a cold
front moving into the New England area within the next 24 hours. The
last prediction has a higher degree of probability. When the astronomers
tell us that there will be a total eclipse of the sun on March 18, 1988,
with totality lasting 3 minutes, and visibility in Sumatra, it is a prediction
with a high degree of, if not perfect, probability.
In ordinary human affairs we do not need and cannot expect certainty
in our judgments and evaluations. This is because the uncertainty principle
is as much a part of living as life itself (which is also uncertain). Yet, with
anything as uncertain as the duration of human life, the insurance com-
panies make their actuarial tables on the basis of their past experience,
and, because of the vast experience they have to draw on, these are, over
the long pull, exceedingly accurate.
If we say, as we have said, and say once again here, that humility is
the first and foremost need of a stock analyst, investor, or trader, this is
not the kind of humility that hangs its head in shameful ignorance. Because
a man admits he “does not know everything,” it is not necessary for him
also to confess that he “does not know anything.” There are all shades
of knowledge and experience, or the lack of them, between total ignorance
and omniscience. If there is one factor that stands in the way of a
reasonable and practical use of stock charts or any other market tool, it
is the feeling that one must be completely right or one is completely wrong.
But, if a particular method, study, or point of view can do nothing
more than improve one’s total performance a bit on balance, then it is
worthwhile. In fact, if it can aid a man in eliminating some of his worst
habitual mistakes, it can be valuable indeed. It can greatly improve his
“batting average.”
As a prelude to any technical study of the market, it would be good
for the serious student to do some reading in psychology, perception,
general semantics, and so on (see Resources for references) to understand
the workings of his own mind, so that he can see clearly what he is trying
to do and how he can apply new knowledge and experience. This type
of study should come first because most of the real tragedies of investment
come about through (1) inadequate or obsolete information, (2) miseval-
uation of the information, (3) faulty conclusions from the data, and,
perhaps most important, (4) stubborn habits of behavior that, like rigid
prejudices, are often based on poorly conceived emotions and that often
fly directly in the face of verifiable facts.
Also, in connection with prediction (or call it planning, judgment,
foresight, etc.), it is a good idea to have some understanding of what
kind of information and what kind of premise one will use as a basis.
Without any orderly, consistent program, it will not be possible to check

back and see what the results of past actions have been in relation to the
reasons on which we based our decisions.
One could say that the technical methods, like any method of predic-
tion, involves looking at the past, checking whether the present conditions
are greatly different, and, if so, making allowances for the differences,
and then making certain conclusions, based on these studies, as to what
seems most likely to happen in the future.
This is not a particularly mysterious process. Although in its details it
may involve a tremendous amount of sheer labor, the principles involved
are simple enough.
For example, if I have the past record of a series of numbers and the
series runs as follows — 7, 7, 7, 7, 7, 7, 7, 7 — and the present term of
the series is 7, I would predict, with some confidence, that the next
(future) term will be 7.
If the past series runs 3, 4, 5, 6, 7, 8, 9, 10, and the present term of
the series is 11, I would predict that the next term will be 12.
If the past series runs 3, 6, 11, 4, 48, 96, and the present term is 19,
I would predict that the next term will be 384.
Depending on the total picture one has, one may look for a continu-
ation of a constant number, or an arithmetic progression, a geometric
progression, an exponential progression, a cyclic or wave-like rhythm, or
any form that seems to fit the past and present facts, projected in the
future, as if we were continuing some sort of “orderly” pattern.
The trick, of course, is to find the “orderly” pattern, which may not
be a simple function but a combination of several quite different functions.
Also, one must be careful not to let one’s enthusiasm run wild to a
point where one “sees” patterns and rhythms where none actually exist.
And, of course, it is necessary to be on guard all the time against the
various “pitfalls” we have discussed, the prejudices and attitudes that are
so ingrained in us that they may distort our vision and “slant” our
evaluation.
It is because these “ingrained” opinions are so deeply a part of our
value systems that they can be so damaging if they are distorting our
perception of the facts. That may be why it is almost impossible to “learn”
stock trading or commodity trading solely from reading a book or attending
a class. It requires days, weeks, months, sometimes years, of personal
close observation and experience to implement the reading or the class-
room study. It takes that time and that experience to revise the old and
sometimes faulty concepts. For they are not going to erase themselves or
amend themselves just on the strength of intellectual acceptance of a new
viewpoint alone. The new ideas must be developed until they become
the “habitual” responses.
One of the “old” tendencies that can be a dangerous pitfall is to predict

in terms of a change in the major trend. This probably comes out of a
whole complicated evaluation in which we appraise a stock according to
certain “fundamental” facts about the company it represents. Such an
attitude can lead to a frame of mind in which any considerable advance
in the price of a stock leads to a certain habitual response, namely, that
the stock is “overvalued” in the market. The conclusion, of course, is that
eventually the stock will “find its true value” and the prediction from all
of this will be that the stock should be sold.
The same situation in reverse occurs when a stock has declined sharply.
The tendency is to feel that the stock “is priced too low,” is “undervalued,”
“can’t go much lower,” etc. And these reactions lead to a prediction that
the stock will shortly advance in price, and, therefore, it should be bought.
Sometimes this type of prediction (that the trend will reverse itself)
will be confirmed in the future action of the stock. However, before
pinning too much confidence on this particular method, one would be
well advised to check the record of past predictions made on this basis.
He may find that it is much harder than he thought to predict, even
approximately, when or where the turning point will come.
I personally prefer to make exactly the opposite prediction. If I had
only the choice of predicting a reversal of the major trend or a continuation
of the major trend, I would have to choose the continuation. As Robert
D. Edwards has put it, and I agree, “A trend should be assumed to continue
in effect until such time as its reversal has been definitely signaled.”
However, what we are talking about here is not the detail of prediction,
not the application of technical methods; it is something much more basic:
the limits of prediction. If we consider the question of whether the trend
or direction of a stock’s price should be predicted in the expectation of
a reversal of the major trend, or in the expectation of a continuation, we
will see that we are once again talking about an “either/or” situation. And,
wherever we can, we try to frame the problem so that we can change
the “either/or” into a matter of degree. Then we will be able to answer
the question in several or many ways, and not in just two ways.
Sometimes, as in this case, we cannot exactly change the “either/or”
question to one of degree, but we can do something that serves much
the same purpose. We can reduce it to a “probability.”
If you say BankAmerica is “going to go up,” and I say BankAmerica
is “going to go down,” then in a month or after whatever time we agree
on, you can take a look at it, and say, “You were right,” or “I was right.”
If the stock has gone up you would be right, in this situation. And, if it
has gone down I would be right.
And this, again, is the two-valued situation, the “either/or.” Which is
what we are trying to avoid.
You see, in this view, if your predictive method is “right” it will give
you the “right” result. If the stock goes up in price, then you are “right,”
and your prediction is “right,” and your predictive method is “right.” But
if the stock goes down, you are “wrong,” your prediction is “wrong,” and
your predictive method is “wrong.”
This leads to trouble. You might be quite “right” about BankAmerica
this month. You might be “right” about Advanced Micro Devices next
month, and about B.F. Goodrich the following month. But, sooner or later,
you will be “wrong” on one. This, almost by definition, makes your method
itself “wrong,” at least in that particular case. It either discredits your
method entirely or it casts a shadow and a doubt on it. At the very least,
it destroys your confidence
Let me suggest here that we consider for a moment other kinds of
prediction, outside the market. We will see how this same failure and
demoralization can occur wherever we attempt to set up a “perfect”
“either/or” predictive method.
But we do not have to do it in a two-valued, absolute way. We can
recognize certain limits of predictive expectation in terms of probabilities,
and then we will not continually be afraid to use our method because of
our lack of confidence in it. We will not be expecting more from our
method than we can reasonably hope for. And we will not be basing our
method on a few accidental “successes.”
Is this clear? It is clear that a stupid method of prediction (such as
betting even money that one can draw a spade from an ordinary deck
of cards) could at times produce a succession of “wins.” If we see someone
make such a bet over and over again, would we feel it was a “right”
method of prediction, even if he won eight times in succession?
Or, to put it another way, suppose we were to have the chance of
betting even money that we would not draw a spade from the deck.
Every time we drew a heart, a diamond, or a club, we would win. Only
when we drew a spade would we lose.
Under these conditions, if we were to lose several times in a row on
this bet, would we discard our method as “wrong?” Would we reverse
our method and bet that we would draw a spade, merely because of a
run of luck against us?
Isn’t it possible to say that, providing the deck of cards is an honest
one, containing the usual cards and properly shuffled, it makes no
difference how many times we “win” or how many times we “lose”? This
does not affect the “rightness” or “wrongness” of our method of evaluation.
And our best policy is to continue to use our evaluative method as long
as we are convinced that it is based on adequate data and valid reasoning.
Of course, we know this. We know this from what we have previously
abstracted from our experience in drawing cards from decks. It seems
terribly redundant to have to go through this long discussion of something

(perhaps an elephant stuck in our front entry) so obvious, so plain. We
know that neither the roulette croupier nor the owners of the casino care
very much whether we or any other player wins or loses. If the casino’s
bank is well-heeled, the “method of evaluation” will wear down the string
of luck or the “system” of any roulette player, as every professional gambler
knows.
And the method of evaluation used by the professional gambler is not
based on being “absolutely right” on any particular play or series of plays
but on a prediction as to the “most probable outcome of a long series of
plays taken as a whole.”
Then why is it that so many people either have no real evaluative
method at all or follow one that represents so little firsthand checking
and verifying that it may be worse than useless? Could it be that because
they are so deeply trained in “either/or” and “right and wrong” they cannot
habituate themselves to a method based on uncertainty?
If we know that on the basis of past experience and in view of the
present outlook we may expect to “win seven times out of ten, in an
even-money series of bets,” we can accept this 7-out-of-10 probability as
something akin to what would be a “measure” or “degree” in some other
types of problem. With certain reservations and precautions we can accept
this as the measure of our expectation, and by continually rechecking and
verifying we can adjust and refine this until it becomes a highly dependable
tool as long as the basic conditions of the contest do not change materially.
We can operate on this basis with considerable confidence. And, with
this foundation for our confidence, we will not “need to be right” all the time.
Think what this means. Consider the nights we have lain awake and
worried about what “the market” would do tomorrow, or whether “XYZ”
would go up or down before the end of the week. We will not be able
to eliminate all anxiety about the market, but we will be able to greatly
reduce the amount of our tension and worry because we will not feel
threatened with a “total failure” of our method every time a stock moves
a point or so “against” us.
What we have done here is to set some limits on the predictive science.
The average person seems to recognize no limits whatever. What they so
often seek and insist on is an infallible method of reading the future. And
they are so sure that if they only keep trying and searching they will
come up with the “right” method, so sure that charlatans mulct them of
millions of dollars every year by supplying spurious “perfect systems.”
(And this is also true on many other streets besides Wall Street.)
We have set limits. We have stopped short of the “100%” upper limit,
representing infallibility, and we have set our goal considerably above
the “0” of the thoroughly discouraged cynic who feels it is “all just luck.”
By observing the results of a method as applied in the past, and noting

the number of successes and failures, we can gauge the (past) success of
the method. We can then project these results into the future as a
probability and say, “I believe, on the basis of the past records, this method
will probably produce an average net return of between 20% and 30%
per year.”
That statement is not nearly positive enough to satisfy the individual
trained to think in absolute terms. Neither is the expected return anywhere
near as large as such a person would expect (on the basis that he will
“always be right”). Neither is it definite enough, for that person we are
speaking of does not think in terms of “somewhere between.” They want
it right out plain and sharp.
Of course, the chances of our being “totally defeated” are much less
than theirs. But, for them, it is necessary to “reach the top,” and that
means shooting at nothing short of perfection.
The novice in the market, as in other fields, is likely to shy away from
anything “technical” and anything that he does not understand. He is
likely to prefer what he considers a “common sense” approach, usually
based on cause-and-effect reasoning. In other words, “this” will probably
happen because of “that.” The price of the stock will advance because
of a coming merger and announced improvement in earnings, etc. This
may be true at times, although the novice will also attach a great deal
more certainty to his conclusions than a more experienced man and will
tend to concentrate on a single fact or reason as the cause, overlooking
the multitude of other conditions that can affect the outcome greatly. At
best, he will probably consider only a few selected data and will not take
into account the remaining factors, or he will attribute far more weight
to his reasons than experience in these matters would substantiate.
Add to this the difficulty of evaluating the various products of a
company, particularly when so many corporations today are widely diver-
sified and may include many divisions engaged in entirely different fields.
Sometimes the key to a situation may lie in the development of some
new process or product by a hitherto obscure subsidiary. Often, it is
possible to give several or many reasons why a stock should be behaving
in a certain way. And it is possible that the most important reason behind
a trend might be entirely overlooked. And in some cases, the real reasons
might not be known or available to the public at all. This last could be
the case when steps were being taken by some outside group to acquire
control of a company in which a campaign for a change of management
was building up.
On top of all these reasons why stock prices may move, there are also
many others not directly connected with the business of the company
represented by the stock — monetary changes, inflation and deflation,
the general prosperity or depression of the country’s economy, various

political factors, and also the prevailing “psychological mood” of investors.
At times investors generally are optimistic and have a feeling of confidence,
and at times the investing public feels discouraged and is not much
interested in stocks at any price. And there are times in which the market
reflects only the general apathy.
Clearly, it is not possible to evaluate all these factors — many of them
debatable, some unverifiable, and others intangible — by the same kind
of methods one would use to analyze a chemical, balance a set of books,
or measure a tract of land. The problem is not only vastly more compli-
cated; it also means reducing to a common denominator matters of fact,
matters of judgment, and matters of speculation as to the probable future
course of things. On the basis of statistics, news, factual information, etc.,
it would not be possible for six men working independently to arrive at
identical “values” for the stock of a company. Not unless, by common
agreement, they all used a common formula agreed on in advance,
omitting many of the debatable and unverifiable points, and then, of
course, the values determined would not be independent and, in any
case, would represent only the arbitrary valuations according to the rule
or formula.
It is important to understand this. Otherwise, the daily chart means
nothing, and, for that matter, the market itself means nothing. For if there
were any complete and precise formulas for determining the value of a
stock in dollars and cents, the democratic auction of the market itself
would be meaningless whenever the market price did not coincide with
the formula price.
But, from the practical angle of what we can get for a stock if we
want to sell it, or what we will have to pay for it if we want to buy it,
the market price is the valuation we have to accept. If a stock is selling
at $50 a share and we and others feel it is worth less, or if we feel it
probably will be worth less, or if we need to raise some money by selling
stock, then, if enough people are selling enough stock, this supply will
tend to bring the price down to $49, to $48, or lower, depending on the
amount of stock offered and the urgency of the selling. On the other
hand, if we should feel that this same stock is worth more than $50 or
that it probably will be worth more, we would be buying it, and our bids
would use up the supply of stock offered at $50 and we might have to
pay $51, $52, or more.
Anyone has the right to feel that $50 is too high or too low a price
for a stock. If an investor feels that $50 is too high a price to pay, he can
bid $40 for it, but he will not get it as long as there are others willing to
pay more. Or if he wants to sell but feels the price of $50 is too low, he
can offer his stock at $60. But, here again, he will not get his price as
long as there are others willing to sell for $50.
Thus, regardless of formulas and theories, ratios, and economic break-
downs, the value of a stock, in terms of what we pay or what we get, is
determined by what the investing public feels it should be. The price is
the result of the bids and offers of all the investors: those who feel it
should be higher and those who feel it should be lower.
It is easy to say, and many have said, that a price determined in this
way by public auction may be unrealistic, that it might be the result of
psychological forces — a wave of optimism, a spell of panic. It is true
that if an investor had perfect insight and a complete understanding of a
situation, he might set the value higher or lower than the market sets it.
If he were right, and if things worked out as he anticipated, this would
be highly profitable to him.
However, to set one’s own opinion squarely against the judgment of
the market calls for a degree of wisdom (or a degree of sheer folly) that
few of us would claim. As far as the internal and corporate affairs of a
company are concerned, there are officers and directors whose livelihood
and business future depend on knowing their own company and its
prospects. There are also employees, many of whom may also be investors
in the company’s stock, who are in a position, at least, to know more
about what is going on than the outside stock trader. There are professional
analysts and managers for large institutions — the banks, insurance
companies, mutual funds, pension funds, etc. There are individual inves-
tors who may have been studying a certain industry or a certain stock
for many years. When a man tells us that a particular stock, selling now,
say, at $50, is really worth $100, we should realize that he is expressing
an opinion, his own judgment, and he is setting that judgment against
the serious evaluation of other investors whose dollars are at stake in this
evaluation.
If we seem to have wandered a considerable distance from discussion
of the charts themselves, it is because this discussion is of paramount
importance in understanding what it is that charts tell us, and why we
do not insist that they not only tell us what is happening but also why
it is happening.
To round out this section, one more important point must be covered.
Clearly, whatever happens in the market to a stock reflects something
that somebody thinks, feels, or believes will affect the future value of that
stock: the record of past earnings or dividends on the assumption of a
continuation of past performance or the projection of a past trend. Today’s
price for any stock reflects and includes all the hopes or fears anyone
may have for its future. It is each man’s opinion merged with the opinion
of every other investor interested in the stock, and the resulting figure is
the ultimate meeting point — ”the bloodless verdict of the marketplace.”
Thus, the market price at any time (which is what the chart gives us
graphically) is a prediction of the future as seen through many eyes. It is
the best educated guess of all those concerned.
But it should be clearly understood that although all of us have to
make predictions as to the probable consequences and outcome of our
action when we buy a house, when we get married, when we take a
new job, or whatever we do, it is not possible to make these predictions
“absolute.” It might be someone’s prediction that at five o’clock he would
get his car at the parking lot and drive home in time for dinner. This
might be a good and reasonable prediction of that future event. But it is
possible for the conditions to change. The car might have a bad battery
and might not start. There might be a highway tie-up that would prevent
his getting home until very late. His wife might have sprained her ankle
and gone to bed. We have to make predictions, the best we know how.
But, we must be prepared, always, to change our plans and to make a
new evaluation if the situation changes in some unexpected way.
This is a key point in the use of charts or in any investment planning.
It is necessary to use the best current data we can get and to apply it in
light of our experience to estimate the probable developments. But we
must never become so “frozen” to today’s opinion that we are unable to
change it tomorrow if there is new evidence calling for “a revised map.”
In discussion of the use of daily charts, we are assuming that the
market price at any moment represents a meeting of bids and offers of
those who want to buy and those who want to sell — therefore, the
market value at that moment — and the chart provides a visual history
of the market action in such a form that it is easy to see, at a glance, the
trend of the stock’s price and any important changes in price trend or in
volume of trading. For such a chart, it is possible to draw some inferences
and form some valid opinions as to the probable future market action.
In other words, the chart is a tool; it is, in fact, merely a factual record,
and its interpretation and use depend on the experience and judgment
of the investor who is using it. Trends and patterns do not cause move-
ments in the market. (We would question even the limited psychological
effect they might have in influencing the trends of large and important
stocks, because large and institutional holders of stocks cannot buy or
liquidate heavily overnight, and among individual investors only a small
percentage are willing or able to act on technical market action.)
SL302XchAppA frame Page 141 Thursday, December 13, 2001 10:14 PM
VII
APPENDICES
A. Some Selected John Magee Letters
After basic training and drill the army enters the battle. How
well does the theory and method hold up in the heat of
combat? Appendix A presents a number of cases from real
life and explores a number of cases from the experience of
Magee’s advisory company. About the only way that market
wisdom can be transmitted is through the examination of
particular cases from actual experience. Some students can
even absorb these lessons without needing to directly expe-
rience the pain which opens one’s eyes to being able to
absorb the lessons.
B. Tekniplat Charting
C. Continuing Study Plan
D. Resources
141
Appendix A
SOME SELECTED
JOHN MAGEE LETTERS
Section 1. Benefits of Professional Management

Case 1. Anonymous. Benefits of Professional Management.
Case 2. The Best and the Brightest. Buy-and-Hold Investing.
Section 2. Analyzing — Timing — The Market

Case 3. August 21, 1982. Buying Panic (and What It Means)
Case 4. September 4, 1982. Dangerous Spikes
Case 5. February 19, 1983. Reflections
Case 6. October 27, 1984. Calling the Turn: A Case of Missing the Point
Case 7. February 1, 1986. We Would Not Want to Get Scared Out of
the Market Too Soon
Case 8. January 24, 1987. The Elusive Crystal Ball
Section 3. Portfolios
Case 9. June 5, 1982. Managing Money
Case 10. April 2, 1983. New Issues, High Technology, Wonder Stocks,
and the Like
Section 4. Laughing at the Pundits

Case 11. December 3, 1983. The Reason(s) for the Move
Case 12. October 13, 1984. Which Way the Market, and Why
Case 13. September 14, 1985. The Hemline Barometer and Other
“Mood” Measures as Crystal Balls to the Future
Case 14. December 15, 1984. The Elliott Wave Theory: Perspective
and Comments
Case 15. June 6, 1987. Earnings Forecasts: Dangerous to Your Financial
Health!
143
Section 5. Technical Questions — Stops

Case 16. May 7, 1983. Beyond the Limits
Case 17. September 1, 1984. Big Money in Brain Surgery: Learn at
Home This Quick, Easy Way
Case 18. September 22, 1984. Forecasting: No Such Thing as a Sure
Thing
Case 19. March 16, 1985. When a Stock Collapses: Crisis or Opportunity?
Case 20. July 6, 1985. The First Shoe Drops
Case 21. July 13, 1985. Protecting Stock Market Profits, or a Trip Into
the Wild Blue Yonder and Back
Case 22. December 20, 1986. Flags, Triangles, and River Sediment
Case 23. January 17, 1987. Big Blue — From Bellwether to Bust!
Case 24. September 28, 1985. An Oversold Market
INTRODUCTION
For untold decades John Magee ran John Magee Inc., an investment
advisory business which published a weekly letter commenting on the
markets. In 1963, after learning some painful lessons firsthand in the
markets and hitting the books (Technical Analysis of Stock Trends, 5th ed.)
I became a client and subsequently student of this old-shoe, totally
unpretentious master of the craft. I do not know how many wild and
crazy phone calls he handled from me, but he was always the soul of a
master who knows that he has a passionate and dedicated student on his
hands. On my visits to him I was always impressed by the calmness of
his office, the dry-as-dirt application to the business at hand — even when
I tried to lure him into commodity trading in 1972.
Magee’s letters were notable for their graphic elegance as well as their
deep insight into the markets. It is obviously impossible to reproduce
those letters in facsimile here, but Richard McDermott (the distinguished
editor of the previous edition of this book) chose a sampling of those
letters that I consider invaluable for the beginning (and sometimes the
professional) trader.
I have supplemented these letters, or, as I have called them, cases,
with some instances of my weekly letter which seem educational. Some
of these letters read like new editions of cases from Magee.
The cases are organized into five sections and their contents are
indicated by the section title.
Section 1
BENEFITS OF PROFESSIONAL
MANAGEMENT
CASE 1
Benefits of Professional Management. From the Files of John Maggee
Technical Analysis:: Delphic Options Research Ltd. www.johnmageeta.com.
Chart 40. Anonymous. A Lesson for Quick Learners. The reader is invited to take
ruler in hand, summon up the lessons he has learned so far, and decide whether he
would buy or sell at this point. The name of the stock is kept anonymous for the
moment in order to give the reader a chance to make a decision uninfluenced by
hindsight. Make an analysis; make a decision; annotate your reasons for your decision
and the outcome will be discussed hereafter. Do this before going to the next page.
145
Chart 41. Juniper, a Lesson for Mutual Fund Managers. Here is a continuation
of the previous Chart 40. At this point the reader knows that the stock is a
promising supplier of pickaxes, gold panning pans, and burros to the Internet
gold rushers and, thus, as in the case of Levis, an infinitely better bet than the
companies buying its equipment. Now would you buy the stock?
Here is an interesting case. During the great Clinton–Gore bull market

many of my students — not to mention the rest of the world — gleefully
jumped into stocks that had been “slammed” and realized good profits as
those stocks quickly recovered their slammed losses. In seminars during
that period I pointed out that this tactic would cease working when the
market topped and that buying slammed stocks would be equivalent to
jumping on the Titanic.
At this point in the stock’s chart a prominent mutual fund manager
enthused on the Yahoo finance site about the buying opportunity in
Juniper. His enthusiasm was understandable, as he was a long-term holder
of the stock, meaning he had already lost 50% from the top. I have
deliberately concealed the manager and the name of his fund to protect
him from scurrilous snickers of technical analysts.
Some Selected John Magee Letters 147
Chart 42. Juniper, a Lesson for Mutual Fund Managers. The end of the story. Sad
ending.
I quote here from my letter of November 24, written in response to

that manager’s buy recommendation and e-mailed to Yahoo and posted
on my site at that time:
JUNIPER November 24 2000
There are those currently touting Juniper as a “buy.” Technicians

would be more likely to short it than buy it. Note the highest
volume on the chart on the breakaway downside gap November
the 21st. The gap and bounce three days later occur on negli-
gible volume and look like short covering. Bounces of this sort
(which are known in the trade as “dead cat bounces”) are often
followed by further price erosion, especially after plunges of
such violence. Only the most adventurous (and perhaps rashest)
of speculators would buy at this point and his stop would be
the nearest low. The serious investor can find other less risky
situations. And if he is set on Juniper patience is certainly in
order until the downtrend has run its course.
Continuation of Case 1
It will be remembered that in Chapter 1 we talked about slammed stocks,
or is a collapse a disaster or a buying opportunity? Here is the end of the
Juniper story. Sometimes a collapse is a buying opportunity. Sometimes

it is an invitation to participate in disaster. Solid technicians are willing to
exercise patience when the technical situation is dicey. Does it need saying
that a fall out of bed on high volume is a dicey situation?
The reader will also find it instructive to read Magee’s letter in Case 19.
CASE 2
The Best and the Brightest. Buy and Hold Investing.
In 1972 a group of the most prominent brokerage house analysts (funda-
mental) on Wall Street got together and picked out a group of stocks to
buy and hold — to buy, throw in the drawer, and forget. The reader will
easily imagine the reaction of Magee, myself, or any moderately competent
technician to this proposition.
On the other hand, as John Kennedy’s economist used to say, who
could quarrel with the list of stocks they chose? A list of the bluest of the
blue chips: Avon Products, Eastman Kodak, IBM, Polaroid, Sears Roebuck,
Xerox. The reader should cast his mind back to 1972. No better blue chips
existed than these regardless of what one might think of these stocks now.
Chart 43 shows what happened to IBM in 20 years. Chart 44 shows Xerox.
It would not be so bad if these two were exceptions to the blue-chip
chosen portfolio. Unfortunately, this buy-and-hold strategy was a Titanic
disaster. The table below shows the performance of the entire portfolio.
Worst of all to a technician, the analysts chose these stocks at the top of
the 1972 market. It does make one wonder about fundamental analysts.
The reader will be amused to read Case 13, in connection with this case.
Following are the results of investing with “the best and brightest.”
Herewith a summary of the results of “one-

decision investing.”
Price Price Percent
Stock 4/14/72 12/31/92 Change
Avon Products 61.00 27 69 (54.6)

Eastman Kodak 42.47 32.26 (24.0)
IBM 39.50 25.19 (36.2)
Polaroid 65.75 31.13 (52.7)
Sears Roebuck 21.67 17.13 (21.0)
Xerox 47.37 26.42 (44.2)
Chart 43. IBM, Best and Brightest. In 1972 a group of the “Best and Brightest”
Wall Street analysts engaging in a drill which could only be described as a chance
to get egg on your face (a panel on so-called One-Decision Investing) picked IBM
as a stock to buy and put away. Twenty years later several smarter analysts
reviewed their decision. The foolhardiness of this kind of methodology is amply
demonstrated by the chart. First of all, the call was made at a market top in the
stock — showing that even professionals can buy the top of markets. Second, no
stop was set on the transaction, which resulted during the 20-year period in an
immediate loss of more than 50% (in 1974). Some years later in October 1987,
the analysts would have tasted sweet vindication seeing their recommendation
double in value. Ah, but for too short a joyful time. October 19 came and went,
and the top came and went, and after 20 years the one decision stock languished.
XRX LAST-Monthly
160
140
120
100
80
60
40

1970 1975 1980 1985 1990
Chart 44. Xerox, Best and Brightest. Another example of those “Best and Bright-
est” analysts making a “one-decision investment.” The decision in this case is
especially ironic and painful because for the next 20 years Xerox never again
regained the price at which those particular pundits had expressed their conven-
tional wisdom. The lesson is clear: Believe the charts, not the experts.
Section 2
ANALYZING — TIMING —
THE MARKET
Chart 4. From newsletter of August 21, 1982, the Dow.
CASE 3
August 21, 1982. Buying Panic (and What It Means)
Two records were set on Wall Street this week (see Chart 4). Both may
endure for quite some time. On Tuesday, the Dow-Jones Industrial Average
rose 38.81 points on near-record trading of 92,860,000 shares, the largest
153
single-day advance in history. On Wednesday, an astounding total of 132.7

million shares traded hands, easily passing the 100-million-share milestone,
as the Dow-Jones Industrial Averages (DJIA) retreated 1.81 points.
Tuesday’s advance, a classical “buying panic,” was front-page news across
the country. Economists and business experts were called on to comment
on the reasons for the upsurge. The consensus was that revised, more
optimistic interest rate forecasts by two noted bond market experts had set
the rally off. Other observers suggested that improving fundamental trends
had been under way in the capital markets for some time, and that Wall
Street (as well as the two “experts”) had simply become aware of that fact.
We have never cared much for analyzing the reasons behind this or
that stock market move. A change in direction in Wall Street may be due
to fundamental changes in the business environment, or to purely psy-
chological causes. There may be one reason, or many reasons, for a
specific move at a given time. We prefer to concentrate, instead, on
analyzing the technical behavior of individual stocks monitored weekly
by our staff and selecting those most attractive for purchase or short sale
in accordance with the current position of the MEI.
What can we say at this time about this most extraordinary stock
market behavior? Did Tuesday’s cathartic 38.81-point DJIA advance con-
stitute a major reversal in the direction of the stock market? A review of
individual stock patterns suggests that the answer to this question is “no,
almost certainly not.” Numerous stocks, we would say almost the majority,
rallied from within a point or less of their r ecent, intermediate-term
downtrending lows. We are unaware of any technical case for describing
such behavior as bottom-like. The proportion of stocks rated strong cur-
rently stands at a relatively low 18%. Single-day high-volume spikes alone
do not constitute reversal patterns. In fact, the number of stocks that have
formed valid, recognizable 3-week to 3-month (or longer) patterns which
we customarily associate with reversals remains extremely low.
What has happened then, and what does it mean? First, Wall Street
has been treated to a rally, the best one-day rally ever. Importantly, the
brokerage industry functioned extremely well, handling the record-setting
activity in an orderly, confidence-building way. Second, the lift-off in many
stocks was great enough to constitute an important potential first leg of
the bottom-forming process in many individual stocks. What is required
individually (and collectively for the market as a whole) is a lower volume
pullback to support, and a high-volume subsequent upmove through the
interim highs set on Tuesday. Then (and only then) can we talk about a
meaningful technical bottom being in place.
Perhaps Tuesday’s 1-day rally is a straw in the wind. Certainly, the MEI
is in clear-cut bullish territory. And certainly, the interest rate climate for
equities has improved dramatically recently (see our letter, “Change in the
Wind?,” page 1, August 7, 1982). If so, the number of strong-rated issues

should begin to increase notably in the weeks and months ahead; profit
opportunities among the numerous stocks off 50% or more from their highs
will abound. In the meantime, some individual stocks continue to swim
against the tide with classically developed bottoming patterns already in
place. We continue to advocate the careful accumulation of these stocks
with purchases spaced over time and protective limits honored if necessary.
Experience has shown that these “early bloomers” are often the best gainers
following sustained MEI readings within the bullish quartile.
CASE 4
September 4, 1982. Dangerous Spikes
During the recent stock market explosion, a common bottoming pattern
has occurred which is anything but common, technically. Specifically, many
stocks — just after piercing support and establishing a new trading low —
have reversed direction dramatically to establish new interim trading highs,
breaking through one or more levels of resistance in the process.
The three charts shown (in the original letter) are particularly dramatic
examples of this unusual technical behavior. In the case of Allegheny
Corporation, a new trading low of 35 ⅝ was reached early last month,
easily exceeding previous important lows of 37¼ (July 1982) and 41⅛
(March, 1982) and confirming the downtrend then in force. Within
3 weeks, however, Y had soared to 43, decisively penetrating July resis-
tance at 41⅞. The moves in American Express (35 to 46) and Western
Union (25 to 34) showed similar disregard for classic bottoming behavior
as well as for previous resistance levels.
These unique spike reversals from new lows to new highs show many
similarities with the broadening, or “megaphone,” patterns usually asso-
ciated with major tops (see Edwards and Magee, Technical Analysis of
Stock Trends, 8th ed.). Because successively lower lows are interspersed
with progressively higher highs, these patterns inherently reflect price
instability and increasing volatility. Stated another way, it is impossible to
state technically whether such an issue is in a downtrend or an uptrend.
Despite the seeming attractiveness of such turn-on-a-dime stocks, we
have avoided recommending these issues in recent weeks. Instead, more
classic trendline reversals combined with traditional bottom formations
have been favored. If we did find ourselves owning these spiking issues,
we would be inclined to sell or sell short against the box at least half the
position, or, as an alternative, to write covered calls at a strike price near
or slightly below the current market price.
To the extent that these dramatic spike rallies reflect the enthusiastic
reaction of investors to the recent sharp decline in interest rates, they may
be regarded as a bullish signal of better times ahead. In selecting which
stocks to buy now, however, we continue to favor those with the reversal
patterns typically associated with the technical bottoming process.
Chart 45. American Express, Bottom Spike.

CASE 5
February 19, 1983. Reflections
This week we were both pleased and honored to receive a copy of a
small booklet titled The Stock Market Innovators Survey. We were pleased
because the book contained a compilation of the investment strategies of
12 professionals “whose consistent success” supports the premise that
“there are investment strategies and stock picking techniques which, albeit
imperfect, vastly improve our ability to profit from buying and selling
common stocks,” and honored because our technical work at John Magee
Inc. is the subject of one of the book’s chapters. We particularly enjoyed
reading the comments (reprinted here with the permission of the pub-
lisher) of William LeFevre, investment strategist, Purcell Graham & Com-
pany, Inc., regarding the inability of many investors to “recognize” a bull
market — particularly in the early stages when one is upon them:
The consensus opinion is always late to recognize the existence

of a new Bull Market. In most cases, Bull Markets are not widely
acknowledged until one third of the move has already occurred.
This is infinitely understandable considering the emotional fac-
tors involved in investing in stocks, and the enormous influence
of institutional investors in today’s market. It takes time and
some palpable proof of better times ahead before the fear
created by a previous slide gives way to greed as the dominant
emotion in the market. Recently burned, currently cautious.
This is true of the institutions as well as the man on the street.
Also, because of the sheer size of institutional investments —
70% or more of the total volume on the NYSE — it is even
more difficult for them to reverse gears. Consequently, the chart
pattern of a new Bull Market disguises a good deal of its
momentum. In the early stages of a Bull Market, a DOW or
S&P chart displays a saw-tooth pattern. Advances are often
interrupted by declines. It is essential to note, however, that
the market advances on increased volume and declines during
periods of relatively inactive trading. Each advance and each
decline takes the market to a point higher than the previous
advance peak or trough. What’s happening is that institutions,
which missed the initial moves, are simply waiting for a cor-
rection before increasing their commitments. When they do
jump in, volume spikes and the market moves higher. So, the
moral of the story is that consensus opinion does not recognize
a new Bull Market until its horns protrude far enough to
“needle” the Bears into buying stocks.
We are reminded of the disbelievers who have recently been predicting

a “100- to 150-point decline” in the DJIA, failing to acknowledge the
significance of the recent move by the DJIA to new all-time highs after
having been turned back at Dow 1000 or thereabouts for nearly 17 years
(see Chart 51 ).
We have made the point often recently, and we make it again: Do not
let the cries of these stock market Cassandras or the buildup of large
profits in your investments make you so nervous that you sell out other-
wise perfectly healthy positions. Evaluate each stock on its individual
merits. Hold onto a position as long as it is technically strong. When it
turns weak, sell it without fail. Leave the forecasting of the market’s twists
and turns to those who have more elegant crystal balls, many of whom
have yet to recognize this bull market. Perhaps another upleg (or two)
will finally “needle” them aboard also.
CASE 6
October 27, 1984. Calling the Turn: A Case of Missing the Point
Recently, we received a copy of an article “Calling the Turn,” which
appeared in the August 1984 issue of Registered Representative Magazine.
Ordinarily, we pass over such reports, forecasts, predictions, and the like
with only the briefest of glances. But in this one case we did hesitate, set
aside the article, and attacked it with relish shortly thereafter. After all,
“Calling The Turn” is a headline with universal appeal. And we are only
human.
The article, it turns out, was really an optimistic assessment of the
outlook for natural gas in the United States. “Are we at the Bottom of a
classic commodity cycle in natural gas?” asks the subtitle. The author then
proceeds to list a number of issues that suggest that, over the long term,
a recovery in natural gas prices is likely. Typical of the points raised are
that (1) “the depression in drilling activity means we’re not replacing the
reserves we’re using,” and (2) “production from existing gas wells is
starting to decline very rapidly.”
Although the author acknowledges that “natural gas prices are probably
not going to get any Major, immediate boost from the crossover between
supply and demand,” he nevertheless advises registered representatives
to approach their clients with confidence and simplicity: “I think we’ve
identified a Major turnaround in the making, and it’s got some great
earnings potential for investors like you.”
Now, our understanding of the meaning of “turning point,” at least in
the context of stocks and commodities, and the marketplaces in which
they trade, is that point at which a change in the major direction or trend
of price occurs. In our view, a recitation of trends affecting the price of
a particular stock or commodity really has little or nothing to do with the
issue of calling the turn of price itself.
A recent case in point, of course, is the behavior of interest rates in
the United States. Certainly, major factors affecting the level of interest
rates in the U.S. throughout 1984 were the strong United States economy
and the huge federal deficit. We are aware of numerous economists and
forecasters who based their predictions of further escalating interest rates
on these underlying factors which to date remain in force. Yet, since June,
there has been a major turning point in Treasury Bills (December 1984),
and decline in interest rates, as Chart 46 illustrates.
We conclude that any article or prediction that heralds a turning point
without specifically considering supply and demand as measured by price
and trading activity in the marketplace is not worth the paper it is printed
on. Or, stated another way, no pun intended, we think the authors of
articles such as “Calling the Turn” have missed the point entirely.
90.8
TREASURY BILLS
90.6
(DECEMBER '84)
90.4
90.2
90.0
89.8
89.6
89.4
89.2
89.0
88.8
88.6
88.4
88.2
88.0
87.8
APR MAY JUN JUL AUG SEP OCT
Chart 46. Treasury Bills. December 1984. The Turning Point.

CASE 7
February 1, 1986. We Would Not Want to Get Scared Out
of the Market Too Soon
We note that a highly regarded colleague, a technician in fact, has likened
the recent “widely publicized 52-point shakeout in the Dow Industrials”
to “the stock market’s performance in early 1946. In February of that year,”
he states, “the Dow Industrials declined…following that February 1946
shakeout, the Dow Industrials recovered by late May before beginning a
23% decline by the final quarter of 1946.” He concludes, “I believe investors
should be prepared for at least the type of declines witnessed in 1946,
and on six occasions during the past two decades.”
There is no doubt that riding herd on a portfolio of stocks, especially
in an active and sharply advanced market, is a tense, nerve-wracking
business. We have often noted that the owners of stocks that are going
up in price rapidly seem to suffer more anxiety than the holders of stocks
that are going down in a bear market. Apparently, the threat is mainly to
the ego. It is always possible to rationalize holding a stock as it topples
and slides to new lows. One can buy more of it, “average” the cost,
accumulate stock at “bargain prices,” and undoubtedly defend it loyally
with optimistic predictions by the chairman of the board.
But when a stock is going up by leaps and bounds, the strain on its
owner seems unbearable. To sell it after a 20-point rise…and then see it
continue up another 20 points (like Union Carbide recently)…can hurt
one’s self-regard. And to hang onto it, and then have it crumble and sag
and fall to pieces before one’s eyes, can also hurt (like Storage Technology
last year).
Thus, it is no wonder that there are so many worried-looking people
pacing up and down at the back of boardrooms these days. They are the
investors who happen to be holding one or more profitable stocks which
have advanced at a rapid clip and in which they are holding a substantial
profit.
It might be easier on the nerves, and, ultimately, on the pocketbook, if
these investors faced the question as a problem in probabilities. They might
ask whether there was any evidence to date that the particular stock was
weakening, and whether this evidence was sufficient to justify selling it. Or,
quite reasonably, after a big runup, decide to put a close stop order just
below the previous day’s close, to gain the benefit of any further straight-
line advance, but to be safely out in case of the slightest reaction. This
would mean, to be sure, sacrificing the ultimate hope of maximum long-
term gains if the trend were interrupted by a normal period of reaction and
then continued up. But it would represent a positive decision and, for some,
it might be worth the possible loss of future profits to be “off the hook.”
Or, the investor might continue to hold the stock through any “normal”
reaction, until or unless it showed symptoms of a major reversal, and then
sell it summarily. Although such an approach never captures the extreme
of any move, holdings retained until a major reversal occurs often yield
large capital gains.
Discomfort is a normal component of speculating, which is what all
investment really is. Whichever investment approach one follows, it surely
helps to understand the element of uncertainty which is part of the picture;
and to realize that buy or sell decisions made on a stock-by-stock basis
have a better chance of working out well than do dramatic across-the-
board decisions to buy or sell all stocks because “the DJIA is about to go
up (or down) 50 points.”
CASE 8
January 24, 1987. The Elusive Crystal Ball
With the DJIA exploding into all-time new highs, we found this article
written by John Magee nearly 25 years ago, still an appropriate comment
on the often asked question, “How far do you think the market will go?”
THE ELUSIVE CRYSTAL BALL
A very good friend of ours, Carl Hamilton, teaches classes in

technical analysis of stock trends. In the winter he teaches
classes in Florida; in the summer, in New Jersey. He once wrote
us concerning what he tells his students.
“I always tell them to sell at the top as they will then make so
much more. When they ask me, ‘What is the Top or how can
one tell the Top?’ I tell them, without smiling, ‘When a stock
does not go any higher, that is the Top.’ When they ask me
when do I expect the Top to be reached, I tell them, ‘At exactly
two o’clock this fall.’”
When somebody asks us what our “objective” is for a certain

stock, or how long the rally is going to go, or whether the
average is going to break 450, we are tempted to say, “Well,
we’re sort of handicapped right now. When Robin Davis took
off for New Brunswick a couple of years ago, he took our
crystal ball with him, and he never sent it back. So we don’t
really know for sure exactly what the market is going to do in
the next six months.”
You could say a silly question rates a silly answer, and we think
some of these questions are silly. But we realize that investors
are really very seriously concerned about this market now (or
for that matter the market any time), and we are not indifferent
or unsympathetic. But, as we have said before, there is a good
deal of nonsense talked and written about the market, and a
great deal of conversation goes back and forth across the board
rooms, over the coffee tables, and around the cocktail lounges
that really amounts to nothing, gets nowhere, settles no prob-
lems and means very little in terms of practical strategy and
market planning.
The main reason we don’t try to pinpoint objectives of time or

extent of a move in the market, either for a single stock or for
the average, is because the forces that will determine market
action may be unknown or unpredictable today. Or, isn’t it
better to be watching the current situation, ready to change
plans in order to cope with a new development, than to be
chained with a self-imposed set of predictions that have to be
defended to the last ditch? There is so much talk, so many
words, that often seem to express only hope or desire, not much
scientific observation. Sometimes it reminds one of the predic-
tion that “Good old Centerville High will win, or lose, or tie.
Actually, it is hard to buy a stock on a breakout and then see

it sell off on a reaction. It is hard to buy on a reaction and
then sometimes see the stock go right on down to new lows.
It is painful to sell short on a sharp down move which may
prove to be a climax before a rally. Discouraging to wait and
miss a fine opportunity altogether. These are the built-in sources
of tension in the market, and the only way to handle them is
to know that there are going to be disappointments, unpredict-
able moves, new events in the world that will call for a new
look and perhaps for radically altered tactics.
In case you didn’t know, we will tell you a secret. That crystal
ball never did work very well. There are some good ways to
operate in the market, we believe, but they don’t depend on
being able to “forecast the future” with absolute certainty and
pinpoint accuracy.
Section 3
PORTFOLIOS
CASE 9
June 5, 1982. Managing Money
Let this be specific. We are thinking of a particular man whom we know.
His name is not Kenneth Hudson, but he is a very real person.
Ken has been highly successful and has a fine business reputation.
The value of his securities at the time we first talked with him amounted
to something over $300,000, a loss of about $100,000 from cost. At that
time he appeared very worried, quite unhappy. If he is still holding the
stocks he held then, he is considerably more worried and considerably
more unhappy today.
There can be no question as to Ken’s competence in his chosen field.
For many years he ran a difficult family business very profitably. When
it came time to sell, he negotiated an excellent transaction, divided
proceeds with several family members, and started another successful
business. He is regarded as a man of superior abilities, high intelligence,
and great determination.
However, a single look at his portfolio, or an hour of conversation
with Ken, and one realizes that he is absolutely ignorant of the nature of
his securities, has had no training or preparation in this area, has no
feeling of self-assurance or confidence, and suffers a great deal of anxiety.
Just for openers, he owns 41 different stocks and bonds. Now there
is such a thing as overconcentrating in a single stock, and there is a good
deal to be said for having some diversification. But to follow the financial
developments of 41 stocks and bonds at once is certainly beyond the
abilities of anyone who is also working at a breakneck pace in his business
or profession.
But there was more evidence of Ken’s confusion. Within the common
stock section of the portfolio, more than 50% of the holdings were in one
167
industry And the holdings were unbalanced, ranging from as high as

$30,000 in one issue to $3,000 in others.
Also the portfolio included not a harmonious but a seemingly random
selection of ultraconservative stocks, “Go-Go” issues, more or less standard
securities of average habits, over-the-counter items, and some esoteric
stocks, apparently in companies in which Ken had friends, relatives, or
other close “inside connections or information.”
All this made it clear why Ken looked so worried and so unhappy.
The investment program on which his retirement would depend was a
mess. And this he probably knew. But he did not know what to do about
it. Here he was, a brilliant and “successful” man with a considerable
fortune. But in all the long years of his education, in courses which
touched on economics, civics, and even finance, he had not had any
definite instruction about stocks, bonds, the financial markets, and how
they operate. And, like many others with a hardworking schedule and
family responsibilities, he did not have the time or the energy to start the
education he had never received.
There is a “gap” and a lack of relevance in the highly specialized
education that prepares so many people so well for “making a living” as
doctors, lawyers, engineers, or business executives but prepares them not
at all to protect and to manage effectively the fruits of their life’s work.
CASE 10
April 2, 1983. New Issues, High Technology, Wonder Stocks,
and the Like
Recently, in one of our favorite daily financial publications, we read about
“the return of the little guy” to the stock market. On the front page, there
was the paving contractor from Chicago who dumped a considerable
portion ($1,300) of his rainy day “nest egg” into 1000 shares of TechBomb
(not its real name) at $1.25 per share. Before the day was over, his mother
had invested $700 in the company and his younger brother $1,300. “It’s
like going to Las Vegas,” he was quoted as saying. “Don’t sit around
worrying about it. Just do it.”
The article went on to mention several other new issues, high tech-
nology, and wonder stocks which have captivated the public’s imagination
recently, often doubling or tripling in a short period. Not that all new
issues or concept stocks are hot air, or close to it, or even that most of
them are, but the enthusiasm generated by the current bull market, as
with every bull market, is undoubtedly producing excesses particularly
dangerous to the new or uninformed investor.
It all reminds us of a piece we wrote a year or so ago entitled “Hole-
In-One.” We noted at the time:
No sane golfer would announce his or her intention of making

a hole-in-one, this afternoon, on the next hole.… Although
most people, consciously or unconsciously, realize that a hole-
in-one is a combination of good golf and good luck, it is strange
how many people go out to play a much tougher game than
golf for the first time in their lives, set their ball up on the tee,
whack it down the fairway or into the woods, and then wonder
why they didn’t make a hole-in-one. They go into the stock
market on a gamble, tip, or rumor, staking savings they cannot
afford to lose on the most speculative stocks, without diversi-
fication or predetermined loss limits.
Champion golfers do not depend on holes-in-one or ‘all or

nothing’ drives. Successful investors do not depend on hot tips
and new issues to convert excessively margined, speculative
positions to ‘once in a lifetime’ profits. Successful people
depend on methods that can advance their interests in good
times… and also protect their interests in hard times. Like bridge
players making the most of the cards they hold, good or bad.
What really amazes us is that many of these new investors are

buying stocks for which no previous price or volume data exist.
Do they not know that when a company strikes a bargain to
go public it invariably tries to obtain the best possible price for
its shares? Only occasionally, very rarely, do stocks — especially
new issues — double or triple in a matter of weeks or months.
In times such as these, the established Edwards and Magee
philosophy of trend following utilizing protective limits is of
particular importance. Not flashy, perhaps, but rational, system-
atic, and time-tested over years of practical application.
Incidentally, the shares of TechBomb were last quoted at $1.12.

Section 4
LAUGHING AT THE PUNDITS
CASE 11
December 3, 1983. The Reason(s) for the Move
Rarely, if ever, do we feature the same chart in two consecutive editions
of Page One. This week, however, the instant gratification from copper’s
breakaway explosion was simply too powerful to ignore. After leaping
out of the potential reversal pattern on a 100-point gap on Monday, it
advanced Wednesday to a high of 69.30 before retreating. For agile traders,
the 300+ point, 3-day move was tantamount to a 75% profit per fully
margined copper contract. Impressive gains were also posted by copper-
related stocks such as Newmont Mining and Phelps-Dodge, as well as by
other metal issues caught up in the storm.
We have no idea as to the reasons behind Monday’s sudden explosion
in copper. And we were more than a bit surprised (and amused) to read
that it was all due to last week’s great London gold robbery!
The price of gold on international markets climbed $18 an

ounce yesterday, to its highest level in more than a month,
sparked by the weekend theft of three tons of bullion…
“Currency Markets,” The New York Times,

November, 29, 1983.
Copper on COMEX rose 135 to 125 points at the close in

response to higher gold and silver prices.
The Journal of Commerce, November 30, 1983.
171
And there you have it. The surge in copper was due to the work of
a gang of London gold thieves!
Our own thought processes admittedly being somewhat slow, we are
skeptical of the “reasons” for the gold (and copper) advances as reported
in our favorite newspapers. With just a slight stretch of the imagination
we could envision a happy group of suddenly wealthy thieves sitting
around a cauldron, melting down their $37 million in ill-gotten gold,
readying it for return to the marketplace. The result in our mind — little
or no effect on supply and demand.
Our founder, John Magee, summarized his views on the reasons for
market moves most eloquently:
Every now and then some stock, a group of stocks, or the

whole market, which has been lying dormant for weeks, sud-
denly takes off in a great explosion of activity.
Some people will say, “Well, there must be a reason in back

of this activity.”
It may be a good reason, it may be a bad reason, it may be a

reason not directly related to the company, but perhaps to
politics, international affairs, matters of control or merger of
corporations, etc. There could be two reasons, three, many
reasons, all true.
We prefer to study carefully what is going on in the market, to

make our inferences and decisions on that and not to dig too
deeply into the rich, confusing veins, arguments, and hypotheses.
We couldn’t agree more.

CASE 12
October 13, 1984. Which Way the Market, and Why
Everyone wants to know “which way the market will go.” The trouble is,
nobody really knows. Usually, there are numerous opinions as to the
future course of stock prices, and just as numerous “theories” behind
those opinions. From time to time, there is even a consensus — most of
the “experts” who have an opinion agree. When that does happen,
however, as often as not the exact opposite actually occurs.
Granted, forecasting the future of anything is difficult; in the stock market
it is particularly so. In fact, so complex are the workings of the stock market
that few “experts” can even agree on the reasons for market movements
that have already occurred. Our favorite source of entertainment on this
score is the stock market column that appears daily in just about every
newspaper. Some recent examples follow.
On September 27, in the Wall Street Journal, we learned from the vice
president of a major wire house: “Some institutions also were buying to
get more stocks in their portfolios before the end of the quarter. Being
invested was the way to look smart (to clients) this quarter,” he said.
Only a week later in the same column, investors were advised by the
senior vice president of the St. Louis office of another major brokerage
firm: “The relatively low volume lately suggests that many institutional
players also are sitting this market out. If you had a real fright in the
market, you would see volumes of 120 million to 130 million plus. But
we are merely in a lackluster market, and whenever volume dries up
prices slide a bit.”
If all this isn’t crystal clear, perhaps the October 10 comments by the
senior executive vice president of a very large wire house can clarify
matters: “The market can’t sustain a rally temporarily. The problem is that
most money managers and the general public are either selling or sitting
on the sidelines.”
We couldn’t agree more. Either the institutions are buying, sitting on
their hands, or selling. That about exhausts the possibilities. True, stock
market columns can make for good, relaxing entertainment, along with
sports columns, TV and movie columns, and the like. But they certainly
shouldn’t be taken as gospel in a matter as serious as investing. As our
founder John Magee noted more than 20 years ago:
Every now and then some stock, a group of stocks, or the

whole market, which has been lying dormant for weeks, sud-
denly takes off in a great explosion of activity.… Some people
will say, “Well, there must be a reason in back of this activity.”
It may be a good reason, it may be a bad reason, it may be a
86 COPPER
(MARCH '84)
84
82
80
78
76
74
72
70
68
66
64
62
60
JUN JUL AUG SEP OCT NOV
Chart 47. Copper. March 1984.
reason not directly related to the company, but perhaps to

politics, international affairs, matters of control or merger of
corporations, etc. There could be two reasons, three, many
reasons, all true. We prefer to study carefully what is going on
in the market, to make our inferences and decisions on that
and not to dig too deeply into the rich, confusing veins,
arguments, and hypotheses.
CASE 13
September 14, 1985. The Hemline Barometer and Other “Mood”
Measures as Crystal Balls to the Future
The market price reflects not only differing value opinions of

many orthodox security appraisers, but also all the hopes and
fears and guesses and moods, rational and irrational, of hundreds
of potential buyers and sellers, as well as their needs and their
resources — in total, factors which defy analysis and for which
no statistics are obtainable, but which are nevertheless all syn-
thesized, weighed and finally expressed in the one precise figure
at which a buyer and seller get together and make a deal.
Technical Analysis of Stock Trends,

by Robert D. Edwards and John Magee
Followers of Edwards and Magee are familiar with the basic tenets of the
pattern recognition school of technical analysis, particularly the hard-to-
measure psychological bias which underlies the individual trader’s deci-
sion-making process. Fundamentalists can argue about rational, fact-filled
reasons to buy or sell. But clearly, the emotional state of the investing
public is a major factor in the movement of the stock market. As chartists,
we are constantly attempting to measure these changes with systematic
analysis of price and volume. On a broader scale, however, an astute
observer can also anticipate changes in the basic emotional foundation
of the public by observing popular culture itself, a sort of “stepping back
from the trees to look at the forest” approach.
Although this is not a new, or even a surprising, theory, we had not
given the matter much thought — aside from a chuckle or two over using
the “hemline” barometer as a measure of bullishness — until we read a
recent article (Barron’s, September 9, 1985) by Robert Prechter of Elliott
Wave fame. Apparently, there is more than a shapely calf to meet the eye
in hemlines and other changes in public taste. Indeed, Mr. Prechter
postulates that popular art, fashion, and mores reflect the dominant public
mood and that the stock market, being a highly reflective arena of
emotional behavior, moves in concert with these major shifts in public
attitude. He further suggests that these dominant moods, whether negative
or positive, have a great deal to do with the character, and are possibly
the cause of, historic events. “Major historic events that are often consid-
ered important to the future (i.e., economic activity, law-making, war) are
not causes of change: they are the result of mass mood changes that have
already occurred.” If this is so, then one can argue, as Mr. Prechter does,
that “evidence of mood change is the single most important ar ea of

discovery for those who wish to peek into the future of fundamental
events. In the world of popular culture, ‘trendsetters’ and the avant-garde
must be watched closely since their ideas are often an expression of the
leading edge of public mood.”
The article goes on to point out how fashion, movies, and, particularly,
popular music tastes have signaled major turning points in the stock
market over the past 35 years. These observations will not help a short-
or intermediate-term trader much, nor will they aid investors in timing a
specific stock position. But, as a broad measure of the general health of
a long-term trend they have merit. Incidentally, by Prechter’s reading of
the popular culture barometer, we appear to be in a period akin to the
mid-1920s.
For further information on this subject, we refer readers to New Classics
Library, Inc., P.O. Box 1618, Gainesville, GA.
CASE 14
December 15, 1984. The Elliott Wave Theory: Perspective
and Comments
This week we had the pleasure of attending the December meeting of
the Market Technicians Association (MTANY) of New York.
Long-term subscribers will remember the MTANY as the organization
which honored John Magee with its “Man of the Year” award in 1978.
The speaker was Robert Prechter, publisher of “The Elliott Wave Theorist,”
an investment advisory which bases its forecasts on interpretations of R.N.
Elliott’s work on the stock market.
Of primary interest to Magee subscribers are Prechter’s comments on
technical analysis itself. The Elliott Wave Theory, it must be remembered,
is really no more than a “catalog” of stock market price movements, laid
one on top of the other, so to speak, until a grand, underlying and
enduring pattern is observed; in short, pure technical analysis. Among
Prechter’s definitions and observations regarding fundamental analysis are
the following:
1. First let’s define “technical” versus “fundamental” data…tech-

nical data is that which is generated by the action of the
market under study.
2. The main problem with fundamental analysis is that its
indicators are removed from the market itself. The analyst
assumes causality between external events and market move-
ments, a concept which is almost certainly false. But, just as
important, and less recognized, is that fundamental analysis
almost always requires a forecast of the fundamental data
itself before conclusions about the market are drawn. The
analyst is then forced to take a second step in coming to a
conclusion about how those forecasted events will affect the
markets! Technicians have only one step to take, which gives
them an edge right off the bat. Their main advantage is that
they don’t have to forecast their indicators.
3. What’s worse, even the fundamentalists’ second step is prob-
ably a process built on quicksand.… The most common
application of fundamental analysis is estimating companies’
earnings for both the current year and next year, and rec-
ommending stocks on that basis… And the record on that
basis alone is very poor, as Barron’s pointed out in a June
4 article, which showed that earnings estimates averaged
18% error in the thirty DJIA stocks for any year already
completed and 54% error for the year ahead. The weakest
link, however, is the assumption that correct earnings esti-
mates are a basis for choosing stock market winners. Accord-
ing to a table in the same Barron’s article, a purchase of the
ten DJIA stocks with the best earnings estimates would have
produced a ten-year cumulative gain of 40.5%, while choosing
the ten DJIA with the worst earnings estimates would have
produced a whopping 142.5% gain.
We enjoyed Prechter’s polished exposition of a technical approach

different from our own. As for his observations about fundamental analysis,
we simply could not agree more.
CASE 15
June 6, 1987. Earnings Forecasts: Dangerous to Your Financial Health!
A recent article in Forbes, “Upward Bias,” asked the question, “Is it possible
that analysts concoct future earnings to justify today’s lofty stock prices?”
The answer appears to be yes. In a group of 20 issues, which analysts
were forecasting as the fastest-growing companies 2 years ago, the author
showed that there was a whopping (surprise) error factor of minus 73%.
This means the average earnings forecast for this group of stocks was
73% under the actual earnings result.
This got us to thinking about a significant peril in fundamental analysis
which we read about a few years back in Contrarian Investment Strategy,
by David Dreman. Dreman, in fact, was quoted in the Forbes article.
Because it is clothed in presumably hard data, with an air of academic
certainty, fundamental research reports are often taken as “gospel.”
Although Dreman is not an advocate of technical analysis, for the often-
cited reason that academic evidence is lacking, his comments on the
pitfalls in fundamental analysis were especially cogent and important when
one considers how it dominates the decision-making process in the
financial industry. According to Dreman, “Research has demonstrated that
earnings and dividends are the most important determinants of stock
prices over time. The core of fundamental analysis is, thus, the develop-
ment of techniques that will estimate these factors accurately.” But, he
concludes, after looking at the record, “a system that appears eminently
sensible in theory has proved exceptionally refractory in practice.”
Without going into considerable detail in this article, we believe
Dreman made a strong case for the argument that the root problem has
to do with the fact that “there are very serious flaws in the analytical
methods (of fundamental forecasting) that lead to consistent investment
error.” Briefly, the problem lies with man’s information-processing capa-
bilities. The human mind processes data in a linear manner. It moves from
one point to the next in a “logical sequence.” However, analyzing complex
financial data requires the ability of the analysts to change the interpre-
tation of any single piece of information depending on how he evaluates
many other inputs. This is called configural reasoning and, from various
tests on the subject, it appears that most of us just cannot do it very well.
Section 5
TECHNICAL QUESTIONS —
STOPS
CASE 16
May 7, 1983. Beyond the Limits
Aside from wanting to know what’s hot, or how far the DJIA will go up
(or down), the most frequently asked questions we receive have to do
with protective stop limits.
Most of the inquiries on the subject ask about a particular limit for a
particular stock. Others, however, want a specific formula for limit place-
ment. And a few suggest that we have substantially deviated from John
Magee’s methodology.
It is true that there has been a change in our method of setting limits
over the past few years. John Magee wrote about using a formula based
on a limit 5% under the last minor low, adjusted for volatility and stock
price level (higher-priced issues make smaller percentage moves than
lower-priced ones). The crux of this formula was a sensitivity index, but
it did not prove to be particularly successful over the years and ultimately
was discarded by the current staff.
However, as Magee wrote, “There is no perfect and absolutely satis-
factory rule.” We agree that a hard and fast formula is not practical. In
general, our guideline for establishing protective stop limits is as follows.
The initial or opening limit for a stock is placed at a point at which
important support is evident (under a trading range or channel, under a
major low, etc.). Most often, this will be a relatively wide limit reflecting
several substantial support zones which have evolved in the basing pattern
preceding our recommendation. An important objective of these initially
wide opening limits is to provide every opportunity for a new recommen-
dation to achieve its potential.
181
As a stock progresses in our favor, limits are advanced more aggres-

sively. We specifically watch trendlines, minor lows, support-resistance
points, and gaps. Especially important is the point that, if violated on a
closing basis, indicates a change in the major trend. We refer those who
wish to fine-tune the limit-setting process to include intraweekly limit
adjustments to the section on progressive stop orders in Technical Analysis
of Stock Trends, by Edwards and Magee).
We also use, on occasion, arbitrary “buy or sell at the market” exit
orders. In particularly fast-moving situations (often after a merger announce-
ment), in which straight-line advances (or declines) make the placement
of protective stop order limit orders difficult or dangerous, this type of
exit is advisable.
Whereas these general principles apply to perhaps 90% of protective
limit-setting situations, there will always be that difficult 10% of the time
when “the rules do not seem to apply.” Consultation with our staff is
recommended in such cases. In addition, subscribers may wish to trade
against their open positions (i.e., sell part of a position on extraordinary
strength, buy back on the pullback, or sell and repurchase covered calls),
all within a period when no limit violation has taken place.
It is understood, of course, that protective stops under long stocks are
never moved down, nor are protective stops over shorts ever moved up.
Although we have modified our method of setting limits over the years,
this fundamental principle of protective limits remains inviolate.
CASE 17
September 1, 1984. Big Money in Brain Surgery: Learn at Home this
Quick, Easy Way
Some Wall Street wisdom is timeless. This commentary, written by John
Magee on July 23, 1966, is as insightful today as it was 18 years ago.
It always fazes us a little to realize how many people spend so

much time, money, and effort, apparently in a quest to discover
the “hidden secrets” of the stock market. Mr. Average Man who
has a few thousand dollars to invest and who may have a very
keen understanding of his own business or profession, so often
comes to Wall Street with the bright hope that he is going to
find the magic word, or the crystal ball, or the unfailing oracle;
a hope, by the way, that is not likely to be realized.
He will keep trying this formula or that “system” in much the

same spirit that one might go out in the woods on a misty
morning and peek behind every big rock along the way in the
expectation that sooner or later he might find a leprechaun
hiding there.
It is not that he is unwilling to put further effort or to spend

money and time in his search. It is that he is searching in the
wrong places for something that does not actually exist as he
imagines it.
So often he is seeking something that will provide a degree of

certainty that nobody can expect in this world. He does not
realize that the market evaluation is a thing in flux, a day-to-
day balance of the prospects for this stock or that stock, and
these prospects can be influenced by conditions that cannot be
predicted with certainty or, in some situations, cannot be pre-
dicted at all. Let a big contract be canceled, let a new “pocket
war” break out somewhere, let any new circumstance come
into the economy or into the affairs of a single company, and
the market will revalue the stock accordingly. No method,
scheme, or plan that we know of can anticipate everything that
may happen in the future. The most that one can hope to
accomplish is to estimate the reasonably expectable conse-
quences of a set of presently known conditions. There remains
a big area of uncertainty, and an essential part of the investor’s
problem is to recognize this, accept it, and understand that a
considerable part of his strategy must be to learn how to cope

with conditions when they do not work out as he had antici-
pated, or when new conditions result in new trends. He must
learn not to make his original judgments “too absolute” and
learn how to defend himself when they must be changed.
And, too, the new investor is often trying to reduce the market
to a much-too-simple affair. He will cram his bookshelves and
his desk with reports and data, stuff his head with figures,
master a dozen rule-of-thumb “methods.” He will have facts,
sometimes too many irrelevant facts. And he may not realize
that thousands of people are watching the market, studying it,
analyzing it by various means, making their evaluations in their
own ways, and some of these people have a great deal of
insight plus a great deal of experience. They know what to do
“if all goes well, according to rule,” but they also know when
“it is time to throw the book out the window” and improvise.
We believe that this ability to roll with the punch, to confront new or
unexpected situations with courage and calmness, does not come from
theory alone or facts alone but from deep awareness of both the mechanics
and the psychology involved: a knowledge that usually comes hard, and
is learned mostly in the “School of Hard Knocks.” Like brain surgery, it
is a matter not to be acquired in a few easy lessons but by actual
experience and insight.
CASE 18
September 22, 1984. Forecasting: No Such Thing as a Sure Thing
Almost nightly we turn on the television (or call the weather number) to
hear a rather pleasant fellow as he tells us about the low extending
southward from Pennsylvania and extending as far west as the Mississippi;
the Canadian cold front, now moving slowly southeastward at a speed of
about 10 miles per hour; the relative humidity; present temperature at
Logan Airport; and the small-craft warnings from Block Island to Long
Island Sound. Also, that the next 2 days will be marked by much colder
air moving into the area, and chances of precipitation are 3 out of 10.
To a good many people, this is either (1) the gospel or (2) the next
best thing to it.
It is certainly not the gospel, however. There are competent men and
women with long experience in the Weather Bureau, who are telling us
what the probabilities seem to be at this time in light of their knowledge
and the data before them. They would be the first to tell you that they
do not know with certainty what the weather will be on Sunday, because
winds can shift and new factors can come into the picture. But, taking it
on balance, the predictions do represent an informed and intelligent
“estimate” of what is most likely to happen. And yet there are some people
who feel personally injured when rain appears at the picnic instead of
the “sunny and clear” which was predicted, and they want to go down
and take a swing at the poor, hard-working weatherman.
Sometimes a meteorological prediction is quite definite. The other night
our friendly weatherman wrote on the board under chances of precipita-
tion the figures 10/10, that is 10 chances out of 10, or “certainty.” Actually,
we did get some rain. But if you had pinned him down on that 10/10
prediction, he would undoubtedly have conceded that a more realistic
figure might have been 95/100 or 98/100 — “close to” certainty but not
“absolute.” There is always a certain element of doubt, calling for tentative
judgment. It is good to know what seems most likely to happen but
always necessary to be prepared to revise a plan when and if data change.
In stocks, many investors are likely to accept the reports or data they
may have as “final” and “absolute,” the veritable “sure thing.” But the
stock that looked strong in August may run into trouble: a reduced
dividend, a bad quarterly report, or whatever. And the weak-looking stock
may turn around and start up. Operating successfully in an environment
of uncertainty, however, is not “just a matter of luck.” It is possible to
make reasonable and good recommendations and decisions as long as
one realizes that stocks, like the weather, are continually changing and
call for the ability of an investor to change his or her mind when conditions
call for it. In fact, there is no such thing as a sure thing. Consistent success
requires constant monitoring of a stock’s trend and the flexibility to
recognize and take action if the trend changes.
CASE 19
March 16, 1985. When a Stock Collapses: Crisis or Opportunity?
In recent weeks, holders of several big-name technology stocks have been
subjected to the agony of a “delayed opening – news pending” announce-
ment followed by a severe decline in the market price of their shares. It
all began 4 weeks ago when Data General announced that “current quarter
earnings could be below expectations of Wall Street analysts” (from its
Monday, February 11 closing price of 72⅞). DGN collapsed to an intraday
low of 56½ before recovering to close at 58¾, off 14⅛ for the day.
On Tuesday of this week, holders of Wang Labs were subjected to a
spine-chilling decline of approximately equal proportions, as were holders
of Computervision (see Chart 48) on Wednesday when that company
predicted “break-even results on less-than-expected sales” for the current
quarter. For Wang, the drop amounted to 9⅜ points. The 1-day 9¾-point
plunge in CVN (to 23⅞) amounted to an astounding $270 million reduction
(one-third) of that company’s market value.
Whereas the foregoing events constituted a crisis for existing holders
of Data General, Wang, and Computervision, they represent an unfolding
opportunity for the balance of the investing public. Just as computer and
technology stocks were the “darlings” of the 1982–1983 stock market rally
and are today its “black sheep,” many of these issues will undoubtedly
score large advances from current levels. In Wall Street, the wheel turns.
Technical analysis is unusually well-suited for such occasions. First, no
technical tenet would justify bottom picking, or buying into a “decline”
such as those currently under way in DGN, WANB, and CVN. Often such
declines are precursors to substantial further declines. What technical
analysis requires after such a jarring decline is a settling-down or cooling-
off period. Typically, these last a minimum of 3 weeks and as long as
several months. And typically, the bottoming process after such drastic
declines involves a series of recognizable events — a rally of 30% to 50%
of the preceding decline followed by a low-volume test of the “crisis”
low. The final configuration of the basing process — head-and-shoulders,
rectangle, or double bottom — cannot be ascertained in advance. One
thing is clear, however; most of today’s fallen angels will be available at
current prices or lower for some time to come. And when the trend is
about to reverse, that fact will be evident on the daily price and volume
chart. Corporate announcements, as so clearly shown this week, simply
do not occur in time to be useful for investor decision making.
Chart 48. Computervision. Opportunity or Trap?

CASE 20
July 6, 1985. The First Shoe Drops
A few weeks back, at the invitation of Barron’s, we penned an article
about the classic technical pattern that often precedes corporate takeovers,
or takeover-related activities. Entitled, “Worth a Thousand Words,” the
Barron’s article (May 6, 1985) highlighted four companies “whose charts
exhibit classic pre-takeover patterns but for which no takeover has (yet)
been announced.” The four companies were Allied Stores, Amerada Hess,
Time, and United Brands.
When contacted by Barron’s, spokesmen for Allied Stores, Time, and
United Brands were quick to deny any knowledge about pending takeover
or takeover-related activities. “We are not talking to anybody,” said Orren
Knauer, an Allied vice president. Time spokesman Louis Slovinsky reported
that “the company isn’t talking to any suitors,” and that the company had
“put in some anti-takeover provisions such as staggered election of direc-
tors.” Even more specific was the spokeswoman for Carl Linder’s American
Financial Corporation which, according to Barron’s, owned 58% of United
Brands’ stock. “There have been no talks either about buying the rest of
the stock or about selling American Financial’s stake,” she declared. As
for Amerada Hess, they failed to return a phone call from Barron’s.
Imagine our surprise on Friday of this week, then, when a company
called FMI Financial offered to buy 4 million shares of United Brands at
20. FMI Financial, the news release went on to say, is controlled by Carl
Lindner, principal shareholder in both American Financial and United
Brands.
Return for a moment to the United Brands chart shown in Barron’s.
To the date of the article, the United Brands chart contained “no less than
five Friday spikes, an extraordinary number in our experience,” we
reported. Add to that the current offer to purchase 4 million shares made
on July 5 — also a Friday! An astounding coincidence, we are sure.
We have often referred to technical analysis as the art of following
footsteps on the charts. Price and volume data do reflect the activities of
“informed players,” as well as all others, and these often do pr ovide
unmistakable clues to impending events. Certainly, this was the case with
United Brands. The jury is still out in the matters of Allied Stores, Amerada
Hess, and Time. Which shoe will drop next?
1985
19
18
UNITED BRANDS
17
16
15
14
13
12
BARRON'S ARTICLE
11
10
...11722
9
600
400
200
JAN FEB MAR APR MAY JUN

FRIDAY SPIKES
Chart 49. United Brands. Astute Chart Analysis Predicts Takeover.

CASE 21
July 13, 1985. Protecting Stock Market Profits, or a Trip Into
the Wild Blue Yonder and Back
Except for the names (which have been changed), this is a true story
about a woman investor we know who got wind of a big move coming
up in Blue Yonder Computer Corporation. According to rumors, the
company had developed a new process by which it could store the King
James version of the Holy Bible on a memory chip the size of your
eyelash, and major production was just around the corner. In June 1983,
Linda High Hopes bought 2,000 shares of Blue Yonder stock for 80 cents
each, or $1600; not an inordinate amount to place in an extremely
speculative stock.
Those around the office, however, shook their heads. How many times
had they heard about impressive new products, discoveries, or processes,
all in connection with low-price (penny) stocks — only to see the bubble
burst in the dawn’s early light?
They were not even particularly impressed when Blue Yonder rose to
$1.20 a share in July, a heady 50% advance in 30 days. They were even
more impressed, moreover, when Linda called up and bought another
1000 shares at $1.25.
Their indifference turned to profound respect (and a little bit of envy)
the following year when Blue Yonder reached $2.80, at which price their
friend bought 2000 additional shares in June), and then when she pur-
chased another 2000 shares in December at $4. By early this year Linda
had accumulated 7,000 shares at an average cost of $2.46 per share. Her
unrealized gain approached $30,000 this spring as Blue Yonder traded
above $6 on the NASDAQ National Market.
Along the way, Linda’s broker suggested she sell half her holdings
(thereby getting her investment back plus a considerable gain), while
“letting her profits run on the balance of the position.” The advice was
received politely but not acted on. And Blue Yonder, which had previously
been something of an erratic performer, settled down into a long holding
pattern at $6. Then in a short time, Blue Yonder sold off sharply, dropping
to $3.60 a share where it again held briefly. No, Linda was not disturbed
by this weakness, nor did she ask for quotes on a daily basis any longer.
It had become a long-term holding.
Imagine everyone’s surprise, however, when Linda’s broker received
a phone call to sell 7000 shares of Blue Yonder last week. We punched
out BYON on the quote machine. It was selling for $1.20 per share! After
some consultation, Linda decided to hold her shares a bit longer, not a
bad decision based on their recent price of $1.80. Her loss, if she sold
today, would be less than $5000 — not overly damaging in the world of
high finance. But the foregone profits of nearly $30,000 are a great loss.
To be successful as an investor, one must learn how to realize profits as
well as how to protect against major losses.
In our service we have noted repeatedly that investors are continually
subjected to information, rumors, and tips of every sort — most of them
well intended — and that unless each investor develops his own philos-
ophy with regard to buying and selling, he will be unable to operate
successfully in the stock market. In the case of Linda High Hopes and
Blue Yonder, simple maintenance of a daily chart, attention to trendlines,
and a firm resolve to “get out of a stock once it turns weak” would have
made all the difference.
CASE 22
December 20, 1986. Flags, Triangles, and River Sediment
What does the thickness of river sediments have to do with classic technical
analysis? Quite a lot according to an interesting article in the December
1986 issue of Technical Analysis of Stocks and Commodities, one of the
better monthly magazines devoted to the subject. The author, Curtis
McKallip, Jr., is a consultant on risk analysis in oil exploration. McKallip
wrote his master’s thesis on the Markov transitions in river sediments of
the Triassic age in East Central New Mexico (you would not need a
sleeping pill if you had that tome by your bed). The statistical method
used to measure the shifting sediments of the river is applied to equally
“shifty” transitions between stock patterns as defined by Technical Analysis
of Stock Trends by Robert D. Edwards and John Magee.
The pattern base for the study, which was titled “Investigating Chart
Patterns Using Markov Analysis,” was weekly prices of 19 commodities
from 1970 to 1979. McKallip marked the obvious formations on his weekly
charts, using the one that was best defined when one pattern enclosed
another. Complex patterns, however, were broken into component parts;
that is, the head-and-shoulders pattern was not measured as a unit but
was considered a collection of trends, triangles, and flags. The article did
include a long-term chart of wheat in which the various patterns were
marked and identified. As a long-time practitioner of pattern recognition,
we had problems with some of the author’s chart interpretations and
nomenclature. What he calls a symmetrical wedge, for instance, is a
rectangle. Chartists, of course, will disagree on formations and our differ-
ences of opinion probably would not have altered McKallip’s results.
Once the charts were marked up, the next step was to count the
transitions from one pattern to another and use the data to set up a
Markov matrix which uses chi-square calculations. McKallip has included
in the article a two-page description of his methodology plus references
(ours included).
This writer is not well grounded in statistical probability and has almost
lost his ability to add or subtract without the use of a calculator. Therefore,
I will not attempt to clarify a subject which is not clear to me. However,
those with a mathematical frame of mind and access to a computer can
obtain a copy of this magazine (for $8) from Technical Analysis, Inc., 9131
California Avenue SW, Seattle, WA 98136; (202) 938-0570; now at
www.traders.com.
Without getting bogged down in the methodology, we can appreciate
the results of the study. The total number of transitions tabulated in the
article was 738. A number of them were too infrequent in the sample
data to be of any statistical value; surprisingly, this included rectangles
(symmetrical wedges). There were, however, three basic pattern groups

that dominated the study: trends (we would call most of these up or down
channels), flags (up and down), and triangles (symmetrical and asymmet-
rical). McKallip noted that “Symmetric Triangles seem to precede Uptrends
but Asymmetric Triangles preceded Downtrends more significantly.” His
data shows a 64% probability that an uptrend will follow a symmetrical
triangle, but his numbers for asymmetrical formations seem inconclusive to
us. By far, the most significant transition pairs in the study concerned flags
and trends. Over half (54%) of the transitions identified were either moving
from a trend to a flag or a flag to a trend. The results of the analysis,
however, were not surprising. The probability matrix showed that an up
flag leads to a downtrend 66% of the time whereas a down flag transforms
into an uptrend 77% of the time. In short, flags proved under Markov
analysis to be highly valuable continuation patterns. Interestingly, the reverse
was also true. Up flags evolved from downtrends 37% of the time and down
flags had a 39% probability of forming from an uptrend.
CASE 23
January 17, 1987. Big Blue — From Bellwether to Bust!
International Business Machines has gone from a market leader to a
laggard during the past year. Over the summer, while it had already slipped
from its bellwether status in performance, it did, in fact, reflect the internal
technical condition of the majority of issues then struggling along in a
consolidation phase (see “Taking the Market’s Temperature,” June 21,
1986). But our “temperature gauge” metaphor for Big Blue faltered when
new lows were consistently made during the second half of 1986 while
the DJIA, and the majority of the market, were holding within consolidation
boundaries. Indeed, the spark of fire that enticed us back into IBM in
November has been reduced to a smolder following Wednesday’s plunge
through support. The breakdown was greatly aided, we might add, by
The Wall Street Journal’s redoubtable “Heard on the Street” column which
contained, among a few distant bullish cries, the following pearls of bearish
wisdom:
“IBM is still a company that’s not scared enough.”

“IBM’s strong balance sheet is lily white and doing nobody any good.”
“Big Blue’s critics now predict a horrible first quarter.”
“Even the company’s most ardent admirers anticipate terrible news
(for 4th quarter and year earnings).”
“Some analysts now say net (4th quarter) earnings more likely
plunged more than 40% to $2.55 a share — and perhaps fell even
more.”
It is no wonder a lot of bulls stampeded out of Big Blue this week.

Looking at this issue from a long-term point of view, however, suggests
that IBM may be an excellent contrarian buy. On the daily chart, a well-
defined downward-slanting channel has evolved since the May 1986 high.
The lower boundary of this pattern is approximately 110. The long-term
monthly chart, on the other hand, shows that a much broader upward-
slanting channel dominated IBM from its 1974 low to the breakout of
resistance in 1983. If the upper boundary line of this long-term channel
is extended, it provides old resistance/new support around 110 during
1987; note the fine test of this line during the 1984 decline.
A line drawn from the 1952 low through the 1981 low crosses this
year at (you guessed it) 110. We initially identified long-term support at
the 1985 low of 118, and placed our stop limit at 115.
However, due to the intersection of the foregoing trendlines at 110,
the limit in IBM is being lowered to 110 this week.
Chart 50. IBM, 1975–1987. Testing a Thesis Based on Long-Term Trend Analysis.
We are not fundamentalists, and, perhaps, IBM’s ills are terminal. But
there are clearly some solid technical reasons to buy Big Blue during the
current reaction notwithstanding the bearish comments in Wall Street.
However, for those wishing to wait for a reversal, it would be wise to
use a penetration of the downward-slanting channel at 132 to enter or add.
Chart 51. Dow-Jones, Illustration of Magee Evaluative Index.

CASE 24
September 28, 1985. An Oversold Market
This week, the MEI fell to 9% strong, its deepest penetration into the
oversold quadrant this year. Not since June 1984 has this index been lower
(see Chart 51). Shortly after its June low of 8% strong, the MEI headed
steadily higher, giving an aggressive buy signal throughout late June and
July.
The June 1984 MEI low of 8% strong, together with the 8% level
reached on February 25, 1984, constituted a double bottom oversold
reading for this index. It corresponded to the 1079 bottom recorded by
the DJIA on June 18, 1984, after which that index advanced steadily to
its recent July peak of 1372.
For more than 20 years, all major stock market bottoms have corre-
sponded with extremely low MEI readings. During the “turbulent period,”
when the stock market oscillated violently but showed no gain at all, MEI
readings of 5% strong or less corresponded with all major DJIA bottoms
until the June 1982 low of 9% strong, which immediately preceded the
stock market’s upward explosion.
That slightly higher than “5% strong or less” bottom was an important
clue that a reinvigorated stock market was at hand; the straight-line DJIA
advance from 770 to nearly 1300 ended a 17-year “do-nothing” period for
stock prices and ushered in the “renewed upswing” period shown on the
chart.
In this context, the “8% strong bottom” of June 1984 and the current
MEI reading of 9% strong take on added meaning. If, in fact, we are in
a period of renewed (or major secular) upswing, stock market bottoms
will tend to be less severe and tops more extremely overbought than
would otherwise be the case. Both the June 1982 DJIA low and that of
June 1984 fit this model. Because secular stock market waves tend to last
for many years even decades, the likelihood is that the current MEI reading
of 9% strong will also define a major DJIA low.
SL302XchAppB frame Page 199 Thursday, December 13, 2001 10:36 PM
Appendix B
TEKNIPLAT CHARTING
The purpose of this discussion is to explain the nature of the bar chart,
something of the history and development of the use of charts in the
evaluation of securities, the philosophy and rationale of charting, some
of the technical patterns seen on charts and their use and interpretation,
methods and details of application and use, and comments and suggestions
as to the setting up and maintaining of daily charts.
WHAT IS A BAR CHART?

A bar chart is one of the many methods of representing information in
graphic form. It consists of a rectilinear grid on which two variables can
be plotted. Thus, the vertical axis might be scaled to represent “miles per
hour” of a moving automobile and the horizontal axis, the “rate of gasoline
consumption.” The vertical axis might be “total number of employees” in
various industries and the horizontal axis “average wage of employees.”
In many kinds of engineering, sociological, and economic problems, the
horizontal axis represents time (hours, days, months, etc.) and the vertical
axis measures the magnitude of a second variable such as population, net
income, pressure, or whatever data are under examination. In the study
of securities, bar charts are widely used to show the record of price trends
and fluctuations over a period. These charts can be adapted to any type
of financial market: stocks, bonds, warrants, debentures, commodities, etc.
They can be used for long periods, perhaps covering many years, or they
may be focused down to short-term trends on a daily or even hourly basis.
In charting security prices, the high and low prices for the day (if it
is a daily chart that is being run) are plotted on the line that represents
the particular day, and the high and low are connected by a vertical line.
Usually, the closing or last price for the day is shown as a cross-line on
this vertical range. It is also possible to show both the opening price and
199
the closing price, using a short line to the left of the vertical range for
the opening and a short line to the right to indicate the close.
The volume of trading may be shown on a separate scale near the
bottom of the sheet, directly under the vertical lines showing the daily
price range. For weekly charts or monthly charts, the procedure is exactly
the same except that each horizontal interval represents a week or a
month instead of a day.
Because the horizontal scale on the chart provides a “calendar,” it is
possible to enter any other data in which one may be interested directly
on the chart. This will include, of course, dividend or ex-distribution dates,
the dates of stock splits, and any data that might seem important as to
earnings, mergers, announcements of new products, etc. By noting on
the proper date the purchase or sale of a stock and the price paid or
received, investors will have a record of these transactions right on the
chart; this will make it easy to check the status of a transaction, the profit
or loss on it, and this record will serve as a valuable study later as to the
degree of success of one’s decisions.
CONSTRUCTION OF A DAILY CHART

A stock chart (daily, weekly, or monthly) ordinarily has a time scale
running from left to right, covering the period included in the chart, and
a vertical scale representing the price of the stock.
The horizontal time scale is of uniform intervals. But the vertical price
scale may be on any of several scales. The chart can be made on ordinary
cross-section paper, or on a chart sheet having arithmetic vertical divisions.
In this case, the spacing is uniform from bottom to top, and the distance
between 10 and 20 will be the same as the distance between 20 and 30,
or between 80 and 90.
Or, the vertical scale may be on logarithmic, square root, cube root, or
some other scale. In such cases, the scale will usually give a larger vertical
distance to a lower-priced stock, and, as the price advances, the vertical
scale becomes more compressed. Thus, the distance between 10 and 20 will
be more than the distance between 20 and 30, and, again, this will be more
than the distance between 80 and 90. The reason for using a scale which
“shrinks” as the price advances is that, obviously, an advance of 5 points in
a stock selling at $10 is much more important in its effect on capital than
an advance of 5 points in a stock selling at $50. In the first case, the 5 points
would represent a gain of 50%, in the second case, only 10%.
Because what we are concerned with is the percentage change in capital
represented by a price move, there is a great deal to be said for using
what is known as a percentage, ratio, or logarithmic scale. The characteristic
of this scale is that it will measure percentage advances or deadlines directly,
PRICE SCALES FOR TEKNIPLAT CHART PAPER
19 38 76 152 304
9 18 36 72 144 288
17 34 68 136 272
8 16 32 64 128 256
15 30 60 120 240
TYPE RU
7 14 28 56 112 224
13 26 52 104 208
6 12 24 48 96 192
SCALE FOR 11 SCALE FOR 22 SCALE FOR 44 SCALE FOR 88 SCALE FOR 176 SCALE FOR
COPYWRIGHT 1961 BY JOHN MAGEE, SPRINGFIELD, MASS.

STOCKS STOCKS STOCKS STOCKS STOCKS STOCKS
5 FROM 10 FROM 20 FROM 40 FROM 80 FROM 160 FROM
31/2 TO 7 7 TO 14 19 14 TO 28 38 28 TO 56 76 56 TO 112 152 112 TO 224
1
4 /2 9 18 36 72 144
17 34 68 136
4 8 16 32 64 128
15 30 60 120
1
3 /2 7 14 28 56 112
13 26 52 104
3 6 12 24 48 96
11 22 44 22
TEKNIPLAT Chart Paper

Published and Distributed by JOHN MAGEE, Inc. Technical Analysis of Stock Trends, 360 Worthington Street, Springfield, 3, Massachusetts
Tekniplat Charting

201
Chart 52. Tekniplat Paper.

and a move of 10% or 35%, or any other percentage, will always appear
as the same vertical distance on the chart regardless of the price of the
stock. Thus, chartwise, a move from $1000 a share to $1500 a share would
look exactly like an advance from $10 to $15, or from $50 to $75; any
advance of 50% in a stock would cover the same vertical distance. This
makes it possible to compare the action of a stock with any other stock
directly, or to compare the action of a stock with a group average, or to
compare stocks or groups with general market averages similarly scaled.
The objection one sometimes hears about logarithmic charts is that the
“squeezing” of the scale as the price advances makes it impossible to chart
precisely to the last eighth when the price has moved up greatly. In other
words, a move of ⅛ point will be shown plainly on stocks in the 10s and
20s but will not show precisely on stocks selling in the 100s. But, one
should realize a move of ⅛ point is quite important, say, when a stock is
selling at $5 a share, and is insignificant on one that is quoted at $150.
The other question new users bring up regarding the logarithmic scale
is that continually “shrinking” intervals seems strange (at first) to them if they
have been used to using plain cross-section paper (i.e., arithmetically scaled
sheets). Actually, the changing log scale provides points of reference that
the eye soon learns to recognize, and there is less chance of entering a price
at the wrong place than when using paper that has a perfectly uniform scale.
HOW TO USE TEKNIPLAT CHART PAPER

If you have never kept charts on this type of paper, known as semilog-
arithmic, ratio, or proportion, these instructions will help you to read and
understand the charts more easily, and they will help you in getting started
if you are setting up charts of your own.
There will be no problem here for the engineer or the experienced
chartist, but many people who have not kept charts before, or who are
familiar only with the arithmetic price scale where the intervals are uniform
throughout, may be puzzled at first by the continually changing vertical
spaces. As you will discover, however, this very feature makes for easier and
faster charting, because the various prices always lie at the same point in
one of the “banks,” and the eye becomes adept in placing the point needed
automatically, without reference to the index figures along the left margin.
On many simple charts, showing hours of work, temperature changes,
depth of water, etc., it is perfectly satisfactory to use ordinary cross-section
paper, so that each hour, degree, or foot is represented by the same
vertical distance on the chart. The difference between 5 feet and 10 feet
is the same as the distance between 105 feet and 110 feet.
But this is not a good way to represent the differences in stock prices.
It is perfectly true that the difference in market value between a stock
selling at $5 a share and one selling at $10 a share is $5, or $500 on a
Tekniplat Charting 203
block of 100 shares, and that the difference between the value of a stock
selling at $100 and one at $105 is also $5, or $500 on a block of 100
shares. But, in this latter case, there is a great deal more capital involved.
For example, if you put $1000 into a stock at $5, you would get
(disregarding commission) 200 shares. And if you sold these at $10, you
would receive $2000. You would have a profit of $1000, or 100%. But, if
you put your $1000 into a stock selling at $105, you would be able to
buy only 9 shares And when you sold 5 points higher at $110, your profit
would be only $45 or 4.5%.
It will give you a better comparison of the percentages of profit in
various stock transactions if the price scale of your chart is designed to
show equal percentages of advance or decline as equal vertical distances,
regardless of the price of the stock. This is exactly what the Tekniplat
charting paper does. A certain vertical distance on the paper will always
indicate the same percentage change, and a trend moving at a certain
angle will always indicate the same rate of percentage change, no matter
what the price of the stock may be.
Clearly, one point of advance or decline is much more important to
you in a stock selling at $5 or $6 a share than in one selling at $100.
Thus it should not surprise you that the interval between $5 and $6 is
much larger than that between $100 and $101. And, because the stocks
at lower prices make larger percentage moves for each point, or half
point, or one-eighth point, these moves will show up more plainly on
their charts Actually, it is not possible on the Tekniplat paper to show a
single eighth of change for a stock selling as high as $100. But this is just
another way of saying that a single eighth is not important at that price.
You might well be concerned about the difference between 1¼ and 1⅜.
But you would not care too much whether you sold at 103 or 103⅛.
Because all your stocks will be plotted on a proportional basis, you
can compare directly the action of any one stock with any other as to
pattern, trend, etc. Thus, a stock selling at $16 can be compared with a
stock selling at $56. However, although the percentage moves will be
strictly comparable, it should be pointed out that, typically, the high-priced
issues make smaller percentage moves than the low-priced ones.
The Price Scale

The price scale on Tekniplat paper consists of two “banks,” occupying
the upper and lower halves of the main chart space. These two banks
are exactly alike. Each represents a doubling of prices from its bottom to
its top, so that whatever value is assigned to the center line, the top line
will be twice that figure and the bottom line will be half of it. Let us say
the center point is marked 20; then the top will be 40 and the nine
intermediate lines will be 22, 24, 26, 28, 30, 32, 34, 36, and 38, reading
from center to top, with each of the smallest spaces representing ¼ point.
In the lower half of the chart, the bottom line will be 10, the intermediate
heavy lines to the center will be 11, 12, 13, 14, 15, 16, 17, 18, and 19,
and each of the smallest spaces will be ⅛ point. Because the spaces get
smaller as one goes up the chart, one bank shades into the next, making
a continuous scale. Clearly, you could have 20 at the top, 10 at the center,
and 5 at the bottom; or 10 at the top, 5 at the center, and 2½ at the bottom.
You may have some trouble at first with the different values assigned
to the small spaces at different price levels; you may wonder whether a
single small space represents ¼ or ⅛ or perhaps a full point. Do not let
this bother you. You can see from the scale where 19 is and where 20
is, and obviously 19½ is the midpoint, 19¼ is one-quarter of the way up,
and so on. Very quickly, you will find that your mind and your eye adjust
almost instantly without any conscious thought or effort.
Where a stock goes off the top or bottom of the paper, it is a simple
matter to rescale by moving the chart scale down one bank. If the chart
runs off the top at 40, mark the center of the paper 40; the top becomes
80 and the bottom, 20.
For uniformity, and because the paper is so ruled that you can divide
either bank of the heavy intermediate lines into 10 parts, with smaller
spaces representing standard stock-trading fractions of these main divi-
sions, you must use the figures 5, 10, 20, 40, 80, etc. as the values for
the center lines, tops, and bottoms of charts.
For selection of scales on stocks for which you are starting new charts,
use the table below.
If the stock now Center line

sells between will be Top Bottom
A
224 and 448 320 640 160
112 and 224 160 320 80
56 and 112 80 160 40
28 and 56 40 80 20
14 and 28 20 40 10
7 and l4 10 20 5
3½ and 7 5 10 2½
1¾ and 3½ 2½ 5 1¼
a
(This table can, of course, be continued up or

down as far as necessary by multiplying or
dividing the key figures by 2.)
The Time Scale

The paper provides for a full year of charting. The sheet is divided into
53 weeks, each consisting of 6 days in which the heavier line represents a
Saturday; this is ordinarily left blank because the major markets are not open
on Saturday. However, the heavier line will serve to make it easier to locate
a day, within a week, quickly. The omission of the Saturday will not
perceptibly affect the trend of the technical patterns. Holidays, when they
occur, are skipped. Usually a small “H” is inserted at the bottom of the chart
to note the holiday and explain the break in the chart. Many technicians
start their charts as of the first of a calendar year, filling in the dates of
Saturdays, marking the end of each week at the bottom of the paper in the
spaces provided, and immediately above these dates, the months.
There is no reason, however, that charts cannot be started at any time,
and, if you keep a large number of charts, it may be a help to start some
of these in each calendar quarter. Thus, you might start all charts from
A to F in January, from G to M in April, from N to S in July, and from
T to Z in October.
The Volume Scale

The volume scale that has proved most satisfactory is arithmetic; that is,
each unit measured vertically represents the same number of shares traded.
Space for volume entries is provided in a special section above the dates.
At one time, a logarithmic volume scale was used, but it was given up
because the highly significant volumes on very active days tended to be
compressed, while low volume in periods of dullness was given too much
emphasis. It is necessary to determine the proper figures for the volume
scale. No rule for this can be suggested. It is simply a matter of trial and
error. With a little experience you will be able to estimate, from your
knowledge of the stock you are about to chart, about how much volume
is likely to appear on very active days, and you can set up a volume scale
that will allow for the maximum expected peak. What you want to avoid
is the situation in which volume too frequently runs beyond the top of
the volume section; it should do this only at times of unusual activity.
When a stock is new to you and you have no knowledge of its habits, it
may be best to mark a tentative volume scale, lightly and in pencil, and
to keep the volume on this scale for a few weeks. Then, if it is necessary
to change the scale, you can do so without having to redraw the entire chart.
Ex-Dividends and Split-Ups

When a stock goes “ex-dividend,” “ex-rights,” etc., the price will usually
drop approximately the amount of the benefit that was “ex.” A note should
be made on the chart on this day, and it can be entered conveniently at

the very bottom, below the dates, showing the amount of the dividend,
approximate value of the rights, or other benefits. If the amount involved
was substantial and the price drop large enough to require explanation,
a dotted line may be drawn vertically on that date from the old price to
the “ex” price, showing that this drop was not a market fluctuation but
merely the adjustment of price to the distribution.
In the case of a split-up, spin-off, or other capital change, a similar
procedure is followed. If the stock is split three shares for one, for example,
the price level will change and the chart will be continued at a new level.
A dotted vertical line plus an explanatory note will make clear what
happened. To get continuity of the chart in such a case, the previous
price pattern can be traced and then transferred with carbon paper in the
correct position to give a continuous chart adjusted to the new basis for
as far back as you need it.
However, if a stock is split two shares for one or four for one, you
will not have to make any change in the chart except to note the fact of
the split, and to change the scale by dividing all figures by 2 or 4 as the
case may be.
In other words, if a stock has been selling at $80 and is split two for
one, we simply rescale the chart with the price at $40 and carry on. Often
it will help to rule a vertical red line through the date on which a split-
up or other capital adjustment takes effect.
Just to reiterate what has been explained previously regarding the
mechanical details of charting:
1. Ordinarily, each day’s high and low prices are connected by a

vertical line, and the last or closing price is indicated by a short
horizontal line which may be redrawn toward the right. The open,
if used, is drawn to the left. Volume is shown on a special scale
at the bottom of the chart, and notes as to ex-dividend dates and
amounts of dividends, ex-rights, ex-distributions, split-ups, stock
dividends, etc. as they occur may be noted below the volume.
Other notes, clippings, record of purchase and sale, and other
memos may be written or attached to the chart where they will
be conveniently at hand each day.
2. The Tekniplat charting paper is ruled for a 6-day week, although
the market operates only from Monday through Friday. The heavy
line indicating a Saturday is not used, but, because it provides a
little break each week, it makes the plotting of the market days
much easier, does not materially affect the accuracy of the chart,
nor distort appreciably the trendlines, patterns, etc. Holidays that
occur during the business week are simply skipped and left blank,
and the fact that the omitted day was a holiday may be indicated
by placing the letter “H” at the bottom of the chart.
The most important factor in charting, of course, is to keep the charts

up-to-date. It will pay to take some time to plan how, where, and when
to keep one’s charts. If possible, find a place, at home or at your office,
where you can be relatively free from interference for at least long enough
each day to post your charts. Experiment a bit with the placement of desk
or table so that you will be getting the best light possible without sharp
shadows and without glare. Have binders or folders so that you can keep
your charts in a convenient arrangement, easily accessible. Try various
grades of pens or pencils to find which will give you the best results.
And have a definite place, a drawer or box, where you can keep an
adequate supply of pencils, erasers, triangles, ruler, or whatever other
equipment you may need.
The most important caution for the beginner who is starting a set of
charts for the first time is not to bite off more than he can handle easily!
It is a great temptation to set up a large portfolio at the very start. But
when some unexpected interruption occurs, such as a day of illness, a
trip out of town, or some emergency work, the charts may be neglected
for 1 day, 2 days, 3 days, and, with each passing day, the load multiplies.
Many enthusiastic beginners have thus become discouraged and have
given up the work before they were fairly into it. It is better to take a
smaller group than one feels he might want, but which he is sure he can
keep up without strain, and then, with increasing speed and greater
familiarity with the method, to add stocks gradually as needed.
CHARTING IN THE COMPUTER AGE

Alas! (or as Malraux would have said, Hélas!) most of the readers of this
book will never know the joys (overrated) of manual charting, just as
they will have to consult a dictionary upon reading such terms as “type-
writer” and “slide rule.” Instead, as all modern readers do, they will have
the greatest invention since the quill pen at their fingertips — namely,
the personal computer.
The drudgery and tedium (to some) of manual charting has been
replaced by the extreme facility of computer-based charting. Numerous
(too numerous to enumerate here) software packages are available to
assist the moderately competent cyber investor in analyzing the markets.
In Appendix D, these resources are detailed. In addition, software is not
even necessary if the investor has a connection to the Internet, as there
are a multitude of Internet sites which beg to assist the investor in charting,
analyzing, dissecting, and trading stocks. These sites are also detailed in
Appendix D.
What everyone — the software packages, the Internet sites, the gurus,
the talking heads, the wise books, the preternaturally gifted brokerage
firms with their precocious pundits — forgot to tell the investor was what
is important about this flood of technology.
What Is Important About This Technology

Computer charting and analysis is only a tool. A powerful tool, but just
a tool. All the analytical techniques in the world running on the most
powerful supercomputers in the world cannot equal experienced and
trained judgment in making decisions about stocks. I like to tell the story
about the extremely sophisticated (Berkeley Ph.D.s) and educated group
I know which, at an enormous expenditure of time and money, created
a system that was nearly perfect in trading the markets. Its only problem
was it was so complex that it could not be run in market real-time.
It is true that in the area of quantitative analysis, the application of
these tools has resulted in noticeable success — particularly among market
makers such as Hull Trading Co. and Chicago Research and Trading Co.
of the Chicago Board of Options Exchange. The novice should be
informed, though, that this success is only partially due to technology.
The options markets are amenable to model-based trading, unlike stock
and commodity markets. This is because they are based on models —
such as the Black-Scholes options pricing model. The stock markets are
behavioral markets. Also, market makers have several built-in “edges,” the
most important of them being the bid–ask spread.
Thus computer tools are really only a brute advance over Tekniplat
charting paper, ruler, and pencil and may have the disadvantage of
depriving the trader of “feel” that comes with hard work. On the other
hand, this brute advance allows the investor to process — or filter — an
unlimited number of stocks. Filtering simply means establishing some
criteria as to stocks that will be considered. For example, we might say
that we wanted only to look at stocks above their 150-day moving average,
or above their 4-week high. That would be a filter. And it could be applied
literally to all stocks.
This ability to process large numbers of stocks — as it were to maintain
an enormous chart case — can be important if the investor is running an
MEI, in which case it would be necessary to look at and classify the chart
of each issue in the group under study.
In addition, experimentation and play with the data are unrestricted.
The investor can skip merrily from daily to weekly to monthly, from bar
charts to candlestick to point-and-figure, ad infinitum.
In the end, the ability to accomplish and compress this large amount
of effort with this tool is the most important element of computer analysis.
Further investigation of computer software and technology, including
references to Internet sites, may be pursued in Appendix D.
At the turn of the millennium, the Exchanges are finally switching their
systems to trade stocks in pennies instead of fractions — reluctantly. So
soon the old Tekniplat chart paper will, like the slide rule, be obsolete.
At the Web site (www.johnmageeta.com) investors interested in manual
charting will be able to get chart paper designed for the new market
facts — decimals and 24/7 trading.
SL302XchAppC frame Page 211 Thursday, December 13, 2001 10:37 PM
Appendix C
CONTINUING STUDY PLAN
On further study of chart-based technical analysis:

Edwards, Robert D., Magee, John, and Bassetti, W. H. C., Technical
Analysis of Stock Trends, 8th ed., Boca Raton, FL: St. Lucie Press,
2001.
(This original and definitive work in the field also covers numerous
subjects that will be of interest to readers of this book: Pragmatic
Portfolio Theory, risk measurement and control, and related topics.)
On credited graduate study seminars open to the public:
Golden Gate University, www.ggu.edu, [email protected].
John Magee Web site, www.johnmageeta.com
On volatilities and options:
(and futures) www.cboe.com
DOW futures and options www.cbot.com
AMEX ishares (DIA, QQQ, SPY) www.amex.com
McMillan, Lawrence G., Options as a Strategic Investment, New York:
New York Institute of Finance, 1993, www.optionstrategist.com
On risk:
Bernstein, Peter, Against the Gods, New York: John Wiley & Sons,
1996.
Jorion, Philippe, Value at Risk, New York: John Wiley & Sons, 1996.
Risk Management 101 (software), Zoologic Inc., New York.
Edwards, Magee, Bassetti, Technical Analysis of Stock Trends, 8th ed.,
St. Lucie Press, Boca Raton, FL, 2001.
211
SL302XchAppC frame Page 212 Thursday, December 13, 2001 10:37 PM
On candlesticks:
Nison, Steve, Japanese Candlestick Charting Techniques, New York:
New York Institute of Finance, 1991.
Nison, Steve, Beyond Candlesticks, New York: John Wiley & Sons,
1994.
On point-and-figure charting:
Cohen, A. W., How to Use the Three Point Reversal Method of Point
and Figure Stock Market Trading, Larchmont, NY: Chartcraft,
1984.
Bassetti, W. H. C., Bassetti, C. D. H., Technical Analysis: Natural and
Unnatural Methods, San Geronimo, CA: Maomao Press, 2002.
On developing moving average systems:

See Schwager, below.
DeMark,Thomas, The New Science of Technical Analysis, New York:
John Wiley & Sons, 1994.
On futures:
Schwager, Jack, Schwager on Futures, Technical Analysis, New
York: John Wiley & Sons, 1996.
On portfolio management:
The Journal of Portfolio Management
Risk Management 101 (software), Zoologic, Inc.
On day trading and short term tactics:
Wyckoff, R. D. and Bassetti, W. H. C., Technical Analysis for Tacti-
cians, San Geronimo, CA: Maomao Press, 2002.
SL302XchAppD frame Page 213 Thursday, December 13, 2001 10:38 PM
Appendix D
RESOURCES
SEC enforcement [email protected]

(Whenever I receive touts or investment spam, I immediately forward it to
this important branch of the SEC. All responsible investors should do the
same.)
john magee technical analysis::delphic options research ltd (jmta::dor)
email [email protected]
jmta::dor website www.johnmageeta.com
TEKNIPLAT chart paper visit www.johnmageeta.com
Volatilities and options: www.optionstrategist.com
www.cboe.com
Software reviews and info www.traders.com
Software demos and packages www.omegaresearch.com
www.comstar.com
www.aiq.com
www.tradestation.com
www.equis.com
Web analysis site www.prophetfinance.com
Morningstar www.morningstar.net
Of General Interest
AARP Investment Program www.aarp.scudder.com
Accutrade www.accutrade.com
ADR.com www.adr.com
American Association of Individual www.aaii.com
Investors
213
American Century www.americancentury.com

American Express Financial Services www.americanexpress.com/direct
(American Express now advertises free trades for some accounts)
American Stock Exchange www.amex.com
Ameritrade (has little-advertised site for www.ameritrade.com
free trades)
Annual Report Gallery www.reportgallery.com
Barron’s www.barrons.com
BigCharts www.bigcharts.com
Bloomberg Financial www.bloomberg.com
Bonds Online www.bondsonline.com
Briefing.com www.briefing.com
Brill’s Mutual Funds Interactive www.fundsinteractive.com
Business Week www.businessweek.com
CBS MarketWatch www.marketwatch.com
Charles Schwab www.schwab.com
Chicago Board of Options Exchange www.cboe.com
CNNFN www.cnnfn.com
DailyStocks www.dailystocks.com
Excite www.excite.com
Federal Deposit Insurance Corp www.fdic.gov
Federal Trade Commission www.ftc.gov
Fidelity Investments www.fidelity.com
Financial Times www.ft.com
Forrester Research www.forrester.com
FundFocus www.fundfocus.com
Fund Spot www.fundspot.com
Gomez Advisers www.gomez.com
H&R Block www.hrblock.com
Hoover’s StockScreener www.stockscreener.com
IPO Central www.ipocentral.com
Lombard www.lombard.com
Marketplayer www.marketplayer.com
Market Technician’s Assoc. www.mta.org
Microsoft MoneyCentral www.moneycentral.com
Resources 215
Morningstar www.morningstar.net
National Assoc. of Securities Dealers www.nasd.com
National Discount Brokers www.ndb.com
Net Investor www.netinvestor.com
New York Stock Exchange www.nyse.com
Online Investor www.onlineinvestor.com
Philadelphia Stock Exchange www.phlx.com
Quick & Reilly www.quickwaynet.com
Quicken www.quicken.com
Quicken Financial Network www.qfn.com
Realty Stocks www.realtystocks.com
Reuters www.reuters.com
SEC Enforcement [email protected]
Securities and Exchange Commission www.sec.gov
Securities Industry Association www.sia.com
Securities Investor Protection www.sipc.org
Corporation
SmartMoney www.smartmoney.com
Social Security Online www.ssa.gov
Standard & Poor’s Fund Analyst www.micropal.com
Standard & Poor’s Ratings Services www.ratingsdirect.com
Stock Guide www.stockguide.com
Stockpoint www.stockpoint.com
Suretrade www.suretrade.com
1040.com www.1040.com
The Motley Fool www.fool.com
TheStreet.com www.thestreet.com
T. Rowe Price www.troweprice.com
TreasuryDirect www.publicdebt.treas.gov
Vanguard Brokerage Services www.vanguard.com
Wall Street Access www.wsaccess.com
Wall Street Journal Interactive Ed. www.wsj.com
Yahoo! Finance www.quote.yahoo.com
Zacks Investment Research www.zacks.com
ZD Interactive Investor www.zdii.com
Brokerage Houses
A. B. Watley www.abwatley.com 888-229-2853

Accutrade www.accutrade.com 800-494-8939
Ameritrade www.ameritrade.com 800-326-7507
Ameritrade (2nd site) www.freetrade.com
Charles Schwab www.schwab.com 800-435-4000
Datek Online www.datek.com
Discover Brokerage www.discoverbrokerage.com 800-688-3462
DLJ Direct www.dljdirect.com 800-825-5723
Dow-Jones Markets www.djmarkets.com
DRIP Central www.dripcentral.com
E*TRADE www.etrade.com 800-786-2575
Empire Financial Group, Inc. www.lowfees.com 800-900-8101
Jack White www.jackwhiteco.com 800-753-1700
Lombard www.lombard.com
National Discount Brokers www.ndb.com 800-888-3999
Net Investor www.netinvestor.com 800-638-4250
Quick & Reilly www.quickwaynet.com 800-672-7220
Suretrade www.suretrade.com 401-642-6900
Vanguard Brokerage Services www.vanguard.com 800-992-8327
Wall Street Access www.wsaccess.com 888-925-5782
Waterhouse Securities www.waterhouse.com 800-934-4134
Web Street Securities www.webstreetsecurities.com 800-932-0438
WitCapital www.witcapital.com 888-494-8227
SL302XchGlossary Page 217 Friday, December 14, 2001 11:48 AM
GLOSSARY
Accumulation: The first phase of a bull market. The period when far-
sighted investors begin to buy shares from discouraged or distressed
sellers. Financial reports are usually at their worst and the public is
completely disgusted with the stock market. Volume is only moderate
but beginning to increase on the rallies.
Activity: See Volume.
Apex: The highest point; the pointed end or tip of a triangle.
Arbitrage: The simultaneous buying and selling of two different, but
closely related, instruments to take advantage of a disparity in their
prices in one market or different markets; for example, the discount
of Dow-Jones futures to cash would result in the immediate purchase
of futures and the sale of cash. In takeovers or acquisitions this is not
arbitrage, but spreading, ersatz arbitrage, or faux arbitrage. True arbi-
trage has two forms, strong and weak (or risk). Strong arbitrage realizes
a profit when initiated and only requires time or distance to realize
the profit. Weak or risk arbitrage has uncontrolled factors, or factors
that must be constantly adjusted to realize the profit.
Area gap: See Common gap.
Area pattern: When a stock or commodity’s upward or downward
momentum has been temporarily exhausted, the ensuing sideways
movement in the price usually traces out a design or arrangement of
form called an area pattern. The shape of some of these area patterns,
or formations, has predictive value under certain conditions. See
Ascending triangle, Broadening formations, Descending triangle, Dia-
mond, Flag, Head and shoulders, Inverted triangle, Pennant, Rectangle,
Right-angle triangles, Symmetrical triangles, and Wedges.
Arithmetic scale: Price or volume scale where the distance on the vertical
axis (i.e., space between horizontal lines) represents equal amounts
of dollars or number of shares.
Ascending (parallel) trend channel: When the tops of the rallies com-
posing an advance develop along a line (sometimes called a return
line), which is also parallel to the basic up trendline (i.e., the line that
217
slopes up across the wave bottoms in an advance); the area between

the two lines is called an ascending or up channel.
Ascending (up) trendline: The advancing wave in a stock or commodity
is composed of a series of ripples. When the bottoms of these ripples
form on, or very close to, an upward-slanting straight line, a basic
ascending or up trendline is formed.
Ascending triangle: One of a class of area patterns called right-angle
triangles. The class is distinguished by the fact that one of the two
boundary lines is practically horizontal while the other slants toward
it. If the top line is horizontal, and the lower slants upward to an
intersection point to the right, the resulting area pattern is called an
ascending triangle. The implication is bullish, with the expectant
breakout though the horizontal line. Measuring formula: add the
broadest part of triangle to the breakout point.
At the money: An option, the strike price of which is equal to the market
value of the underlying futures contract or instrument.
Averages: See Dow-Jones Industrial Averages, Moving averages, Dow-
Jones Transportation Averages, and Dow-Jones Utility Averages.
Averaging cost: An investing technique in which the investor buys a
stock or commodity at successively lower prices, thereby “averaging
down” his average cost of each stock share or commodity contract.
Purchases at successively higher prices would “average up” the price
of stock shares or commodity contracts. It is an invention of the
financial industry to bamboozle an investor uninformed enough to
practice this shuffle.
Axis: In the graphical sense, an axis is a straight line for measurement
or reference. It is also the line, real or imagined, on which a formation
is regarded as rotating.
Balanced program: Proportioning capital, or a certain part of capital,
equally between the long side and the short side of the market, and
or amongst different asset classes.
Bar chart: Also called a line or vertical chart. A graphic representation
of prices using a vertical bar to connect the highest price in the time
period to the lowest price. Opening prices are noted with a small
horizontal line to the left. Closing prices are shown with a small
horizontal line to the right. Bar charts can be constructed for any time
period in which prices are available. The most common time periods
found in bar charts are hourly, daily, weekly, and monthly. However,
with the growing number of personal computers and the availability
of “real-time” quotes, it is not unusual for traders to use some period
of minutes to construct a bar chart.
Basing point: The price level in the chart that determines where a stop
loss point is placed. As technical conditions change, the basing point,
Glossary 219
and stops, can be advanced (in a rising market) or lowered (in a

falling market). See Progressive stops.
Basic trendlines: See Trendlines.
Basis points: The measure of yields on bonds and notes; one basis point
equals 0.01% of yield.
Basket trades: Large transactions made up of a number of various stocks.
Bear market: In its simplest form, a bear market is a period when prices
are primarily declining, usually for a long period. Bear markets gen-
erally consist of three phases: the first phase is distribution; the second
is panic; the third is akin to a washout, where those investors who
have held out through the first two phases finally give up and liquidate.
Bent neckline: See Neckline.
Beta: A measure of sensitivity to market swings.
Beta (coefficient): A measure of the market or nondiversifiable risk
associated with any given security in the market.
Block trades: Large transactions of a particular stock sold as a unit.
Blow-off: See Climactic top.
Blue chips: The nickname given to generally high-priced companies with
good records of earnings, dividends, and price stability. Also called
gilt-edged securities. Examples are IBM, AT&T, General Motors and
General Electric.
Book value: The theoretical measure of what a stock is worth based on
the value of the company’s assets less the company’s debt.
Bottom: See Ascending triangle, Dormant bottom, Double bottom, Head-
and-shoulders (Kilroy) bottom, Rounding bottom, and Selling climax.
Boundary: The edges of a pattern.
Bowl: See Rounding bottom.
Bracketing: A trading range market or a price area that is nontrending.
Breakaway gap: The hole or gap in the chart created when a stock or
commodity breaks out of an area pattern.
Breakout: When a stock or commodity exits an area pattern.
Broadening formation: Sometimes called inverted triangles, these are
formations that start with narrow fluctuations that widen between
diverging, rather than converging, boundary lines. See also Right-
angled broadening triangle, Broadening formation, Broadening top,
Head-and-shoulders top, and Diamond patterns.
Broadening top: An area reversal pattern that may evolve in any one
of three forms, comparable in shape, respectively, to inverted sym-
metrical, ascending, or descending triangles. Unlike triangles, however,
the tops and bottoms of these patterns do not necessarily stop at
clearly marked diverging boundary lines. Volume, rather than dimin-
ishing in triangles, tends to be unusually high and irregular throughout
pattern construction. No measuring formula is available.
Bull market: A period when prices are primarily rising, normally for an
extended period. Usually, but not always, divisible into three phases.
The first phase is accumulation. The second phase is one of fairly
steady advance with increasing volume. And the third phase is marked
by considerable activity as the public begins to recognize and attempt
to profit from the rising market.
Call: An option that gives the buyer the right to buy the underlying
instrument at a specific price within a certain time period and which
obligates the seller to sell the instrument.
Call margin: See Margin call.
Candlestick chart: Japanese charting method where bars are color coded
according to direction of price movement.
Cats and dogs: Low-priced stocks of questionable investment value.
Channel: If the tops of the rallies and bottoms of the reactions develop
lines that are approximately parallel to one another, the area between
these lines is called a channel. See also Ascending trend channel,
Descending trend channel, and Horizontal trend channel.
Chart: A graphic representation of a stock or commodity in terms of
price and or volume. See also Bar chart, Candlestick chart, and Point-
and-figure chart.
Clean-out day: See Selling climax.
Climactic top: A sharp advance, accompanied by extraordinary volume
(i.e., much larger volume than the normal increase), which signals the
final “blow-off” of the trend, followed by either a reversal or at least by
a period of stagnation, formation of consolidation pattern, or a correction.
Climax day: See One-day reversal.
Climax, selling: See Selling climax.
Closing price: The last sale price of the trading session for a stock. In
commodities it represents an official price determined from a range
of prices deemed to have traded at or on the close; also called a
settlement price.
Closing the gap: When a stock or commodity returns to a previous gap
and retraces the range of the gap. Also called “covering the gap” or
“filling the gap.” See Gap.
Coil: Another term for a symmetrical triangle.
Commission: The amount charged by a brokerage house to execute a
trade in a stock, option, or commodity transaction. A commission is
charged for each purchase and each sale. In commodities, a commis-
sion is charged only when the original entry trade has been closed
with an offsetting trade. This is called a round-turn commission.
Common gap: Also called area gap. Any hole or gap in the chart
occurring within an “area pattern.” The forecasting significance of the
common gap is nil. See Gap.
Glossary 221
Comparative relative strength: Compares the price movement of a

stock with that of its competitors, industry group, or the whole market.
Complex head-and-shoulders: Also called “multiple head and shoul-
ders,” it is a head-and-shoulders pattern with more than one right and
left shoulder and or head. See Head-and-shoulders pattern.
Composite average: A stock average composed of the 65 stocks that
make up the Dow-Jones industrial average and the Dow-Jones utility
average.
Composite leverage: In the Edwards and Magee book, Technical Anal-
ysis of Stock Trends, it is a formula for combining the principal factors
affecting a given sum of capital used (i.e., sensitivity, price, and margin)
into one index figure.
Confirmation: In a pattern, it is the point at which a stock or commodity
exits an area pattern in the expected direction by an amount of price
and volume sufficient to meet minimum pattern requirements for a
bona fide breakout. In the Dow Theory, it means both the industrial
average and the transportation average have registered new highs or
lows during the same advance or decline. If only one of the averages
establishes a new high (or low) and the other one does not, it would
be a nonconfirmation, or divergence. This is also true of oscillators.
To confirm a new high (or low) in a stock or commodity an oscillator
needs to reach a new high (or low) as well. Failure of the oscillator
to confirm a new high (or low) is called a divergence and would be
considered an early indication of a potential reversal in direction.
Congestion: The sideways trading from which area patterns evolve. Not
all congestion periods produce a recognizable pattern, however.
Consolidation pattern: Also called a continuation pattern, it is an area
pattern which breaks out in the direction of the previous trend. See
Ascending triangle, Descending triangle, Flag, Head-and-shoulders
consolidation, Pennant, Rectangle, Scallop, and Symmetrical triangle.
Continuation gap: See Runaway gap.
Continuation pattern: See Consolidation pattern.
Convergent pattern (trend): Those patterns with upper and lower
boundary lines that meet, or converge, at some point if extended to
the right. See Ascending triangle, Descending triangle, Symmetrical
triangle, Wedges, and Pennants.
Correction: A move in a commodity or stock that is opposite to the
prevailing trend but not sufficient to change that trend; called a rally
in a downtrend and a reaction in an uptrend. In the Dow Theory, a
correction is a secondary trend against the primary trend, that usually
lasts from 3 weeks to 3 months and retraces from one-third to two-
thirds of the preceding swing in the primary direction.
Covering the gap: See Closing the gap.
Cradle: The intersection of the two converging boundary lines of a

symmetrical triangle. See Apex.
Daily range: The difference between the high and low price during one
trading day.
Demand: Buying interest for a stock at a given price.
Descending (parallel) trend channel: When the bottoms of the reac-
tions comprising a decline develop along a line (sometimes called a
return line), that is also parallel to the basic down trendlines (i.e., the
line that slopes down across the wave tops in a decline); the area
between the two lines is called a descending or down channel.
Descending trendline: The declining wave in a stock or commodity is
composed of a series of ripples. When the tops of these ripples form
on, or very close to, a downward-slanting straight line, a basic descend-
ing or downtrend line is formed.
Descending triangle: One of a class of area patterns called right-angled
triangles. The class is distinguished by the fact that one of the two
boundary lines is practically horizontal while the other slants toward
it. If the bottom line is horizontal and the upper slants downward to
an intersection point to the right, the resulting area pattern is called
a descending triangle. The implication is bearish, with the expectant
breakout through the flat (horizontal) side. Minimum` measuring for-
mula: add the broadest part of the triangle to the breakout point.
Diamond: Usually a reversal pattern, but it will also be found as a
continuation pattern. It could be described as a complex head-and-
shoulders pattern with a V-shaped (bent) neckline, or a broadening
pattern that, after two or three swings, changes into a regular triangle.
The overall shape is a four-point diamond. Because it requires a fairly
active market, it is more often found at major tops. Many complex
head-and-shoulder tops are borderline diamond patterns. The major
difference is in the right side of the pattern. It should clearly show
two converging lines with diminishing volume as in a symmetrical
triangle. Minimum measuring formula: add the greatest width of the
pattern to the breakout point.
Distribution: The first phase of a bear market which really begins in the
last stage of a bull market. The period when far-sighted investors
sense that the market has outrun its fundamentals and begin to unload
their holdings at an increasing pace. Trading volume is still high;
however, it tends to diminish on rallies. The public is still active but
beginning to show signs of caution as hoped-for profits fade away.
Divergence: When new highs (or lows) in one indicator are not realized
in another comparable indicator. See Confirmation.
Divergent pattern (trend): Those patterns with upper and lower bound-
ary lines that meet at some point if extended to the left. See Broadening
formation.
Glossary 223
Diversification: The concept of placing one’s funds in different industry

groups and investment vehicles to spread risk. Not placing all one’s
financial eggs in one basket.
Dividends: A share of the profits — in cash or stock equivalent — that
is paid to stockholders.
Dormant bottom: A variation of a rounding (bowl) bottom, but in an
extended, flat-bottomed form. It usually appears in “thin” stocks (i.e.,
those issues with a small number of shares outstanding) and, charac-
teristically, will show lengthy periods during which no sales will be
registered for days at a time. The chart will appear “fly-specked” due
to the missing days. The technical implication is for an upside breakout.
Double bottom: Reversal pattern. A bottom formed on relatively high
volume that is followed by a rally (of at least 15%) and then a second
bottom (possibly rounded) at the same level (plus or minus 3%) as
the first bottom on lower volume. A rally back though the apex of
the intervening rally confirms the reversal. More than a month should
separate the two bottoms. Minimum measuring formula: Take the
distance from the lowest bottom to the apex of the intervening rally
and add it to the apex.
Double top: A high-volume top is formed followed by a reaction (of at
least 15%) on diminishing activity. Another rally back to the previous
high (plus or minus 3%) is made, but on lower volume than the first
high. A decline through the low of the reaction confirms the reversal.
The two highs should be more than a month apart. Minimum mea-
suring formula: Add to the breakout point the distance from the highest
peak to the low of the reaction. Also called an “M” formation.
Double trendline: When two relatively close parallel trendlines are
needed to define the true trend pattern. See Trendline.
Dow-Jones Industrial Average: Developed by Charles Dow in 1885 to
study market trends. Originally composed of 14 companies (12 railroads
and 2 industrials), the rails by 1897 were separated into their own
average, and 12 industrial companies of the day were selected for the
industrial average. The number was increased to 20 in 1916 and to 30
in 1928. The stocks included in this average have been changed from
time to time to keep the list up to date, or to accommodate a merger.
The only original issue still in the average is General Electric.
Dow-Jones Transportation Average: Established at the turn of the cen-
tury with the new industrial average, it was originally called the Rails
Average and was composed of 20 railroad companies. With the advent
of the airlines industry the average was updated in 1970 and the name
changed to Transportation Average.
Dow-Jones Utility Average: In 1929, utility companies were dropped from
the Industrial Average and a new utility average of 20 companies was
created. In 1938, the number of issues was reduced to the present 15.
Downtick: A securities transaction that is at a price that is lower than

the preceding transaction;
Downtrend: See Descending trendline and Trend.
End run: When a breakout of a symmetrical triangle pattern reverses its
direction and trades back through support (if an upside breakout) or
resistance (if a downside breakout), it is termed an “end run around
the line,” or “end run” for short. The term is sometimes used to denote
breakout failure in general.
Equilibrium market: A price area that represents a balance between
demand and supply.
Ex-dividend: The day when the dividend is subtracted from the price of
the stock.
Ex-dividend gap: The gap in price caused when the price of a stock is
adjusted downward after the dividend payment is deducted.
Exercise: The means by which the holder of an option purchases or sells
shares of the underlying security.
Exhaustion gap: Relatively wide gap in the price of a stock or commodity
that occurs near the end of a strong directional move in the price.
These gaps are quickly closed, most often within 2 to 5 days, which
helps to distinguish them from runaway gaps which are not usually
covered for a considerable length of time. An exhaustion gap cannot
be read as a major reversal, or even necessarily a reversal. It signals
a halt in the prevailing trend which is ordinarily followed by some
sort of area pattern development.
Expiration: The last day on which an option can be exercised.
Exponential smoothing: A mathematical-statistical methodology of fore-
casting that assumes future price action is a weighted average of past
periods; a mathematical series in which greater weight is given to
more recent price action.
Falling wedge: An area pattern with two downward-slanting, converging
trendlines. Normally it takes more than 3 weeks to complete, and
volume will diminish as prices move toward the apex of the pattern.
The anticipated direction of the breakout in a falling wedge is up.
Minimum measuring formula: A retracement of all the ground lost
within the wedge. See Wedge.
False breakout: A breakout that is confirmed but that quickly reverses
and eventually leads the stock or commodity to a breakout in the
opposite direction. Indistinguishable from premature breakout or gen-
uine breakout when it occurs.
Fan lines: A set of three secondary trendlines drawn from the same
starting high or low, that spread out in a fan shape. In a primary
uptrend, the fan would be along the tops of the secondary (interme-
diate) reaction. In a primary downtrend, the fan would be along the
Glossary 225
bottoms of the secondary (intermediate) rally. When the third fan line
is broken, it signals the resumption of the primary trend.
50-day moving-average line: Determined by summing the closing price
over the past 50 trading days and dividing by 50, and so on.
Five-point reversal: See Broadening pattern.
Flag continuation pattern: A flag is a period of congestion, less than
4 weeks in duration, that forms after a sharp, near vertical, change in
price. The upper and lower boundary lines of the pattern are parallel,
though both may slant up, down, or sideways. In an uptrend, the
pattern resembles a flag flying from a mast, hence the name. Flags are
also called measuring or half-mast patterns because they tend to form
at the midpoint of the rally or reaction. Volume tends to diminish
during the formation and increase on the breakout. Minimum measur-
ing formula: add the distance from the breakout point, which started
the preceding “mast” rally or reaction, to the breakout point of the flag.
Floating supply: The number of shares available for trading at any given
time. Generally the outstanding number of shares, less shares closely
held and likely to be unavailable to the public. Shares of a company
held by its employee pension fund, for example, would not generally
enter the trading stream and could be subtracted from the outstanding
shares.
Formation: See Area patterns.
Front-month: The first expiration month in a series of months.
Fundamental: Information on a stock pertaining to the business of the
company and how it relates to earnings and dividends. In a commod-
ity, it would be information on any factor that would affect supply or
demand.
Futures: An investment contract between buyer and seller in which the
parties contract to receive or deliver the underlying instrument at a
fixed price by a fixed time in the future. Generally a speculative
instrument that requires very low “margins” (or performance bonds)
but that is marked to market daily, requiring the losing party to supply
cash as his equity fluctuates. Used extensively for hedging by com-
mercials — grain companies, mining companies, etc. Primary impor-
tance to stock traders are futures contracts on the Industrials and the
S&P at the CBOT.
Gap: A hole in the price range that occurs when either (1) the lowest
price at which a stock or commodity is traded during any time period
is higher than the highest price at which it was traded on the preceding
time period, or (2) the highest price of one time period is lower than
the lowest price of the preceding time period. When the ranges of
the two time periods are plotted, they will not overlap or touch the
same horizontal level on the chart — there will be a price gap between
them. See Common or Area gap, Ex-dividend gap, Breakaway gap,

Runaway gap, Exhaustion gap, and Island reversal.
Graph: See Chart.
Half-mast formation: See Flag continuation pattern.
Head-and-shoulders pattern: In its normal form, this pattern is one of
the more common and more reliable of the major reversal patterns.
It consists of the following four elements (a head and shoulders top
will be described for illustration): (1) a rally which ends a more or
less extensive advance on heavy volume, and which is then followed
by a minor reaction on less volume — this is the left shoulder; (2)
another high-volume advance which exceeds the high of the left
shoulder, followed by another low-volume reaction which takes prices
down to near the bottom of the preceding reaction, and below the
top of the left shoulder high — this is the head; (3) a third rally, but
on decidedly less volume than accompanied either of the first two
advances, and which fails to exceed the high established on the head
— this is the right shoulder; and (4) a decline through a line drawn
across the preceding two reaction lows (the neckline), and a close
below that line equivalent to 3% of the stock’s market price — this
is the confirmation of the breakout. A head-and-shoulders or Kilroy
bottom, or any other combination head-and-shoulders pattern, con-
tains the same four elements inverted. The main difference between
a top formation and a bottom formation is in the volume patterns.
The breakout in a top can be on low volume. The breakout in a
bottom must show a “conspicuous burst of activity.” Minimum mea-
suring formula: add the distance between the head and neckline to
the breakout point. Occasionally an inverted head-and-shoulders or
Kilroy pattern (called a consolidation head-and-shoulders) will form
which is a continuation pattern.
Head-and-shoulders bottom: Area pattern that reverses a decline. See
Head-and-shoulders pattern. Also called Kilroy bottom.
Head-and-shoulders or Kilroy consolidation: Area pattern that con-
tinues the previous trend. See Head-and-shoulders pattern.
Head-and-shoulders top: Area pattern that reverses an advance. See
Head-and-shoulders pattern.
Heavy volume: The expression “heavy volume,” as used by Edwards
and Magee, means heavy only with respect to the recent volume of
sales in the stock one is watching.
Hedging: To try to lessen risk by making a counterbalancing investment.
In a stock portfolio, an example of a hedge would be to buy 100
shares of XYZ stock, and to buy one put option of the same stock.
The put would help protect against a decline in the stock, but it would
also limit potential gains on the upside.
Glossary 227
Historical data: A series of past daily, weekly, or monthly market prices.

Hook day: A trading day in which the open is above or below prior
day’s high or low and the close is below or above prior day’s close
with narrow range.
Horizontal channel: When the tops of the rallies and bottoms of the
reactions form along lines that are horizontal and parallel to one
another; the area between is called a horizontal trend channel. It may
also be called a rectangle during the early stages of formation.
Horizontal trendline: A horizontal line drawn across either the tops or
bottoms in a sideways trending market.
Hybrid head-and-shoulders: A small head-and-shoulders pattern within
a larger head-and-shoulders pattern. See Head-and-shoulders pattern.
Industrial average: See Dow-Jones Industrial Average.
Inside day: A day in which the daily price range is totally within the
prior day’s daily price range.
Insiders: Individuals who possess fundamental information that is likely
to affect the price of a stock but which is unavailable to the public.
An example would be an individual who knows about a merger before
it is announced to the public. Trading by insiders on this type of
information is illegal.
Intermediate trend: In the Edwards and Magee book, Technical Analysis
of Stock Trends, the term “intermediate” or “secondary” refers to a trend
(or pattern indicating a trend) against the primary (major) trend that
is likely to last from 3 weeks to 3 months, and that may retrace one-
third to two-thirds of the previous primary advance or decline.
Inverted bowl: See Rounding top.
Inverted triangle: See Right-angled broadening triangle.
ishares: Ishares are stock-like instruments (ETF’s or Exchange Traded
Funds) traded on the American Stock Exchange which represent a
small percentage of a major index, for example, the DIA is 10% of
the Dow Jones Industrials. See www.amex.com.
Island reversal: A compact trading range, usually formed after a fast
rally or reaction, that is separated from the previous move by an
exhaustion gap, and from the move in the opposite direction that
follows by a breakaway gap. The result is an island of prices detached
by a gap before and after. If the trading range contains only 1 day,
it is called a 1-day reversal. The two gaps usually occur at approxi-
mately the same level. By itself, the pattern is not of major significance,
but it does frequently send prices back for a complete retracement of
the minor move that preceded it.
Kilroy bottom: See Head-and-shoulders bottom.
Leverage: Using a smaller amount of capital to control an investment of
greater value. For example, exclusive of interest and commission costs,
if you buy a stock on 50% margin, you control $1 of stock for every
50 cents invested or leverage of 2-to-1.
Limit move: A change in price that exceeds the limits set by the exchange
on which the contract or security is traded.
Limit order: A buy or sell order that is limited in some way, usually in
price. For example, if you placed a limit order to buy IBM at 100, the
broker would not fill the order unless he could do so at your price
or better (i.e., at 100 or lower).
Limit up, limit down: Commodity exchange restrictions on the maximum
upward or downward movement permitted in the price for a com-
modity during any trading session.
Line, Dow Theory: A line in the Dow Theory is an intermediate sideways
movement in one or both of the averages (industrial and or transpor-
tation) in the course of which prices fluctuate within a range of 5%
(of mean price) or less.
Logarithmic scale: See Semi-logarithmic scale.
Magee Evaluative Index: Constructed by examining each stock in the
universe under consideration and ranking it weak, neutral, or strong
and compiling the percentages. Extreme readings in the industrials
(5–8% strong for bottoms, 80% for tops) mark major market bottoms,
and tops.
Major trend: In the Edwards and Magee book, Technical Analysis of
Stock Trends, the term “major” (or “primary”) refers to a trend (or
pattern leading to such a trend) that lasts at least 1 year and shows
a rise or decline of at least 20%.
Margin: The minimum amount of capital required to buy or sell a stock.
The rate, currently 50% of value, is set by the government. In a
commodity, margin is also the minimum (usually about 10%) needed
to buy or sell a contract. But the rate is set by the individual exchanges.
The two differ in cost as well. In a stock, the broker lends the investor
the balance of the money due and charges interest for the loan. In a
commodity, margin is treated as a good faith payment. The broker
does not lend the difference so no interest expense is incurred.
Market on close: An order specification that requires the broker to get
the best price available on the close of trading.
Market order: An instruction to buy or sell at the price prevailing when
the order reaches the floor of the Exchange.
Market reciprocal: Normal average range of a stock based on the
average range for a number of years, divided by the current average
range. The result is the reciprocal of the market movement for the
period. Wide market activity, for example, would show a small dec-
imal, less than 1. Dull trading would be a larger number.
Mast: The vertical rally or reaction preceding a flag or pennant formation.
Glossary 229
Measuring formula: The formula for determining the minimum amount

a stock or commodity is likely to move after a successful breakout of
an area pattern. See individual patterns for specific formulas.
Measuring gap: See Runaway gap.
Minor trend: In the Edwards and Magee book, Technical Analysis of
Stock Trends, the term “minor” refers to brief fluctuations (usually less
than 6 days and rarely longer than 3 weeks) that, in total, make up
the intermediate trend.
Momentum indicator: A market indicator that uses volume statistics for
predicting the strength or weakness of a current market and any
overbought or oversold conditions, and to distinguish turning points
within the market.
Money management rules: Per Pragmatic Portfolio Theory, a Portfolio
Risk Profile dictates (e.g., how much capital should be risked on any
one trade, in any one position, and for the portfolio as a whole). See
Pragmatic Portfolio Theory. Refer to Technical Analysis of Stock Trends
(8th ed.).
Moving average: A mathematical technique to smooth data. It is called
“moving” because the number of elements are fixed but the time
interval advances. Old data must be removed when new data are
added, which causes the average to “move along” with the progression
of the stock or commodity price.
Moving average crossovers: The point at which the various moving
average lines pass through or over each other.
Multiple head-and-shoulders pattern: See Complex head-and-shoulders.
Natural systems: Systems based on market data alone without any inter-
vening numerical processes (e.g., chart analysis and high-low systems,
as Donchian’s systems).
Narrow range day: A trading day with a narrower price range relative
to the previous day’s price range.
Neckline: In a head-and-shoulders pattern, it is the line drawn across
the two reaction lows (in a top), or two rally highs (in a bottom),
that occur before and after the head. This line must be broken by 3%
to confirm the reversal. In a diamond pattern, which is similar to a
head-and-shoulders pattern, the neckline is bent in the shape of a V
or inverted V. See Diamond pattern and Head-and-shoulders pattern.
Negative divergence: When two or more averages, indices, or indicators
fail to show confirming trends.
Odd lot: A block of stock consisting of less than 100 shares.
Operational risk: Determined by taking stop price from market price,
in simplest form. For complete exposition refer to Technical Analysis
of Stock Trends (8th ed.).
One-day reversal: See Island reversal.
Option: The right granted to one investor by another to buy (called a

call option) or sell (called a put option) 100 shares of stock, or one
contract of a commodity, at a fixed price for a fixed period. The
investor granting the right (the seller of the option) is paid a nonre-
fundable premium by the buyer of the option.
Order: See Limit order, Market order, and Stop order.
Oscillator: A form of momentum or rate-of-change indicator that is
usually valued from +1 to –1 or from 0% to 100%.
Overbought: Market prices that have risen too steeply and too quickly.
Oversold: Market prices that have declined too steeply and too quickly.
Overbought/oversold indicator: An indicator that attempts to define
when prices have moved too far and too quickly in either direction
and thus are liable to a reaction.
Panic: The second stage of a bear market when buyers thin out and
sellers become more urgent. The downward trend of prices suddenly
accelerates into an almost vertical drop while volume rises to climactic
proportions. See Bear market.
Panic bottom: See Selling climax.
Pattern: See Area pattern.
Peak: See Top.
Penetration: The breaking of a pattern boundary line, trendline, or
support and resistance level.
Pennant: A pennant is a flag with converging, rather than parallel,
boundary lines. See Flag continuation pattern.
Point-and-figure chart: A method of charting believed to have been
created by Charles Dow. Each day the price moves by a specifi c
amount (the arbitrary box size), an X (if up) or O (if down) is placed
on a vertical column of squared paper. As long as prices do not
change direction by a specified amount (the reversal), the trend is
considered to be in force and no new column is made. If a reversal
takes place, another vertical column is started immediately to the right
of the first but in the opposite direction. There is no provision for
time on a point-and-figure chart.
Portfolio risk: Measured by operational, temporal, and catastrophic ele-
ments, reducible to a daily (or any other time frame) figure which
may be used to simulate catastrophic risk by assuming x standard
deviation moves. Refer to Technical Analysis of Stock Trends (8th ed.).
Pragmatic Portfolio Theory: PPT dictates the following: (1) portfolio
should be balanced according to the MEI; (2) a continual process of
rebalancing occurs, per rhythmic trading; (3) all positions should be
risk balanced insofar as possible; (4) that risk measurement is constant
in three dimensions: operational, time, catastrophic. For a complete
exposition, refer to Technical Analysis of Stock Trends (8th ed.).
Glossary 231
Premature breakout: A breakout of an area pattern, then a retreat back

into the pattern. Eventually the trend will break out again and proceed
in the same direction. At the time they occur, false breakouts and
premature breakouts are indistinguishable from each other or from a
genuine breakout.
Primary trend: See Major trend.
Program trading: Trades based on signals from various computer pro-
grams, usually entered directly from the trader’s computer to the
market’s computer system. Also futures/cash arbitrage or hedging. Also
large transactions of baskets of stock by large traders.
Progressive stop: A stop order that follows the market up or down. See
Stop.
Protective stop: A stop order used to protect gains or limit losses in an
existing position. See Stop.
Pullback: Return of prices to the boundary line of the pattern after a
breakout to the downside. Return after an upside breakout is called
a “throwback.”
Put: An option to sell a specified amount of a stock or commodity at an
agreed time at the stated exercise price.
Rail Average: See Dow-Jones Transportation Average.
Rally: An increase in price that retraces part of the previous price decline.
Rally tops: A price level that finishes a short-term rally in an ongoing trend.
Range: The difference between the high and low during a specific time
period.
Reaction: A decline in price that retraces part of the previous price
advance.
Reciprocal, market: See Market reciprocal.
Recovery: See Rally.
Rectangle: A trading area that is bounded on the top and the bottom
with horizontal, or near horizontal, lines. A rectangle can be either a
reversal or continuation pattern depending on the direction of the
breakout. Minimum measuring formula: add the width (difference
between top and bottom) of the rectangle to the breakout point.
Resistance level: A price level at which a sufficient supply of stock is
forthcoming to stop, and possibly turn back for a time, an uptrend.
Retracement: A price movement in the opposite direction of the previous
trend.
Return line: See Ascending or Descending trend channels.
Reversal gap: A chart formation where the low of the last day is above the
previous day’s range with the close above mid-range and above the open.
Reversal pattern: An area pattern that breaks out in a direction opposite
to the previous trend. See Ascending triangle, Broadening formation,
Broadening top, Descending triangle, Diamond, Dormant bottom,
Double bottom or top, Triple bottom or top, Head-and-shoulders,

Rectangle, Rounding bottom or top, Saucer, Symmetrical triangle, and
Rising or Falling wedge.
Right-angled broadening triangle: Area pattern with one boundary line
horizontal and the other at an angle that, when extended, will converge
with the horizontal line at some point to the left of the pattern. Similar
in shape to ascending and descending triangles except they ar e
inverted and look like flat-topped or bottomed megaphones. Right-
angled broadening formations generally carry bearish implications
regardless of which side is flat. But any decisive breakout (3% or
more) through the horizontal boundary line has the same forceful
significance as does a breakout in an ascending or descending triangle.
Right-angled triangles: See Ascending and Descending triangles.
Rising wedge: An area pattern with two upward-slanting, converging
trendlines. Normally it takes more than 3 weeks to complete, and
volume will diminish as prices move toward the apex of the pattern.
The anticipated direction of the breakout in a rising wedge is down.
Minimum measuring formula: a retracement of all the ground gained
within the wedge.
Risk: The variable which must be controlled. In its simplest form the
distance between the market price and the stop price on the position.
Generally defined as volatility by theorists and academicians.
Risk per trade: RPT is determined by multiplying the position size by
the difference between the stop price and the market price. This is
constrained by the percentage of capital risk that may be ventured
on any one position, such as 3% of capital may be risked on one
trade so the position size must be adjusted to fit this constraint. Refer
to Technical Analysis of Stock Trends (8th ed.).
Round lot: A block of stock consisting of 100 shares of stock.
Round trip: The cost of one complete stock or commodity transaction
(i.e., the entry cost and the offset cost combined).
Rounding bottom: An area pattern that pictures a gradual, progressive,
and fairly symmetrical change in the trend from down to up. Both
the price pattern (along its lows) and the volume pattern show a
concave shape, often called a bowl or saucer. There is no minimum
measuring formula associated with this reversal pattern.
Rounding top: An area pattern that pictures a gradual, progressive, and
fairly symmetrical change in the trend from up to down. The price
pattern, along its highs, shows a convex shape sometimes called an
inverted bowl. The volume pattern is concave-shaped (a bowl) as
trading activity declines into the peak of the price pattern and increases
when prices begin to fall. There is no measuring formula associated
with this reversal pattern.
Glossary 233
Runaway day: A day’s trading that traverses a noticeably longer range

in one direction than the days around it.
Runaway gap: A relatively wide gap in prices that occurs in an advance
or decline gathering momentum. Also called a “measuring gap” as it
frequently occurs at just about the halfway point between the breakout
that started the move and the reversal day that calls an end to it.
Minimum measuring formula: take the distance from the original
breakout point to the start of the gap, and add it to the other side of
the gap.
Running market: A market wherein prices are moving rapidly in one
direction with very few or no price changes in the opposite direction.
Saucer: See Rounding bottom and Scallops.
Scallops: A series of rounding bottom (saucers) patterns where the rising
end always carries prices a little higher than the preceding top at the
beginning of the pattern. Net gains will vary from stock to stock, but
there is a strong tendency for it to amount to 10 to 15% of the price.
The total reaction, from the lefthand top of each saucer to its bottom,
is usually in the 20 to 30% area. Individual saucers in a scallop series
are normally 5 to 7 weeks long and rarely less than 3 weeks. The
volume will show a convex or bowl pattern.
Secondary trend: See Intermediate trend.
Selling climax: A period of extraordinary volume that comes at the end
of a rapid and comprehensive decline that exhausts the margin
reserves of many speculators and patience of investors. Total volume
turnover may exceed any single day’s volume during the previous
upswing as panic selling sweeps through the stock or commodity.
Also called a clean-out day, a selling climax reverses the technical
conditions of the market. Although it is a form of a 1-day reversal, it
can take more than 1 day to complete.
Semi-logarithmic scale: Price or volume scale on which the distance
on the vertical axis (i.e., space between horizontal lines) represents
equal percentage changes.
Sensitivity: An index used by Edwards and Magee to measure the prob-
able percentage movement (sensitivity) of a stock during a specified
percentage move in the stock market as a whole. Very like beta.
Shake-out: A corrective move large enough to “shake out” nervous
investors before the primary trend resumes.
Short interest: The number of shares that have been sold short and not
yet repurchased. This information is published monthly by the New
York Stock Exchange.
Short sale: A transaction in which the entry position is to sell a stock or
commodity first and to repurchase it (hopefully at a lower price) at
a later date. In the stock market, shares not owned can be sold by
borrowing shares from the broker and replacing them when the
offsetting repurchase takes place. In the commodity market, contracts
are created when a buyer and seller get together through a floor
broker. As a result, the procedure to sell in the commodity market is
the same as it is to buy.
Shoulder: See Head-and-shoulders patterns.
Smoothing: A mathematical approach that removes excess data variability
while maintaining a (presumably) correct appraisal of the underlying
trend.
Spike: A sharp rise in price in a single day or two.
Stochastic: Literally means random. Adopted by some technicians to
name process of analyzing closing prices relative to trend direction.
Stock split: A procedure used by management to establish a different
market price for its shares by changing the common stock structure
of the company. Usually a lower price is desired and established by
canceling the outstanding shares and reissuing a larger number of
new certificates to current shareholders. The most common ratios are
2-to-1, 3-to-1, and 3-to-2. Occasionally, a higher price is desired and
a reverse split takes place when one new share is issued for some
multiple number of old shares.
Stop: A contingency order that is placed above the current market price
if it is to buy, or below the current market price if it is to sell. A stop
order becomes a market order only when the stock or commodity
moves up to the price of the buy stop, or down to the price of a sell
stop. A stop can be used to enter a new position or exit an old
position. See Protective stop or Progressive stop.
Stop loss: See Protective Stop.
Stop systems: Magee constructed several stop systems — all of them
interesting and valuable. These may be classified as follows: (1) support
and resistance, (2) trendline, (3) hair-trigger or near progressive stops,
and (4) 3-days-away procedure. These are simple for the long-term
investor, complex for the speculator. Refer to Technical Analysis of
Stock Trends (8th ed.).
Supply: Amount of stock available at a given price.
Supply line: See Resistance.
Support level: The price level at which a sufficient amount of demand
is forthcoming to stop, and possibly turn higher for a time, a downtrend.
Symmetrical triangle: Also called a coil. Can be a reversal or continu-
ation pattern. A sideways congestion where each minor top fails to
attain the height of the previous rally and each minor bottom stopping
above the level of the previous low. The result is upper and lower
boundary lines that converge, if extended, to a point on the right.
The upper boundary line must slant down and the lower boundary
Glossary 235
line must slant up, or it would be a variety of wedge. Volume tends

to diminish during formation. Minimum formula: add the widest dis-
tance within the triangle to its breakout point.
Tangent: See Trendline.
Tape reader: One who makes trading decisions by watching the flow of
New York Stock Exchange and American Stock Exchange price and
volume data coming across the electronic ticker tape. Today, a day trader.
Tekniplat paper: A specially formatted two-cycle semi-logarithmic graph
paper, with sixth-line vertical accents, used to chart stock or commod-
ity prices. (Tekniplat Paper is available at www.johnmageeta.com.)
Test: A term used to describe the activity of a stock or commodity when
it returns to, “tests” the validity of a previous trendline or support or
resistance level.
Thin issue: A stock that has a low number of floating shares and is
lightly traded.
3-day-away rule: A time period used by Edwards and Magee in marking
suspected minor tops or bottoms.
Throwback: Return of prices to the boundary line of the pattern after a
breakout to the upside. Return after a downside breakout is called a
pullback.
Top: See Broadening top, Descending triangle, Double top, Head-and-
shoulders top, Triple top, and Rounding top.
Trend: The direction prices are moving. See Ascending, Descending, and
Horizontal parallel trend channels, Convergent trend, Divergent trend,
Intermediate trend, Major trend, and Minor trend.
Trend channel: A parallel probable price range centered about the most
likely price line.
Trending market: Price moves in a single direction, usually closing at
an extreme for the day.
Trendline: A straight line that connects a series of higher lows (an up
trendline), a series of lower highs (a downtrend line), or a series of
highs and or lows on a horizontal line.
Triangle: See Ascending triangle, Descending triangle, Right-angle broad-
ening triangle, and Symmetrical triangle.
Triple bottom: Similar to a flat head-and-shoulders bottom, or rectangle,
the three bottoms in a triple bottom.
Triple top: An area pattern with three tops that are widely spaced and
with quite deep, and usually rounding, reactions between them. Less
volume occurs on the second peak than the first peak, and still less
on the third peak. Sometimes called a “W” pattern, particularly if the
second peak is below the first and third. The triple top is confirmed
when the decline from the third top penetrates the bottom of the
lowest valley between the three peaks.
200-day moving-average line: Determined by summing the closing price

over the past 200 trading days and dividing by 200, etc.
U/d volume: Is the ratio between the daily up volume to the daily down
volume. It is a 50-day ratio determined by dividing the total volume
on those days when the stock closed up from the prior day by the
total volume on days when the stock closed down.
Uptick: A securities transaction made at a price higher than the preceding
transaction.
Uptrend: See Ascending trendline and Trend.
Utility average: See Dow-Jones Utility Average.
Validity of trendline penetration: The application of the following three
tests, when a trendline is broken, to determine whether the break is
valid or whether the trendline is still basically intact: (1) the extent of
the penetration, (2) the volume of trading on the penetration, and (3)
the trading action after the penetration.
Valley: The V-shaped price action that occurs between two peaks. See
Double top and Triple top.
Volatility: A measure of a stock’s tendency to move up and down in
price, based on its daily price history over the latest 12-month (or
other) period.
Volume: The number of shares in stocks or contracts in commodities that
are traded over a specified period.
“W” formation: See Triple top.
Wedge: A chart formation in which the price fluctuations are confined
within converging straight (or practically straight) lines, but differing
from a triangle in that both boundary lines either slope up or slope
down. See Falling wedge and Rising wedge.
GLOSSARY OF PATTERNS
This section contains chart patterns for the following:
Major bullish (bottoming patterns)

Major bearish (topping patterns)
Major continuation patterns (of previous trend)
Measurement patterns
237
Diagram 21. Major Bullish (Bottoming) Patterns: Triple Bottom, Fan, Head-and-
Shoulders (Kilroy) Bottom (Simple), Head-and-Shoulders (Kilroy) Bottom (Com-
plex). Note usefulness of describing complex H-and-S Bottom a Kilroy Bottom,
as various “shoulders” can be described as “fingers.”
Glossary 239
Diagram 22. Major Bullish (Bottoming) Patterns: 1-Day Reversal, Island Rever-
sal, Rounding Bottom (Bowl/Saucer), and Dormant Bottom.
Diagram 23. Major Bearish (Topping) Patterns: Triple Top, Fan, Head-and-Shoul-
ders Top (Simple), and Head-and-Shoulders Top (Complex).
Glossary 241
Diagram 24. Major Bearish (Topping) Patterns: 1-Day Reversal, Island Reversal,
Rounding Top (Inverted Bowl), Broadening Top.
Diagram 25. Indeterminate Patterns: Rectangle, Diamond, and Triangle

(Symmetrical).
Glossary 243
Diagram 26. Major Continuation Patterns (of Previous Trend): Head-and-Shoul-

ders (Kilroy) Consolidation, Pennant, Flag, and Wedge (Rising).
Diagram 27. Measurement Patterns: Flag and Triangle.

Glossary 245
Diagram 28. Measurement Patterns: Rectangle, Head-and-Shoulders (Kilroy)

Bottom, and Wedge (Rising).
LIST OF DIAGRAMS
1. How Resistance Forms.................................................................... 22
2. How Support Forms........................................................................ 22
3. Old Resistance Becomes New Support ......................................... 23
4. Valid Support Levels........................................................................ 23
5. The Bull Trap................................................................................... 24
6. The Bear Trap.................................................................................. 24
7. Decoding a Bar Chart ..................................................................... 25
8. Kilroy Bottom................................................................................... 26
9. Construction of Uptrend Line......................................................... 55
10. Construction of Downtrend Line.................................................... 56
11. Construction of Sideways Trendlines............................................. 57
12. Formation of Downtrend Channel ................................................. 58
13. Formation of Sideways Channel .................................................... 58
14. Formation of Uptrend Channel ...................................................... 59
15. Diagram Illustrating Different Kinds of Gaps ............................... 62
16. Diagram of Island Reversal............................................................. 68
17. Equivolume Graphic...................................................................... 105
18. Illustration of Candlestick Method ............................................... 106
19. Point-and-Figure Patterns .............................................................. 109
20. A Spectrum of Investors (Nonprofessional) ......................... 118-119
21. Major Bullish (Bottoming) Patterns: Triple Bottom, Fan,
Head-and-Shoulders (Kilroy) Bottom (Simple), Head-and-
Shoulders (Kilroy) Bottom (Complex) ......................................... 238
22. Major Bullish (Bottoming) Patterns: 1-Day Reversal, Island
Reversal, Rounding Bottom (Bowl/Saucer), and Dormant
Bottom ............................................................................................ 239
23. Major Bearish (Topping) Patterns: Triple Top, Fan, Head-
and-Shoulders Top (Simple), Head-and-Shoulders Top
(Complex)....................................................................................... 240
24. Major Bearish (Topping) Patterns: 1-Day Reversal, Island
Reversal, Rounding Top (Inverted Bowl), Broadening Top ...... 241
25. Indeterminate Patterns: Rectangle, Diamond, and Triangle
(Symmetrical) ................................................................................. 242
26. Major Continuation Patterns (of Previous Trend): Head-and-
Shoulders (Kilroy) Consolidation, Pennant, Flag, and Wedge
(Rising) ........................................................................................... 243
27. Measurement Patterns: Flag and Triangle ................................... 244
28. Measurement Patterns: Rectangle, Head-and-Shoulders
(Kilroy) Bottom, and Wedge (Rising) .......................................... 245
Glossary 247
LIST OF CHART PATTERNS

1. Dow-Jones Averages Chart Showing Divergences and
Confirmations of Industries by Transportation ............................... 5
2. The Dow Industrials Uptrend........................................................... 8
3. Xerox, in a Downtrend..................................................................... 9
4. Dow-Jones Industrials ..................................................................... 10
5. American Express, Support and Resistance Illustration ............... 20
6. IBM. Straight Trend from 1953–1962 ............................................. 28
7. Ebay, Largely Horizontal at this Moment in Time ....................... 31
8. Dow-Jones Industrials. Three Bull Market Tops: 1929, 1987,
1998 .................................................................................................. 32
9. Microsoft. How a Historic Bull Market Ended.............................. 35
10. IBM. January 1962, End of Another Historic Bull Market ........... 37
11. Advanced Micro Devices, Inc......................................................... 38
12. B.F. Goodrich Company.................................................................. 39
13. Bankamerica Corporation ............................................................... 41
14. Qualcomm, Symmetrical Triangles ................................................. 42
15. Lucent, Descending Triangle .......................................................... 44
16. American Airlines, Ascending Triangle .......................................... 45
17. Comdisco, Inc. ................................................................................. 46
18. Gap, Inc............................................................................................ 47
19. Nike Kilroy Bottom ......................................................................... 49
20. Dillard Department Stores Inc........................................................ 50
21. Citicorp, Rounding Top................................................................... 52
22. Oracle, with Trend Channel and Earnings Gap ........................... 53
23. IBM, Double Top in a Relatively Complex Situation ................... 65
24. Consolidated Edison ........................................................................ 66
25. Apple, Brought Low by Earnings Hysteria.................................... 67
26. Lucent, Illustrating Key Reversal Days .......................................... 71
27. Microsoft, Illustrating Stop-Setting with 3-Days-Away
Procedure ................................................................................... 76–77
28. Welles Wilder RSI Illustration ......................................................... 94
29. George Lane Stochastic Illustration ................................................ 95
30. Bollinger Band Illustration .............................................................. 96
31. Rate of Change Illustration ............................................................. 97
32. Relative Strength Index Illustration ................................................ 98
33. Moving Average Convergence/Divergence and Bollinger
Bands ................................................................................................ 99
34. The Dow, Circa 2000. A Broadening Top and Moving
Average ........................................................................................... 100
35. Microsoft with Two Moving Average Systems ............................ 101
36. A 200-Day Moving Average on the Dow-Jones at the Turn

of the Century................................................................................ 103
37. Microsoft ......................................................................................... 110
38. Microsoft, Same Data, Charted with Candlestick Method.......... 111
39. Microsoft, Same Data, Charted with Point-and-Figure
Method............................................................................................ 112
40. Anonymous. A Lesson for Quick Learners ................................. 145
41. Juniper, a Lesson for Mutual Fund Managers ............................. 146
42. Juniper, a Lesson for Mutual Fund Managers ............................. 147
43. IBM, Best and Brightest ................................................................ 150
44. Xerox, Best and Brightest ............................................................. 151
45. American Express, Bottom Spike ................................................. 157
46. Treasury Bills. December 1984. The Turning Point ................... 161
47. Copper. March 1984 ...................................................................... 174
48. Computervision. Opportunity or Trap? ........................................ 187
49. United Brands. Astute Chart Analysis Predicts Takeover........... 189
50. IBM, 1975–1987. Testing a Thesis Based on Long-Term
Trend Analysis ............................................................................... 195
51. Dow-Jones, Illustration of Magee Evaluative Index ................... 196
52. Tekniplat Paper.............................................................................. 201
SL302X_frame_IDX Page 249 Wednesday, January 16, 2002 11:05 AM
INDEX
1-day reversal, see also Island reversal At the money, 218

pattern AT&T, 219
after brisk trading, 46 Average, composite, 221
definition of, 227 Average, moving, see Moving average
example of, 239, 241 Averages, divergent, 5
selling climax as form of, 39–40, 233 Averages, Dow-Jones, see Dow-Jones
3-Days-Away-Procedure, 75–77, 235 Industrial Average (DJIA); Dow-
5-point reversal, see Broadening formation Jones Transportation Average;
50-day moving average line, 225, 236 Dow-Jones Utility Average
150-day moving average line, 104 Averaging cost, 218
200-day moving average line, 36–37, Avon Products, 149
103–104, 236 Axis, 11, 218
A B
Accumulation, 217 Balanced program, 79, 218
Activity, see Volume BankAmerica, 41
Advanced Micro Devices, Inc., 38 Bar chart
Against the Gods, 211 construction of, 200–202
Air pocket gap, 42, 44, 53 definition of, 11, 199–200, 218
Allegheny Corporation, 156 patterns in, 238–245; see also specific
Allied Stores, 188 types
Amerada Hess, 188 predictive value of, 12, 130
American Airlines, 45 scales on, see Scale
American Express, 20, 156, 157 use of, as a tool, 2, 11–12, 84
American Financial Corporation, 188 Barron’s, 175, 177–178, 188
American Stock Exchange (AMEX), 87, 123, Basic trendlines, 52–53
227, 235 Basing points, 18, 44, 52, 75, 218–219
Apex, 43, 217 Basis points, 219
Apple, 67 Basket trades, 219
Appreciation, 7 Bassetti, C.D.H., 212
Arbitrage, 217 Bassetti, W.H.C., 90, 211, 212
Area gaps, 62–63; see also Common gap The Battle for Investment Survival , 118
Area pattern, 19–21, 217 Bear flag, 47, 50
Area reversal pattern, 219 Bear market, 1, 39–40, 219, 230; see also
Arithmetic scale, 217 Bearish patterns
Arms, Richard W., 105 Bear trap, 24
Ascending trend channel, 217–218 Bearish patterns, 106–107, 240–241
Ascending trendline, 217–218 descending triangle, 43, 222
Ascending triangle pattern, 19, 43, 45, downtrend line, 56
63–64, 218–219 rectangles, 42
249
right-angled broadening triangle, 232 Broadening top pattern, 100, 219, 241
rising wedge, 47 Broadening triangle pattern, right-angle,
Bent neckline, see Head-and-shoulders 231–232
neckline pattern Buffet, Warren, 119
Bernstein, Peter, 211 Bull market
The Best and the Brightest group, 74, 116, definition of, 1, 220
149–151 example of, 8, 32, 35, 37
Beta, 219 indicators of, 175–176; see also Bullish
Beyond Candlesticks, 212 patterns
B.F. Goodrich Co., 39 phases of, 217, 220, 222
Big Blue, see International Business recognition of, 158–159
Machines (IBM) and runaway days, 70
Black-Scholes options pricing model, 208 Bull trap, 24
Block trades, 219 by American Airlines, 45
Blow-off strategy, 59, 62; see also Climactic by American Express, 20
top; Tactics by day traders, 122
Blue chip companies, 4, 149–151, 219 by Lucent, 44
Bollinger, John, 96 by Microsoft, 35, 77, 110, 112
Bollinger’s Bands, 96, 99 Bullish patterns, 106–107, 158–159, 238–239
Book value, 219 ascending triangle, 43, 218
Booms, 13, 171–172 falling wedge, 41, 46
Bottom pattern sawtooth, 158
dormant, 223, 239 uptrend line, 55
double, 39, 109, 223 Busts, see Collapses; Crashes; Panics
Kilroy, see Kilroy bottom pattern Buying, see also Tactics
pendant, see Kilroy bottom pattern after consolidation, 40
rounding, 223, 232, 239; see also Scallop and-selling vs. buy-and-hold, 1, 104,
pattern 149–151
triple, 235, 238 in head-and-shoulders pattern, 49
Bounce, dead cat, 146–147 of low-priced stocks, 15
Boundary, 219 on the reaction, 42
Bowl pattern, see Rounding bottom pattern as support, 19
Bracketing, 219 without technical analysis, 169–170,
Breakaway gap 190–191
after island reversal pattern, 68–69, 227 Buying order, limited, 228
definition of, 62–64, 219
example of, 45, 52, 65, 146–147
Breakout
C
bona fide, as confirmation, 221 Call, 124, 156, 220, 230
definition of, 219 Candlestick Charts, 106–107, 111, 220; see
end run after, 224 also Beyond Candlesticks
failure of, 224 Capital
false, 13, 44, 46, 224 management rules, for portfolio,
movement, minimum after, see 124–125, 229
Measuring formula margin, minimum amount of, 54, 228
premature, 231; see also False breakout risk per trade, 87, 232
of prices, on charts, 19–21, 25 Cats and dogs stocks, 220
support and resistance after, 41–42 CBOT, see Chicago Board of Trade (CBOT)
Breakout pattern, 30, 36–37, 62–64 Channel, trend, see Trend channels
Bridge Rule, 75 Channeling stocks, 21
Broadening formation, 156, 219, 222 Chart paper, 201–207, 209
Index 251
Chart patterns, list of, 247–248 Consolidation patterns, 19, 37–39, 221
Charts, 220; see also Interpreting charts; diamonds, 222
Predictive methods flags and pennants, 45–48
bar, see Bar chart horizontal trend channels, 40
candlestick, 106–107, 111, 220 inverted head-and-shoulders, 226
computer generated, 208–209; see also Kilroy bottom, 226
Internet; Software rectangles, 40, 231
P&F, see Point-and-figure (P&F) charting symmetrical triangles, 40, 43, 234–235
Tekniplat, 201–207, 235 Continuation gaps, see Runaway gap
Chicago Board of Options Exchange, 208 Continuation patterns, 243; see also
Chicago Board of Trade (CBOT), 124 Consolidation patterns
Chicago Research and Trading Co., 208 Contrarian Investment Strategy, 179
Church spire top pattern, 42 Convergent pattern, 221
Citicorp, 52 Copper prices, chart of, 174
Clean-out day, see Selling Correction, 221
Climactic top, 220 Cost, averaging, 218
Climax day, 39–40; see also Island reversal Cost, transaction, 232
pattern Cradle point, 43–44, 222
Clinton-Gore administration, 8 Crashes, 13, 21
Closing price, 218, 220 Crystal ball, 164–165, 175–176; see also
gap in, 38–39 Philosopher’s Stones
in Stochastic Indicator, 95 Currency, as a trading vehicle, 122
use of, in bar charts, 11
use of, in Candlestick charting, 106
Closing the gap, 220 D
Cohen, A.W., 103, 212 Daily range, 222
Coil, 220 Data collection, 11–12, 28–29, 129, 200,
Collapses, 13, 186–187; see also Crashes; 206–207
Panics Data General, 186–187
Comdisco, Inc. (CDO), 46 Day traders, see Short-term traders
COMEX, 171 Dead cat bounce, 146–147
Commission, 220 Demand, 222
Commodity exchange restrictions, 228 DeMark, Thomas, 212
Common gap, 62–63, 220 Depreciation, 7
Comparative relative strength, 221 Descending trend channel, 222
Complex head-and-shoulders pattern, 221; Descending trendline, 222
see also Diamond pattern Descending triangle pattern, 21, 43, 44, 219,
Composite average, 221 222
Composite leverage, 84–85, 221 DIA
Computervison, 186–187 investment in, 87, 123, 125
Confirmation, 4–5, 221, 224, 235 percentage of DJIA, 18, 227
Congestion period web site, 211
breakout from, 40, 194 Diagrams, list of, 246
consolidation patterns in, see Diamond pattern, 222, 242
Consolidation patterns Dillard Department Stores Inc., 50
definition of, 221 Distribution, 222
example of, 22–24 Divergence, 221–222, 229
gaps in, 62–64 Divergent averages, 5
reversal patterns in, see Reversal patterns Divergent pattern, 222
support and resistance in, 63 Diversification, 81–82, 85–87, 124–125, 223
Consolidated Edison, 66 Dividends, 11, 179, 205–206, 223, 224
DJIA, see Dow-Jones Industrial Average Elliott Wave Theory, 113, 175, 177
(DJIA) End run, 43, 46, 224
Donchian’s systems, 229 Entry and profit protection, 73–74
Dormant bottom pattern, 223, 239 Equilibrium market, 224
Double bottom pattern, 39, 109, 223 Equivolume, 105
Double top pattern, 109, 223 European Currency Unit (Euro), 122
Double trendline, 36, 223; see also Trend EveryMan’s EveryStock, 25, 74–75
channels Ex-dividend, 11, 224; see also Dividends
Dow, Charles, 1–4, 48, 109, 223, 230 Exchange Traded Funds, see Ishares
Dow-Jones futures and options web site, Exercise, 224
211 Exhaustion gap
Dow-Jones Futures Contract, 124 before island reversal pattern, 68, 227
Dow-Jones Industrial Average (DJIA) definition of, 62, 64–65, 224
150-day moving average line, 104 example of, 112
200-day moving average chart, 103 Exit orders, 182
advance, record, 153–155 Expiration, 224
in a bull market, examples of, 8, 32 Exponential moving average, 101
“buying the market” with, 3 Exponential smoothing, 224
in the Composite average, 221
confirmation/divergence chart, 5
confirmation of, by Transportation, 4 F
definition of, 223
fundamental analysis of, 177–178 Falling wedge pattern, 41, 46, 224
MEI chart, 196 False breakout, 13, 44, 46, 224
Microsoft added to, 35 Fan lines, 32, 224–225, 238, 240
shakeout in, 162 Feedback, 11–12, 28–29, 129
sideways trend chart, 10 Filtering, 75, 77, 102, 209
uptrend chart, 8 Five-point reversal, see Broadening
Dow-Jones Transportation Average, 4, 5, formation
223 Flag, bear, 47, 50
Dow-Jones Utility Average, 5, 221, 223 Flag pattern
Dow Theory, 1–6, 57, 122–123, 221, 228 breakout from, 48
Down channel, see Descending trend in consolidation patterns, 45–48
channel definition of, 225
Downtick, 224 example of, 243
Downtrend, 7, 9, 19, 21, 192–193; see also formed by support and resistance, 17–18
Descending trendline in Markov analysis, 192–193
Downtrend channel, 58 mast pattern before, 228
Downtrend line, 56 Floating supply, 225; see also Thin issue
Dreman, David, 179 FMI Financial, 188
Dynamic trendline, see Moving average Forbes, 179
Forecasting, 1, 179, 185, 220; see also
Predictive methods
E Formation
area, 19–21, 217
Earnings, forecasting, 179 broadening, 156, 219, 222
Earnings gap, 53, 67 congestion, see Congestion period
Earnings reports, 67, 84 “M,” 223
Eastman Kodak, 149 narrowing, 42
Ebay, 31 “W,” 235, 240
Edwards, Robert D., 211 Formula, minimum measuring, see
Elliott, R.N., 113, 175, 177 Measuring formula
Index 253
Front-month, 225 Horizontal trendline, 227

Fudge factors, 74 How to use the Three Point Reversal Method
Fundamental analysis vs. technical analysis, of Point and Figure Stock
84, 149–151, 177 Market Trading, 109, 212
Fundamental information, 134, 225 Hull Trading Co., 208
Further study, recommendations for, Hybrid head-and-shoulders pattern, 227
211–212
Futures, 124, 225
I
G IBM, see International Business Machines
(IBM)
Gamblers, trading plans for, 121 Inactive stocks, 21
Gann Angles, 113 Index, sensitivity, 233; see also Beta
Gap, 61–64, 225–226; see also specific types Industrial average, see Dow-Jones Industrial
closing of, 220 Average (DJIA)
example of, 66 Inside day, 227
formation of, 18, 38–39, 46–47 Insider trading, 6, 14
Gap, Inc., 47 Insiders, 227
General Electric, 219, 223 Intermediate reaction, see Intermediate
General Motors, 219 trend
Gilt-edged securities, see Blue chip Intermediate trend, 7, 227
companies International Business Machines (IBM)
Golden Gate University, 211 blue chip company, 219
Graph, see Charts bull market chart, 37
Greenspan, Alan, 6 double top chart, 65
downtrend, 27
long-term trend analysis chart, 195
H one-decision investing, 149–150
Hair-trigger stop, 77 trend analysis, 36, 194–195
Half-mast patterns, 48; see also Flag pattern uptrend, 27, 28
Hamilton, Carl, 164 Internet, web sites, 211, 213–216
Hamilton, William Peter, 48 Interpreting charts, 28–30, 33–34, 62, 206
Head-and-shoulders (Kilroy) bottom Inverted bowl pattern, see Rounding top
pattern, 26, 49, 51, 226, 238 pattern
Head-and-shoulders neckline pattern, 21, Inverted symmetrical triangles pattern, 219
48–50, 229, 238 Inverted triangles pattern, 219; see also
Head-and-shoulders pattern, 19–21, 48–50, Right-angle triangles
226, 243 Investment contracts, 225
Head-and-shoulders pattern, complex, 221; Investment system tools, 89–114
see also Diamond pattern Investment techniques, 218
Head-and-shoulders pattern, hybrid, 227 Investors, 117–120, 132–140; see also Long-
Head-and-shoulders top pattern, 48, 51, 69, term investors; Mid-term
226, 240 investors; Short-term traders
Heavy volume, 226 Ishares
Hedging, 32, 85, 123–125, 225–226 “buying the market” with, 3
Historical data, 227 definition of, 18, 227
Hook day, 227 in portfolio, 82, 87, 123, 125
Horizontal channel, 63, 227; see also web site on, 211
Rectangular horizontal channel Island reversal pattern, 68–69, 227, 239, 241
J M
Japanese Candlestick Charting Techniques, “M” formation, 223
106, 212 MACD, see Moving Average
John Magee Technical Analysis::Delphic Convergence/Divergence
Options Research, Ltd. (MACD)
(JMTA::DOR), 145, 213 Magee Evaluative Index (MEI)
John Magee’s Inc. and asset allocation, 79–80
e-mail address, 107, 213 calculation of, for the NASDAQ, 122
objective, 3 and computer charting, 209
portfolio strategy, 81 definition of, 18, 228
in The Stock Market Innovators Survey , DJIA, relationship to, 197
158 newsletter on, 197
web site, 211 and an oversold market, 197
Jorion, Philippe, 102, 117, 211 panics, reaction to, 154–155
The Journal of Portfolio Management, 212 and portfolio management, 85
Juniper Networks, 146–148 Magee, John, see also John Magee’s Inc.
Justice Department vs. Microsoft, 35 developer of stop systems, 73
The Magee Method, 81–87
methodology of, 79–80
K Technical Analysis of Stock Trends, 211
Winning the Mental Game on Wall
Key reversal day, 31, 45, 62, 71, 122 Street, 74
Kilroy bottom pattern, 26, 49, 51, 226, 238 Major trend
consolidation patterns in, 40
definition of, 7, 228
L evaluation of, 27, 33–36
head-and-shoulders pattern in, 51
Lane, George, 95
waves in, 48
LeFevre, William, 158
Malraux, Andre, 87, 89
Leverage, 227–228 Margin, 54, 228
Leverage, composite, 84–85, 221 Market on close, 228
Limit move, 228 Market order, 228
Limit order, 228 Market reciprocal, 228
Limit up/Limit down, 228 Market Technicians Association of New
Linder, Carl, 188 York (MTANY), 177
Line, in Dow Theory, 228 Markov analysis, 192–193
Liquidity, 80, 82, 85 Mast pattern, 228
Loeb, Gerald, 118 McDermott, Richard, 144
Logarithmic scale on charts, 200–202; see McKallip, Curtis, Jr., 192
also Semi-logarithmic scale McMillan, Lawrence G., 211
trend channels shown on, 27 Measuring formula, 41, 229
trendlines shown on, 36 for ascending triangle, 43–45, 218
use of, in technical analysis, 15 for broadening top, 219
Long-term investors for descending triangle, 222
characteristics of, 118–119, 132 for double bottom, 223
choice of analytical method for, 84 for double top, 223
considerations for, 117, 119–120 for falling wedge, 224
mental preparation of, 132–140 for flags, 225, 244
moving average, use by, 102–104 for head-and-shoulders, 50–51, 226, 245
trading plans for, 122–125 for rectangles, 41, 231, 245
Lucent, 44, 71 for rising wedge, 232
Index 255
for rounding bottom, 232 N

for rounding top, 232
for runaway gap, 233 Narrow range day, 229
for symmetrical triangles, 235, 244 Narrowing formation, 42
NASDAQ, 87, 122
for total trading, 27
Natural systems, 79–80, 85, 90, 229
Measuring gaps, see Runaway gap
Negative divergence, 229
Measuring pattern, see Flag pattern New Classics Library, Inc., 176
Megaphone pattern, see Broadening The New Science of Technical Analysis, 212
formation New York Stock Exchange (NYSE), 233, 235
MEI, see Magee Evaluative Index (MEI) Newmont Mining, 171
Mental preparation, 127–140 Newsletter, from John Magee, Inc.
Microsoft on booms, 171–172
3-days-away stop-setting chart, 76–77 on bull market patterns, 158–159
bar chart, 110 on collapses, 186–187
Bollinger Bands chart, 96 on forecasting earnings and dividends,
Bollinger’s Bands chart, 99 179, 185
bull market chart, 35 on the MEI, 197
on money management, 167–168
candlestick chart, 111
on an oversold market, 197
Equivolume chart, 105
on panics, meaning of, 153–155
MACD chart, 99 on Philosopher’s Stones, 183–184
moving average chart, 101 on predicting market behavior, 164–165,
P&F chart, 112 171–179
ROC chart, 97 on rumors, tips, new issues, and wonder
RSI chart, 94, 98 stocks, 169–170, 190–191
Stochastic Indicator chart, 95 on selling too soon, 162–163
Mid-term investors on spikes, as reversal patterns, 156–157
characteristics of, 118–119, 132 on stops, 181–182
choice of analytical method for, 84 on takeovers, 188
on technical vs. fundamental analysis,
considerations for, 117–119
177–179
mental preparation of, 132–140
on turning points, 160–161
moving average, use by, 102–104 Nike, 49
trading plans for, 122 Nison, Steve, 106, 212
Minimum measuring formula, see Measuring NYSE, see New York Stock Exchange
formula (NYSE)
Minor trend, 229
Model-based trading, 208
Momentum, 93, 229, 230 O
Money management rule, 74, 229
Odd lot, 229
Move, limit, 228 On-balance volume (OBV) analysis, 104
Moving average, 36–37, 59, 94, 100–104, One-day reversal pattern, see also Island
229; see also specific types reversal pattern
Moving Average Convergence/Divergence after brisk trading, 46
(MACD), 99 definition of, 227
MTANY, see Market Technicians Association example of, 239, 241
of New York (MTANY) selling climax as form of, 39–40, 233
Multiple head-and-shoulders pattern, see One-Decision Investing, 149–151
Complex Head-and-shoulders Opening price, 11, 38, 106, 218
pattern Operational Risk, 74, 87, 229
Operational Risk Control, 86 Philosopher’s Stones, 92, 106, 183–184

Options Point-and-figure (P&F) charting, 108–109,
Black-Scholes pricing model, 208 112, 212, 230
definition of, 124, 230 Points, basing, see Basing points
exercise of, 224 Points, basis, 219
expiration of, 224 Polaroid, 149
web sites on, 211, 213 Portfolio
Options as a Strategic Investment, 211 analysis and review of, 125
Oracle, 53 diversification of, see Diversification
Order, contingency, 234 hedging in, see Hedging
Order, exit, 182 management, 84–87, 167–170, 190–191;
Order, limit, 228 see also Pragmatic Portfolio
Order, market, 228 Theory
Order, stop, 234; see also Stops operational risk in, 86–87, 230
Oscillator, 85, 221, 230 program, balanced, 79
Overbought, 94–95, 97–98, 230 program, unbalanced, 167–168
Oversold, 94–95, 97–98, 197, 230 Positions, 81–82, 85–87, 124, 167–168
Overvalued stock, 134, 138–139 Pragmatic Portfolio Theory, 229, 230
Prechter, Robert, 175–178
Predictive methods, 12, 131–140, 164–165,
P 171–179; see also Crystal ball;
Page One, 171 Philosopher’s Stones
Panic bottom pattern, see Selling climax Premature breakout, 231; see also False
breakout
Panics, 13, 21, 61, 153–155, 230
Paper, chart, 201–207, 209 Price
Paper profits, 74 in bar charts, 11–12
Paper, Tekniplat, 235 measurement of, 43–45
Parallel trend channel, 217–218, 222 in technical analysis, 6–7, 84
Parameters for technical analysis, 102–104 and value of stock, 134, 137–140, 175
Patterns Price level, 19–21, 25, 38–39, 62
in bar charts, 238–245; see also specific Price limit, see Limit move; Stops
types Price phase line, 99
basic assumptions, 45 Price range, 21, 61, 95, 97, 228; see also
bearish, see Bearish patterns Trend channels
bullish, see Bullish patterns Price scale, on Tekniplat paper, 203–204
in candlestick charts, 107 Price, strike, 218
in Markov analysis, 192–193 Primary issues, 4
in P&F charts, 108–109 Primary trend, see Major trend
recurrence of, 30 Profit goals and trade management, 87; see
support and resistance, formed by, also Capital
17–18 Program trading, 231
takeovers, before, 188 Progressive stops, 18, 76–77, 81, 231; see
Peak, see Top also Stops
Pendant bottom pattern, see Kilroy bottom Protective stops, 81, 231; see also Stops
pattern Psychological preparation, 127–140
Penetration, 21, 230 Pullback, 19–21, 231
Pennant pattern, 45–48, 230, 243; see also Pundits, 171–179; see also Predictive
Flag pattern methods
Percentage scale, 200–202 Put, 124, 230, 231
Phelps-Dodge, 171 Pyramiding, 58
Index 257
Q Right-angled broadening triangle pattern,

232
QQQ, 87, 123, 125, 211 Rising wedge pattern, 47, 232, 243
Qualcomm, 42 Risk management, 79–80, 124, 232; see also
Operational risk
Risk Management 101, software program,
R 211, 212
Risk Per Trade (RPT), 232
Rails Average, see Dow-Jones
ROC, see Rate of Change (ROC)
Transportation Average
Round lot, 232
Rally, 221, 231
Round trip, 232
Rally tops, 231
Round-turn commission, 220
Random walkers, 2
Rounding bottom pattern, 223, 232, 239; see
Range, 231
also Scallop pattern
Ranking of stock, in MEI, 228
Rounding top pattern, 51, 52, 77, 232, 241
Rate, margin, 228
RPT, see Risk per trade (RPT)
Rate of Change (ROC), 97
RSI, see Relative Strength Index (RSI)
Ratio scale, 200–202
Rule, money management, 74, 229
Reaction, 221, 231
Rumors, tips, new issues, and wonder
Reciprocal, market, 228
stocks, 169–170, 190–191
Record keeping, 11–12, 28–29, 129, 200,
Run, end, 43, 46, 224
206–207
Runaway days
Recovery, 231
definition of, 70, 233
Rectangle pattern, 19–21, 40–43, 231, 242
example of, 35, 77, 110, 112
Rectangular horizontal channel, 30, 31, 40,
Runaway gap
41
definition of, 62, 64, 233
Registered Representative Magazine, 160
example of, 35, 52, 110, 112
Relative strength, 98
vs. exhaustion gaps, 224
Relative strength analysis, 94
Running market, 233
Relative strength, comparative, 221
Relative Strength Index (RSI), 94, 98
Resistance, 17–22, 25, 31, 41–42 S
Resistance level, zone, or band, 19, 22–25,
231, 235 Saucer pattern, see Rounding bottom
Retracement, 231 pattern
Return line, 53–54, 58, 217–218, 222 Scale
Reversal days, 45, 62, 70; see also 1-day arithmetic, 217
reversal; Key reversal day logarithmic, see Logarithmic scale
Reversal gap, 231 percentage, 200–202
Reversal patterns, 18, 37–40, 231–232 price, 203–204
area, 219 ratio, 200–202
diamonds, 222, 242 semi-logarithmic, 12, 130, 233
double bottom, 39, 109, 223 time, 205
head-and-shoulders, see Head-and- volume, 205
shoulders pattern Scallop pattern, 233
island, see Island reversal pattern Schabacker, Richard W., 48
rectangles, see Rectangle pattern Schwager, Jack, 24, 212
symmetrical triangles, see Symmetrical Sears Roebuck, 149
triangle pattern Secondary issues, 4
Reverse split, 234 Secondary trend, see Intermediate trend
Rhythmic trading, 79–80, 85, 229 Securities and Exchange Commission (SEC),
Right-angle triangles, 218, 222 213
Security transactions, 224, 236 The Stock Market Innovators Survey,

Selling 158–159
clean-out day, 233 Stock split, 234
in head-and-shoulders pattern, 49 Stop, hair-trigger, 77
of low-priced stocks, 15 Stop-loss point, 74, 218–219
as resistance, 19 Stop-loss protection, 46; see also Stops
tactics, see Tactics Stop orders, see Stops
too soon, 162–163 Stops
without technical analysis, 169–170, classification of, 234
190–191 computation of, 75, 81
Selling climax, 123, 233; see also Panics definition of, 73, 234
Selling order, limited, 228 example of, 76–77
Selling strength, 58 exit orders as, 182
Semi-logarithmic scale on charts, 12, 130, setting of, for risk management, 86–87,
233 181
Sensitivity, 84–85, 181, 233 setting of, in bull markets, 32
Settlement price, see Closing price setting of, initial, 74–75
Shakeout, 162, 233 setting of, progressive, see Progressive
Short interest, 233 stops
Short sale, 233–234 setting of, protective limit, 81, 231
Short-term traders, see also Tape reader setting of, target, 121
characteristics of, 118–119, 132 setting of, trailing, see Progressive stops
considerations for, 117, 119–120 stopping on strength, 121
mental preparation of, 132–140 Storage Technology, 162
moving average, use by, 102–104 Straight-line trend, 27, 28, 38
philosophy of, 34 Strength, comparative relative, 221
trading plans for, 121–122 Strike price, 156, 218
Shoulder, see Head-and-shoulders pattern Studies in Tape Reading, 48
Sideways trend, 10, 31, 36, 228, 234–235; Study plan, 211–212
see also Congestion period Supply, 234
Sideways trend channel, 58 Supply and demand, 19, 21
Sideways trend line, 57 Supply, floating, 225; see also Thin issue
Signal line, 99 Supply level, 43, 234; see also Resistance
Simple moving average, 100 level, zone, or band
Simple trendline, 36 Support, 17–22, 25, 31, 40–42
Slammed stocks, 146–148 Support level, zone, or band, 19, 22–25, 74,
Smoothing, 100, 224, 234 234
Symmetrical triangle pattern, 39–46, 52, 224,
Software, 91
234–235, 242; see also Coil
program, 211–213
Spam, recommendations for handling, 213
Speculation, 14
Speculators, 117–120, 122, 132–140
T
Spikes, 18, 25, 70, 154–157, 234 Tactics, 58, 93; see also Newsletter, from
Spin-off, 206 John Magee, Inc.; Record
Split, reverse, 234 keeping
Split, stock, 234 Takeover, indication of impending, 188
Split-ups, 11, 206 Tangent, see Trendlines
Spreading, 217 Tape reader, 235
SPY, 87, 123, 125, 211 Tape, Rollo, 48
Standard deviation from price, 96 Target stops, 121
Stochastic Indicator, 95, 234 Tax plan, 123, 125
Index 259
Technical analysis, see also Data collection electronic, 91, 208–209; see also Software
basic assumptions of, 4–5, 14–15, 21 number driven/statistical, 91–93
basic tenets of, 3, 5–6 Top pattern
feedback, see Feedback double, 109, 223
foundation of the Magee Method, 83–84 rounding, 51–52, 77, 232, 241
vs. fundamental analysis, 84, 149–151, triple, 235, 240
177–179 Touts, 84, 213
and the MEI, 18, 85 Trades, 219, 231
origin of, 2 Trading
price in, 6–7, 84 model-based, 208
psychological preparation for, 127–140 rhythmic, 79–80, 85, 229
skills, learning of, 28–29, 33–35, 51–52 Trading, insider, 6, 14, 227
of stock value, 134, 175, 186 Trading market, 219
tools for, 89–114 Trading plans, 124–125
validity of, 3 Trailing stops, see Progressive stops
volume in, 6 Training plan, 211–212
Technical Analysis for Tacticians, 212 Transaction cost, 232
Technical Analysis: Natural and Unnatural Transactions, 224, 233–234, 236
Methods, 90, 212 Trap, bear, 24
Technical Analysis of Stock and Trap, bull, see Bull trap
Commodities, 192 Treasury bills, chart on, 161
Technical Analysis of Stock Trends, 211 Trend channel patterns
Tekniplat charting, 201–207, 209, 213, 235 ascending, 217–218
Test, 235, 236 descending, 222
Thin issue, 223, 235 down, 58
Three-Days-Away-Procedure, 75–77, 235 horizontal, 63, 227
Throwback, 19–21, 77, 231, 235 rectangular horizontal, see Rectangular
Time frames horizontal channel
for charts, 11 sideways, 58
for cooling-off period, 186 up, 59
for a double bottom pattern, 223 Trend channels, 27, 53–54, 58–59, 220, 235;
for a double top pattern, 223 see also Double trendline
for efficient trading, 84 Trending market, 235
for exhaustion gaps, 224 Trendline patterns
for falling wedge pattern, 224 ascending, 217–218
for flags, 225 basic, 52–53
for intermediate trend, 227 descending, 222
for investment, 125 double, 36, 223; see also Trend channels
for island reversal pattern, 227 down, 56
for a major trend, 228 horizontal, 227
for minor trends, 229 sideways, 57
for moving average, 102–104 simple, 36
for a rising wedge, 232 Trendlines, 18, 36, 52, 55–57, 235; see also
for scallop pattern, 233 Moving average
for secondary trend, 227 Trends
for technical analysis, 102–104 categories of, 7; see also specific types
on Tekniplat paper, 205, 206–207 definition of, 235
Time, Inc., 188 dishonest manipulation of, 14, 84
Timing, analyzing the market, 153–165 in Dow Theory, 5–6
Tools following of, 86
charts, see Charts in price range violations, 21
recurrence of, 30 Volume, 236

technical analysis of, 6–7 in bar charts, 11–12, 200
Triangle pattern, 17–19, 21 in the Magee Method, 84
ascending, see Ascending triangle price, relationship to, 104–105
pattern spike, in EveryMan’s Everystock chart,
descending, 222 25
inverted, 219; see also Right-angle in technical analysis, 6–7
triangles Volume analysis, 92–93, 104–106
right-angle broadening, 231–232 Volume, heavy, 226
Volume scale, on Tekniplat paper, 205
symmetrical, see Symmetrical triangle
pattern
Triple bottom pattern, 235, 238
W
Triple top pattern, 235, 240
Turning points, 4, 42, 134, 160–161 “W” formation, see Triple top pattern
Wall Street Journal, 1, 4, 84, 173–174, 194
Wang Labs, 186–187
U Wedge pattern, 236
Wedge pattern, falling, 41, 46, 224
U/d volume, 236 Wedge pattern, rising, 47, 232, 243
Undervalued stock, 134, 138–139 Weighted moving average, 101
Union Carbide, 47, 162 Western Union, 156
United Brands, 188–189 Wilder, J. Wells, 94
Uptick, 236 Williams, Larry, 92
Uptrend, 7–8, 19, 21, 32, 41 Winning the Mental Game on Wall Street,
Uptrend channel, 59, 217–218 74
Uptrend line, 55 World Wide Web (www) sites, 211, 213–216
Wyckoff, Richard, 48, 212
V
X
Validity of trendline penetration, 236
Valley, 236 Xerox, 9, 151
Value at Risk, 102, 117, 211
ValueLine, 53
Y
Volatilities, web sites on, 211, 213, 232
Volatility, 236; see also Risk Yields, 219
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THE INTRODUCTION TO THE

St. Lucie Press

Library of Congress Cataloging-in-Publication Data

Catalog record is available from the Library of Congress

Visit the CRC Press Web site at www.crcpress.com

© 2002 by CRC Press LLC

No claim to original U.S. Government works

John Magee (1901–1987), a graduate of MIT and a leading expert on

AIQ Systems Metastock

First of all, to that irrepressible Maine–iac and distinguished technical

To the uninitiated the field of technical analysis presents an aspect of

xii The Introduction to the Magee System of Technical Analysis

WHAT THIS BOOK DOES NOT DO

THE PLAN OF THE BOOK

PURPOSE OF THE BOOK

EDITORIAL METHODS AND ORGANIZATION

xiv The Introduction to the Magee System of Technical Analysis

“About Gender in Grammar

“In Dictionary of Modern American Usage, Garner notes: ‘English

“Inadequate or not it is preferable to s/he/it and other bastardizations

be seen to be stuck with malformed style and sentences no womyn

“About Gender in Investors

“And, as long as we are on the subject of gender, we might as well

I have found the previous edition of this marvelously concise little

SECTION I: A BRIEF HISTORY OF DOW THEORY AND

SECTION II: THE CENTRAL CONCEPTS AND

xviii The Introduction to the Magee System of Technical Analysis

SECTION III: MAGEE’S METHODOLOGY: RISK

SECTION IV: OTHER TECHNICAL ANALYSIS TOOLS:

SECTION V: CONSIDERATIONS FOR TRADERS/

SECTION VI: TRADING IS ONLY HALF SYSTEMS AND

SECTION VII: APPENDICES

Magee summarizes the basics of technical analysis, its origins

Dow Theory, deriving from original editorials in the Wall Street

2 The Introduction to the Magee System of Technical Analysis

Dow Theory is wholly a technical method. Technical analysts

4 The Introduction to the Magee System of Technical Analysis

THEORIES AND ASSUMPTIONS

1. The averages, in their day-to-day fluctuations, discount everything

The fundamental premise of technical analysis is that it is possible to

Basic Tenets of Technical Analysis 5

12000 INDU LAST-Daily 11/30/2000 TRAN LAST-Daily 11/30/2000 12000

Created with Trade Station

Chart 1. Dow-Jones Averages Chart Showing Divergences and Confirmations of

The technician’s assumption is that if confirmation occurs between the

6 The Introduction to the Magee System of Technical Analysis

however, deserve attention. These principles are, in brief, the foundations

BASIC TENETS OF TECHNICAL ANALYSIS

Basic Tenets of Technical Analysis 7

For our purposes, it is more instructive to discuss some of the basic

8 The Introduction to the Magee System of Technical Analysis

12000 $INDUA LAST-Monthly 11/30/2000

1975 1980 1985 1990 1995

Basic Tenets of Technical Analysis 9

65 XRX LAST-Weekly 12/01/2000

1995 1996 1997 1998 1999 2000

10 The Introduction to the Magee System of Technical Analysis

INDU LAST-Daily 10/04/2001

4/1999 7/1999 10/1999 00 4/2000 7/2000 10/2000 01 4/2001 7/2001

Chart 4. Dow-Jones Industrials in a Sideways Trend, with a moving average line.

HOW TECHNICIANS USE BAR CHARTS

Basic Tenets of Technical Analysis 11

What Is A Bar Chart?