ANALYSIS STOCK TRENDS
By
Robert D. Edwards
and
John Magee
Chapter 1
The Technical Approach to
Trading and Investing
Trading and Investing
tressing thinness of the market at times—one of the undoubted effects
of regulation—has resulted in a few more "false moves/'
more spells of uninteresting (and unprofitable) inactivity. But, in
the main, the market goes right on repeating the same old movements
in much the same old routine. The importance of a knowledge
of these phenomena to the trader and investor has been in no
whit diminished.
Part Two, which has to do with the practical application of
these market patterns and phenomena, with the tactics of trading,
is all new. For more than fifteen years (his total market experience
extends back for nearly thirty years), John Magee has invested and
traded exclusively via the technical theory, kept thousands of
charts, made hundreds of actual trades, tested all sorts of applications,
audited and analyzed methods, tactics and results from
every conceivable angle, depended on his profits for his living. His
contribution is that of one who has tried and knows.
It may well be added here—and will be often repeated in the
following pages—that the technical guides to trading in stocks are
by no means infallible. The more experience one gains in their use,
the more alive he becomes to their pitfalls and their failures. There
is no such thing as a sure-fire method of "beating the market"; the
authors have no hesitancy in saying that there never will be.
Nevertheless, a knowledge and judicious application of the principles
of technical analysis does pay dividends—is more profitable
(and far safer) for the average investor than any other of the presently
recognized and established approaches to the problems of
buying and selling securities.
of regulation—has resulted in a few more "false moves/'
more spells of uninteresting (and unprofitable) inactivity. But, in
the main, the market goes right on repeating the same old movements
in much the same old routine. The importance of a knowledge
of these phenomena to the trader and investor has been in no
whit diminished.
Part Two, which has to do with the practical application of
these market patterns and phenomena, with the tactics of trading,
is all new. For more than fifteen years (his total market experience
extends back for nearly thirty years), John Magee has invested and
traded exclusively via the technical theory, kept thousands of
charts, made hundreds of actual trades, tested all sorts of applications,
audited and analyzed methods, tactics and results from
every conceivable angle, depended on his profits for his living. His
contribution is that of one who has tried and knows.
It may well be added here—and will be often repeated in the
following pages—that the technical guides to trading in stocks are
by no means infallible. The more experience one gains in their use,
the more alive he becomes to their pitfalls and their failures. There
is no such thing as a sure-fire method of "beating the market"; the
authors have no hesitancy in saying that there never will be.
Nevertheless, a knowledge and judicious application of the principles
of technical analysis does pay dividends—is more profitable
(and far safer) for the average investor than any other of the presently
recognized and established approaches to the problems of
buying and selling securities.
Few human activities have been so exhaustively studied during
the past fifty years, from so many angles and by so many different
sorts of people, as has the buying and selling of corporate
securities. The rewards which the stock market holds out to those
who read it right are enormous; the penalties it exacts from careless,
dozing or "unlucky" investors are calamitous—no wonder it
has attracted some of the world's most astute accountants, analysts
and researchers, along with a motley crew of eccentrics, mystics
and "hunch players," and a multitude of just ordinary hopeful
citizens.
the past fifty years, from so many angles and by so many different
sorts of people, as has the buying and selling of corporate
securities. The rewards which the stock market holds out to those
who read it right are enormous; the penalties it exacts from careless,
dozing or "unlucky" investors are calamitous—no wonder it
has attracted some of the world's most astute accountants, analysts
and researchers, along with a motley crew of eccentrics, mystics
and "hunch players," and a multitude of just ordinary hopeful
citizens.
Able brains have sought, and continue constantly to seek, for
safe and sure methods of appraising the state and trend of the
market, of discovering the right stock to buy and the right time to
buy it. This intensive research has not been fruitless—far from it.
There are a great many successful investors and speculators (using
the word in its true sense which is without opprobrium) who, by
one road or another, have acquired the necessary insight into the
forces with which they deal and the judgment, the forethought
and the all-important self-discipline to deal with them profitably.
In the course of years of stock market study, two quite distinct
schools of thought have arisen, two radically different methods of
arriving at the answers to the trader's problem of What and When.
In the parlance of "the street," one of these is commonly referred
to as the fundamental or statistical, and the other as the technical. (In
recent years a third approach, the cyclical, has made rapid
progress and, although still beset by a "lunatic fringe," it promises to contribute a great deal to our understanding of economic
trends.
safe and sure methods of appraising the state and trend of the
market, of discovering the right stock to buy and the right time to
buy it. This intensive research has not been fruitless—far from it.
There are a great many successful investors and speculators (using
the word in its true sense which is without opprobrium) who, by
one road or another, have acquired the necessary insight into the
forces with which they deal and the judgment, the forethought
and the all-important self-discipline to deal with them profitably.
In the course of years of stock market study, two quite distinct
schools of thought have arisen, two radically different methods of
arriving at the answers to the trader's problem of What and When.
In the parlance of "the street," one of these is commonly referred
to as the fundamental or statistical, and the other as the technical. (In
recent years a third approach, the cyclical, has made rapid
progress and, although still beset by a "lunatic fringe," it promises to contribute a great deal to our understanding of economic
trends.
The stock market fundamentalist depends on statistics. He examines
the auditors' reports, the profit-and-loss statements, the
quarterly balance sheets, the dividend records and policies of the
companies whose shares he has under observation. He analyzes
sales data, managerial ability, plant capacity, the competition. He
turns to bank and treasury reports, production indexes, price
statistics and crop forecasts to gauge the state of business in
general, and reads the daily news carefully to arrive at an estimate
of future business conditions. Taking all these into account, he
evaluates his stock; if it is selling currently below his appraisal, he
regards it as a buy.
the auditors' reports, the profit-and-loss statements, the
quarterly balance sheets, the dividend records and policies of the
companies whose shares he has under observation. He analyzes
sales data, managerial ability, plant capacity, the competition. He
turns to bank and treasury reports, production indexes, price
statistics and crop forecasts to gauge the state of business in
general, and reads the daily news carefully to arrive at an estimate
of future business conditions. Taking all these into account, he
evaluates his stock; if it is selling currently below his appraisal, he
regards it as a buy.
As a matter of fact, aside from the greenest of newcomers
when they first tackle the investment problem, and to whom, in
their inexperience, any other point of view is not only irrational
but incomprehensible, your pure fundamentalist is a very rare
bird. Even those market authorities who pretend to scorn charts
and "chartists" utterly, are not oblivious to the "action" chronicled
by the ticker tape, nor do they conceal their respect for the Dow
Theory which, whether they realize it or not, is in its very essence
purely technical.
Definition of Technical Analysis
The term technical, in its application to the stock market, has
come to have a very special meaning, quite different from its ordinary
dictionary definition. It refers to the study of the action of the
market itself as opposed to the study of the goods in which the
market deals. Technical Analysis is the science of recording, usually
in graphic form, the actual history of trading (price changes,
volume of transactions, etc.) in a certain stock or in "the averages"
and then deducing from that pictured history the probable future
trend.
The term technical, in its application to the stock market, has
come to have a very special meaning, quite different from its ordinary
dictionary definition. It refers to the study of the action of the
market itself as opposed to the study of the goods in which the
market deals. Technical Analysis is the science of recording, usually
in graphic form, the actual history of trading (price changes,
volume of transactions, etc.) in a certain stock or in "the averages"
and then deducing from that pictured history the probable future
trend.
FIGURE 1. Monthly price ranges of U.S. Steel common from January, 1929 to
December, 1946. Compare the great swings in the market price for this stock—
from 1929 (extreme high, 261 3/0 to 1932 (extreme low, 21 1/4), from 1932 to 1937,
from 1937 to 1938, from 1942 to 1946—with its book values for those years as
cited on page 6.
December, 1946. Compare the great swings in the market price for this stock—
from 1929 (extreme high, 261 3/0 to 1932 (extreme low, 21 1/4), from 1932 to 1937,
from 1937 to 1938, from 1942 to 1946—with its book values for those years as
cited on page 6.
The technical student argues thus: It is futile to assign an intrinsic
value to a stock certificate. One share of United States Steel,
value to a stock certificate. One share of United States Steel,
for example, was worth $261 in the early fall of 1929, but you
could buy it for only $22 in June of 1932! By March, 1937, it was
selling for $126 and just one year later for $38. In May of 1946, it
had climbed back up to $97, and ten months later, in 1947, had
dropped below $70, although the company's earnings on this last
date were reputed to be nearing an all-time high and interest rates
in general were still near an all-time low. The book value of this
share of U.S. Steel, according to the corporation's balance sheet,
was about $204 in 1929 (end of the year), $187 in 1932, $151 in
1937, $117 in 1938 and $142 in 1946. This sort of thing, this wide
divergence between presumed value and actual price, is not the
exception; it is the rule. It is going on all the time. The fact is that
the real value of a share of U.S. Steel common is determined at any
given time solely, definitely and inexorably by supply and
demand, which are accurately reflected in the transactions consummated
on the floor of the New York Stock Exchange.
Of course, the statistics which the fundamentalists study play a
part in the supply-demand equation—that is freely admitted. But
there are many other factors affecting it. The market price reflects
not only the 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 synthesized, weighed and finally expressed
in the one precise figure at which a buyer and a seller get
together and make a deal (through their agents, their respective
stock brokers). This is the only figure that counts.
Moreover, the technician claims with complete justification
that the bulk of the statistics which the fundamentalists study are
past history, already out-of-date and sterile, because the market is
not interested in the past or even in the present! It is constantly
looking ahead; attempting to discount future developments,
weighing and balancing all the estimates and guesses of hundreds
of investors who look into the future from different points of view
and through glasses of many different hues. In brief, the going
price, as established by the market itself, comprehends all the fundamental
information which the statistical analyst can hope to
learn (plus some which is perhaps secret from him, known only to
a few insiders) and much else besides of equal or even greater importance.
All of which, admitting its truth,
and through glasses of many different hues. In brief, the going
price, as established by the market itself, comprehends all the fundamental
information which the statistical analyst can hope to
learn (plus some which is perhaps secret from him, known only to
a few insiders) and much else besides of equal or even greater importance.
All of which, admitting its truth,
would be of little significance
were it not for the fact, which no one of experience doubts, that
prices move in trends and trends tend to continue until something
happens to change the supply-demand balance. Such changes are
usually detectable in the action of the market itself. Certain patterns
or formations, levels or areas, appear on the charts which
have a meaning, can be interpreted in terms of probable future
trend development. They are not infallible, it must be noted, but
the odds are definitely in their favor. Time after time, as experience
has amply proved, they are far more prescient than the
best informed and most shrewd of statisticians.
The technical analyst may go even further in his claims. He
may offer to interpret the chart of a stock whose name he does not
know, so long as the record of trading is accurate and covers a long
enough term to enable him to study its market background and
habits. He may suggest that he could trade with profit in a stock
knowing only its ticker symbol, completely ignorant of the company,
the industry, what it manufactures or sells, or how it is capitalized.
Needless to say, such practice is not recommended, but if
your market technician is really experienced at his business, he
could, in theory, do exactly what he claims.
Should the reader, at this point, find the technical approach to
trading or investing, as explained in the foregoing, completely abhorrent,
perhaps he had better close the book now. For it is
primarily the technical approach, the science of technical analysis,
with which the remainder of it deals.
were it not for the fact, which no one of experience doubts, that
prices move in trends and trends tend to continue until something
happens to change the supply-demand balance. Such changes are
usually detectable in the action of the market itself. Certain patterns
or formations, levels or areas, appear on the charts which
have a meaning, can be interpreted in terms of probable future
trend development. They are not infallible, it must be noted, but
the odds are definitely in their favor. Time after time, as experience
has amply proved, they are far more prescient than the
best informed and most shrewd of statisticians.
The technical analyst may go even further in his claims. He
may offer to interpret the chart of a stock whose name he does not
know, so long as the record of trading is accurate and covers a long
enough term to enable him to study its market background and
habits. He may suggest that he could trade with profit in a stock
knowing only its ticker symbol, completely ignorant of the company,
the industry, what it manufactures or sells, or how it is capitalized.
Needless to say, such practice is not recommended, but if
your market technician is really experienced at his business, he
could, in theory, do exactly what he claims.
Should the reader, at this point, find the technical approach to
trading or investing, as explained in the foregoing, completely abhorrent,
perhaps he had better close the book now. For it is
primarily the technical approach, the science of technical analysis,
with which the remainder of it deals.
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