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Library of Congress Cataloging-in-Publication Data

Kirkpatrick, Charles D.Technical analysis : the complete resource for financial market technicians / Charles D. Kirkpatrick and Julie

Dahlquist. — 2nd ed.p. cm.

Includes bibliographical references and index.ISBN 978-0-13-705944-7 (hbk. : alk. paper)1. Technical analysis (Investment analysis) 2. Investment analysis. I. Dahlquist, Julie R., 1962- II. Title. HG4529.K564 2011332.63’2042—dc22

2010032991

TThhiiss bbooookk iiss ssoolldd wwiitthh tthhee uunnddeerrssttaannddiinngg tthhaatt nneeiitthheerr tthhee aauutthhoorr nnoorr tthhee ppuubblliisshheerr iiss eennggaaggeedd iinnrreennddeerriinngg lleeggaall,, aaccccoouunnttiinngg,, oorr ootthheerr pprrooffeessssiioonnaall sseerrvviicceess oorr aaddvviiccee bbyy ppuubblliisshhiinngg tthhiiss bbooookk.. EEaacchhiinnddiivviidduuaall ssiittuuaattiioonn iiss uunniiqquuee.. TThhuuss,, iiff lleeggaall oorr ffiinnaanncciiaall aaddvviiccee oorr ootthheerr eexxppeerrtt aassssiissttaannccee iiss rreeqquuiirreeddiinn aa ssppeecciiffiicc ssiittuuaattiioonn,, tthhee sseerrvviicceess ooff aa ccoommppeetteenntt pprrooffeessssiioonnaall sshhoouulldd bbee ssoouugghhtt ttoo eennssuurree tthhaatt tthheessiittuuaattiioonn hhaass bbeeeenn eevvaalluuaatteedd ccaarreeffuullllyy aanndd aapppprroopprriiaatteellyy.. TThhee aauutthhoorr aanndd tthhee ppuubblliisshheerr ddiissccllaaiimmaannyy lliiaabbiilliittyy,, lloossss,, oorr rriisskk rreessuullttiinngg ddiirreeccttllyy oorr iinnddiirreeccttllyy,, ffrroomm tthhee uussee oorr aapppplliiccaattiioonn ooff aannyy ooff tthheeccoonntteennttss ooff tthhiiss bbooookk..

CONTENTS

Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xxivAboutt the Authors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xxvi

Part I: Introduction

1 INTRODUCTION TO TECHNICAL ANALYSIS . . . . . . . . . . . . . . .3

2 THE BASIC PRINCIPLE OF TECHNICAL ANALYSIS—THE TREND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

How Does the Technical Analyst Make Money? . . . . . . . . . . . . . . . . 10What Is a Trend? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11How Are Trends Identified? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12Trends Develop from Supply and Demand . . . . . . . . . . . . . . . . . . . . 14What Trends Are There? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15What Other Assumptions Do Technical Analysts Make? . . . . . . . . 17Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19Review Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

3 HISTORY OF TECHNICAL ANALYSIS ......................................23

Early Financial Markets and Exchanges . . . . . . . . . . . . . . . . . . . . . . 23Modern Technical Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26Current Advances in Technical Analysis . . . . . . . . . . . . . . . . . . . . . . 30

4 THE TECHNICAL ANALYSIS CONTROVERSY ..........................33

Do Markets Follow a Random Walk? . . . . . . . . . . . . . . . . . . . . . . . . . 35Fat Tails ................................................................................................36Drawdowns...........................................................................................37Proportions of Scale .............................................................................39

Can Past Patterns Be Used to Predict the Future? . . . . . . . . . . . . . . 40What About Market Efficiency?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

New Information...................................................................................42Are Investors Rational? ........................................................................46Will Arbitrage Keep Prices in Equilibrium?.........................................47

Behavioral Finance and Technical Analysis . . . . . . . . . . . . . . . . . . . . 49Pragmatic Criticisms of Technical Analysis . . . . . . . . . . . . . . . . . . . . 50What Is the Empirical Support for Technical Analysis? . . . . . . . . . 52Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52Review Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53

Part II: Markets and Market Indicators

5 AN OVERVIEW OF MARKETS . . . . . . . . . . . . . . . . . . . . . . . .57

In What Types of Markets Can Technical Analysis Be Used? . . . . 58Types of Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

Cash Market .........................................................................................60Derivative Markets ...............................................................................62Swaps and Forwards.............................................................................66

x Contents

How Does a Market Work? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66Who Are the Market Players?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68How Is the Market Measured? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69

Price-Weighted Average .......................................................................70Market Capitalization Weighted Average .............................................71Equally Weighted (or Geometric) Average ...........................................72

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73Review Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73

6 DOW THEORY .......................................................................75

Dow Theory Theorems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78The Primary Trend................................................................................80The Secondary Trend ............................................................................81The Minor Trend...................................................................................81Concept of Confirmation ......................................................................82Importance of Volume...........................................................................83

Criticisms of the Dow Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86Review Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

7 SENTIMENT............................................................................89

What Is Sentiment? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90Market Players and Sentiment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91How Does Human Bias Affect Decision Making? . . . . . . . . . . . . . . . 92Crowd Behavior and the Concept of Contrary Opinion . . . . . . . . . 95How Is Sentiment of Uninformed Players Measured?. . . . . . . . . . . 96

Sentiment Indicators Based on Options and Volatility .........................97Polls ....................................................................................................102Other Measures of Contrary Opinion ................................................107Unquantifiable Contrary Indicators ..................................................116Historical Indicators .........................................................................117

Contents xi

How Is the Sentiment of Informed Players Measured?. . . . . . . . . 118Insiders ...............................................................................................118

Sentiment in Other Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124Treasury Bond Futures Put/Call Ratio ...............................................124Treasury Bond COT Data ..................................................................125Treasury Bond Primary Dealer Positions ..........................................125T-Bill Rate Expectations by Money Market Fund Managers .............126

Hulbert Gold Sentiment Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128Review Questions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129

8 MEASURING MARKET STRENGTH.......................................131

Market Breadth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133The Breadth Line or Advance-Decline Line .......................................134Double Negative Divergence ..............................................................136Traditional Advance-Decline Methods That No Longer Are

Profitable......................................................................................138Advance-Decline Line to Its 32-Week Simple Moving Average..........139Breadth Differences ............................................................................140Breadth Ratios ....................................................................................146Breadth Thrust ....................................................................................147Summary of Breadth Indicators..........................................................148

Up and Down Volume Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149The Arms Index ..................................................................................149Ninety Percent Downside Days (NPDD)............................................15210-to-1 Up Volume Days and 9-to-1 Down Volume Days .................153

Net New Highs and Net New Lows. . . . . . . . . . . . . . . . . . . . . . . . . . . 154New Highs Versus New Lows .............................................................155High Low Logic Index .......................................................................156Hindenburg Omen .............................................................................157

Using Moving Averages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157Number of Stocks above Their 30-Week Moving Average ..................157

Very Short-Term Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159Breadth and New Highs to New Lows ...............................................159Net Ticks .............................................................................................160

Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161Review Questions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162

xii Contents

9 TEMPORAL PATTERNS AND CYCLES....................................163

Periods Longer than Four Years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164Kondratieff Waves, or K-Waves ..........................................................16434-Year Historical Cycles...................................................................166Decennial Pattern ...............................................................................168

Periods of Four Years or Less . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169Four-Year or Presidential Cycle .........................................................170Election Year Pattern ..........................................................................171Seasonal Patterns ...............................................................................172

January Signals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174January Barometer ............................................................................174January Effect.....................................................................................174

Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175Review Questions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176

10 FLOW OF FUNDS..................................................................177

Funds in the Marketplace . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 178Money Market Funds .........................................................................178Margin Debt ......................................................................................179Secondary Offerings ..........................................................................180

Funds Outside the Security Market. . . . . . . . . . . . . . . . . . . . . . . . . . 181Household Financial Assets ...............................................................182Money Supply .....................................................................................183Bank Loans .........................................................................................184

The Cost of Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185Short-Term Interest Rates ...................................................................185Long-Term Interest Rates (or Inversely, the Bond Market) ...............187Money Velocity....................................................................................187Misery Index ......................................................................................188

Fed Policy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 190Fed Policy Futures ..............................................................................191The Federal Reserve Valuation Model................................................192Three Steps and a Stumble .................................................................193Yield Curve ........................................................................................194

Contents xiii


Part III: Trend Analysis

11 HISTORY AND CONSTRUCTION OF CHARTS . . . . . . . . . . . .199

History of Charting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201What Data Is Needed to Construct a Chart?. . . . . . . . . . . . . . . . . . 204What Types of Charts Do Analysts Use? . . . . . . . . . . . . . . . . . . . . . 206

Line Charts .........................................................................................207Bar Charts ..........................................................................................210Candlestick Charts .............................................................................211

What Type of Scale Should Be Used? . . . . . . . . . . . . . . . . . . . . . . . . 213Arithmetic Scale..................................................................................213Semi-Logarithmic Scale......................................................................214

Point-and-Figure Charts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 215One-Box (Point) Reversal ...................................................................216Box Size ..............................................................................................217Multibox Reversal...............................................................................217Time ....................................................................................................218Arithmetic Scale..................................................................................220Logarithmic Scale...............................................................................220


12 TRENDS—THE BASICS........................................................223

Trend—The Key to Profits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224Trend Terminology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225Basis of Trend Analysis—Dow Theory . . . . . . . . . . . . . . . . . . . . . . . 225How Does Investor Psychology Impact Trends? . . . . . . . . . . . . . . . 226How Is the Trend Determined? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227

Peaks and Troughs ..............................................................................228

xiv Contents

Determining a Trading Range . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 230What Is Support and Resistance? .......................................................230Why Do Support and Resistance Occur? ...........................................230What About Round Numbers? ...........................................................232How Are Important Reversal Points Determined? .............................232How Do Analysts Use Trading Ranges?.............................................236

Directional Trends (Up and Down) . . . . . . . . . . . . . . . . . . . . . . . . . . 237What Is a Directional Trend? .............................................................238How Is an Uptrend Spotted? ..............................................................238Channels .............................................................................................243Internal Trend Lines ...........................................................................244Retracements ......................................................................................245Pullbacks and Throwbacks .................................................................247

Other Types of Trend Lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247Trend Lines on Point-and-Figure Charts............................................248Speed Lines ........................................................................................248Andrews Pitchfork .............................................................................249Gann Fan Lines ..................................................................................250


13 BREAKOUTS, STOPS, AND RETRACEMENTS .........................255

Breakouts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255How Is Breakout Confirmed? .............................................................256Can a Breakout Be Anticipated? ........................................................262

Stops . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263What Are Entry and Exit Stops? .........................................................263Changing Stop Orders ........................................................................264What Are Protective Stops? ................................................................264What Are Trailing Stops?....................................................................265What Are Time Stops?.........................................................................268What Are Money Stops?......................................................................269How Can Stops Be Used with Breakouts?..........................................269Using Stops When Gaps Occur ..........................................................269Waiting for Retracement .....................................................................270Calculating a Risk/Return Ratio for Breakout Trading......................271Placing Stops for a False (or “Specialist”) Breakout ........................272

Contents xv


14 MOVING AVERAGES ............................................................275

What Is a Moving Average? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 276How Is a Simple Moving Average Calculated? . . . . . . . . . . . . . . . . 276

Length of Moving Average..................................................................279Using Multiple Moving Averages .......................................................280

What Other Types of Moving Averages Are Used? . . . . . . . . . . . . 281The Linearly Weighted Moving Average (LWMA) ..............................282The Exponentially Smoothed Moving Average (EMA) .......................282Wilder Method ...................................................................................284Geometric Moving Average (GMA)....................................................284Triangular Moving Average................................................................285Variable EMAs....................................................................................285

Strategies for Using Moving Averages. . . . . . . . . . . . . . . . . . . . . . . . 285Determining Trend..............................................................................285Determining Support and Resistance .................................................286Determining Price Extremes ..............................................................287Giving Specific Signals.......................................................................288

What Is Directional Movement?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 288Constructing Directional Movement Indicators.................................289Using Directional Movement Indicators ............................................289

What Are Envelopes, Channels, and Bands?. . . . . . . . . . . . . . . . . . 291Percentage Envelopes ........................................................................291Bands ..................................................................................................292Trading Strategies Using Bands and Envelopes.................................294Channel .............................................................................................295


xvi Contents

Part IV: Chart Pattern Analysis

15 BAR CHART PATTERNS . . . . . . . . . . . . . . . . . . . . . . . . . . .301

What Is a Pattern?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 302Common Pattern Characteristics .......................................................302

Do Patterns Exist? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 303Behavioral Finance and Pattern Recognition ....................................304

Computers and Pattern Recognition . . . . . . . . . . . . . . . . . . . . . . . . . 305Market Structure and Pattern Recognition . . . . . . . . . . . . . . . . . . . 306Bar Charts and Patterns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 307How Profitable Are Patterns? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 308Classic Bar Chart Patterns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 309

Double Top and Double Bottom .........................................................309Rectangle (Also “Trading Range” or “Box”)....................................310Triple Top and Triple Bottom..............................................................313Standard Triangles .............................................................................314Descending Triangle...........................................................................315Ascending Triangle .............................................................................317Symmetrical Triangle (Also “Coil” or “Isosceles Triangle”)............317Broadening Patterns ...........................................................................320Diamond Top ......................................................................................321Wedge and Climax ..............................................................................322

Patterns with Rounded Edges—Rounding and Head-and-Shoulders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 325Rounding Top, Rounding Bottom (Also “Saucer,” “Bowl,” or

“Cup”) .........................................................................................325Head-and-Shoulders...........................................................................326Shorter Continuation Trading Patterns—Flags and Pennants

(Also “Half-Mast Formation”) ....................................................329

Long-Term Bar Chart Patterns with the Best Performanceand the Lowest Risk of Failure. . . . . . . . . . . . . . . . . . . . . . . . . 332


Contents xvii

16 POINT-AND-FIGURE CHART PATTERNS ...............................335

What Is Different About a Point-and-Figure Chart? . . . . . . . . . . . 336Time and Volume Omitted...................................................................336Continuous Price Flow Necessary .....................................................336“Old” and “New” Methods ...............................................................337

History of Point-and-Figure Charting. . . . . . . . . . . . . . . . . . . . . . . . 337One-Box Reversal Point-and-Figure Charts . . . . . . . . . . . . . . . . . . 339

Consolidation Area on the One-Box Chart (Also “Congestion Area”) ..........................................................................................340

Trend Lines in One-Box Charts ..........................................................340The Count in a One-Point Chart ........................................................341Head-and-Shoulders Pattern ..............................................................343The Fulcrum .......................................................................................344Action Points.......................................................................................344

Three-Point (or Box) Reversal Point-and-Figure Charts . . . . . . . 345Trend Lines with Three-Box Charts....................................................346The Count Using Three-Box Reversal Charts ....................................347The Eight Standard Patterns for Three-Box Reversal Charts.............348Other Patterns ....................................................................................354


17 SHORT-TERM PATTERNS .....................................................359

Pattern Construction and Determination. . . . . . . . . . . . . . . . . . . . . 362Traditional Short-Term Patterns . . . . . . . . . . . . . . . . . . . . . . . . . . . . 362

Gaps....................................................................................................363Spike (or Wide-Range or Large-Range Bar) ......................................370Dead Cat Bounce (DCB) ...................................................................371Island Reversal ...................................................................................373One- and Two-Bar Reversal Patterns .................................................373Multiple Bar Patterns .........................................................................380Volatility Patterns ...............................................................................384Intraday Patterns ................................................................................386

Summary of Short-Term Patterns . . . . . . . . . . . . . . . . . . . . . . . . . . . 389

xviii Contents

Candlestick Patterns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 390One- and Two-Bar Candlestick Patterns ............................................391Multiple Bar Patterns .........................................................................396Candlestick Pattern Results ................................................................401


Part V: Trend Confirmation

18 CONFIRMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .407

Analysis Methods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 408Overbought/Oversold .........................................................................408Failure Swings ....................................................................................409Divergences ........................................................................................409Reversals.............................................................................................410Trend ID..............................................................................................410Crossovers ..........................................................................................411Classic Patterns ..................................................................................411

Volume Confirmation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 411What Is Volume? .................................................................................411How Is Volume Portrayed? .................................................................412Do Volume Statistics Contain Valuable Information? ........................414How Are Volume Statistics Used?.......................................................415Which Indexes and Oscillators Incorporate Volume? ........................416Volume Spikes .....................................................................................425Examples of Volume Spikes.................................................................426

Open Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 427What Is Open Interest? .......................................................................427Open Interest Indicators .....................................................................428

Price Confirmation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 429What Is Momentum?...........................................................................430How Successful Are Momentum Indicators?......................................431Specific Indexes and Oscillators.........................................................432


Contents xix

xx Contents

Part VI: Other Technical Methods and Rules

19 CYCLES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .449

What Are Cycles? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 452Other Aspects of Cycle Analysis .........................................................455

Translation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 457How Can Cycles Be Found in Market Data? . . . . . . . . . . . . . . . . . . 458

Fourier Analysis (Spectral Analysis) ..................................................458Maximum Entropy Spectral Analysis .................................................459Simpler (and More Practical) Methods .............................................459

Projections. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 467Projecting Period................................................................................468Projecting Amplitude ..........................................................................470


20 ELLIOTT, FIBONACCI, AND GANN........................................477

Elliott Wave Theory (EWT). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 477Ralph Nelson Elliott ...........................................................................478Basic Elliott Wave Theory...................................................................478Impulse Waves ....................................................................................480Corrective Waves ................................................................................483Guidelines and General Characteristics in EWT...............................486Projected Targets and Retracements ..................................................488Alternatives to EWT............................................................................490Using EWT .........................................................................................491

The Fibonacci Sequence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 492Fibonacci ............................................................................................493The Fibonacci Sequence.....................................................................493The Golden Ratio................................................................................493Price and Time Targets .......................................................................495W. D. Gann .........................................................................................497


Part VII: Selection

21 SELECTION OF MARKETS AND ISSUES: TRADING AND

INVESTING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .503

Which Issues Should I Select for Trading? . . . . . . . . . . . . . . . . . . . 503Choosing Between Futures Markets and Stock Markets ....................504

Which Issues Should I Select for Investing? . . . . . . . . . . . . . . . . . . 506Top-Down Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 507

Secular Emphasis ...............................................................................507Cyclical Emphasis ..............................................................................510Stock Market Industry Sectors............................................................515

Bottom Up—Specific Stock Selection and Relative Strength. . . . 516Relative Strength.................................................................................517Academic Studies of Relative Strength ...............................................517Measuring Relative Strength ..............................................................518

Examples of How Selected Professionals Screen for FavorableStocks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 520William O’Neil CANSLIM Method.....................................................521James P. O’Shaughnessy Method .......................................................521Charles D. Kirkpatrick Method..........................................................522Value Line Method..............................................................................522Richard D. Wyckoff Method ................................................................522


Part VIII: System Testing and Management

22 SYSTEM DESIGN AND TESTING . . . . . . . . . . . . . . . . . . . . . .529

Why Are Systems Necessary? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 530Discretionary Versus Nondiscretionary Systems ................................530

How Do I Design a System?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 532Requirements for Designing a System ................................................532Understanding Risk ............................................................................533

Contents xxi

Initial Decisions .................................................................................534Types of Technical Systems .................................................................535

How Do I Test a System? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 538Special Data Problems for Futures Systems.......................................539Testing Methods and Tools .................................................................540Test Parameter Ranges .......................................................................540

Optimization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 546Methods of Optimizing .......................................................................546Measuring System Results for Robustness .........................................549


23 MONEY AND RISK MANAGEMENT .......................................559

Risk and Money Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 560Testing Money-Management Strategies . . . . . . . . . . . . . . . . . . . . . . 561Money-Management Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 562

Concepts .............................................................................................562Reward to Risk....................................................................................564Normal Risks ......................................................................................564Unusual Risks .....................................................................................570

Money-Management Risk Strategies. . . . . . . . . . . . . . . . . . . . . . . . . 572Monitoring Systems and Portfolios . . . . . . . . . . . . . . . . . . . . . . . . . . 577If Everything Goes Wrong . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 577Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 577Review Questions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 578

Part IX: Appendices

A BASIC STATISTICS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .581

Returns. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 581Probability and Statistics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 582

xxii Contents

Descriptive Statistics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 583Measures of Central Tendency ...........................................................583Measures of Dispersion ......................................................................585Relationships Between Variables........................................................586

Inferential Statistics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 591Modern Portfolio Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 594Performance Measurement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600Advanced Statistical Methods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 602Artificial Intelligence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 603Review Questions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 604

B TYPES OF ORDERS AND OTHER TRADER TERMINOLOGY ...607

An Order Ticket . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 609

BIBLIOGRAPHY ..............................................................................611

INDEX ............................................................................................637

Contents xxiii

C H A P T E R 1

INTRODUCTION TO TECHNICAL

ANALYSIS

Technical analysis—these words may conjure up many different mental images. Perhaps youthink of the stereotypical technical analyst, alone in a windowless office, slouched over stacks ofhand-drawn charts of stock prices. Or, maybe you think of the sophisticated multicolored com-puterized chart of your favorite stock you recently saw. Perhaps you begin dreaming about all themoney you could make if you knew the secrets to predicting stock prices. Or, perhaps youremember sitting in a finance class and hearing your professor say that technical analysis “is awaste of time.” In this book, we examine some of the perceptions, and misperceptions, of techni-cal analysis.

If you are new to the study of technical analysis, you might be wondering just what techni-cal analysis is. In its basic form, technical analysis is the study of prices in freely traded marketswith the intent of making profitable trading or investment decisions. Technical analysis is rootedin basic economic theory. Consider the basic assumptions presented by Robert D. Edwards andJohn Magee in the classic book, Technical Analysis of Stock Trends:

• Stock prices are determined solely by the interaction of demand and supply.

• Stock prices tend to move in trends.

• Shifts in demand and supply cause reversals in trends.

• Shifts in demand and supply can be detected in charts.

• Chart patterns tend to repeat themselves.

Technical analysts study the action of the market itself rather than the goods in which themarket deals. The technical analyst believes that “the market is always correct.” In other words,rather than trying to consider all the factors that will influence the demand for Gadget Interna-tional’s newest electronic gadget and all the items that will influence the company’s cost andsupply curve to determine an outlook for the stock’s price, the technical analyst believes that allof these factors are already factored into the demand and supply curves and, thus, the price of thecompany’s stock. We find that stock prices (and prices for any security in freely traded markets)

3

4 Part 1 Introduction

are influenced by psychological factors as well, most of them indecipherable. Greed, fear, cogni-tive bias, misinformation, expectations, and other factors enter into the price of a security, mak-ing the analysis of the factors nearly impossible. The technical analyst, thus, disregards all theseimponderables and studies how the marketplace is accepting the multitude of exogenous infor-mation and beliefs with the intention of finding secrets in that action that have predictive poten-tial.

Students new to any discipline often ask, “How can I use the knowledge of this disci-pline?” Students new to technical analysis are no different. Technical analysis is used in twomajor ways: predictive and reactive. Those who use technical analysis for predictive purposesuse the analysis to make predictions about future market moves. Generally, these individualsmake money by selling their predictions to others. Market letter writers in print or on the Weband the technical market gurus who frequent the financial news fall into this category. The pre-dictive technical analysts include the more well-known names in the industry; these individualslike publicity because it helps market their services.

On the other hand, those who use technical analysis in a reactive mode are usually not wellknown. Traders and investors use techniques of technical analysis to react to particular marketconditions to make their decisions. For example, a trader may use a moving average crossover tosignal when a long position should be taken. In other words, the trader is watching the marketand reacting when a certain technical condition is met. These traders and investors are makingmoney by making profitable trades for their own or clients’ portfolios. Some of them may evenfind that publicity distracts them from their underlying work.

The focus of this book is to explain the basic principles and techniques for reacting to themarket. We do not attempt to predict the market, nor do we provide you with the Holy Grail or apromise of a method that will make you millions overnight. Instead, we want to provide you withbackground, basic tools, and techniques that you will need to be a competent technical analyst.

As we will see when we study the history of technical analysis, the interest in technicalanalysis in the United States dates back over 150 years, when Charles H. Dow began to writenewsletters that later turned into the Wall Street Journal and developed the various Dow averagesto measure the stock market. Since that time, much has been written about technical analysis.Today, there are entire periodicals, such as the Technical Analysis of Stock and Commodities andthe Journal of Technical Analysis, devoted to the study of the subject. In addition, there are manyarticles appearing in other publications, including academic journals. There are even a number ofexcellent books on the market. As you can see from this book’s extensive bibliography, which isin no way a complete list of every published item on technical analysis, a massive quantity ofmaterial about technical analysis exists.

So, why does the world need another book on technical analysis? We began lookingthrough the multitude of materials on technical analysis a few years ago, searching for resourcesto use in educational settings. We noticed that many specialized books existed on the topic, butthere was no resource to provide the student of technical analysis with a comprehensive summa-tion of the body of knowledge. We decided to provide a coherent, logical framework for thismaterial that could be used as a textbook and a reference book.

Our intent in writing this book is to provide the student of technical analysis, whether anovice college student or an experienced practitioner, with a systematic study of the field of tech-nical analysis. Over the past century, much has been written about the topic. The classic works of

Charles Dow and the timeless book by Edwards and Magee still contain valuable information forthe student of technical analysis. The basic principles of these early authors are still valid today.However, the evolving financial marketplace and the availability of computer power have led toa substantial growth in the new tools and information available to the technical analyst.

Many technical analysts have learned their trade from the mentors with whom they haveworked. Numerous individuals who are interested in studying technical analysis today, however,do not have access to such a mentor. In addition, as the profession has advanced, many specifictechniques have developed. The result is that the techniques and methods of technical analysisoften appear to be a hodgepodge of tools, ideas, and even folklore, rather than a part of a coher-ent body of knowledge.

Many books on the market assume a basic understanding of technical analysis or focus onparticular financial markets or instruments. Our intent is to provide the reader with a basic refer-ence to support a lifelong study of the discipline. We have attempted to provide enough back-ground information and terminology that you can easily read this book without having to refer toother references for background information. We have also included a large number of referencesfor further reading so that you can continue learning in the specialized areas that interest you.

Another unique characteristic of this book is the joining of the practitioner and the aca-demic. Technical analysis is widely practiced, both by professional traders and investors and byindividuals managing their own money. However, this widespread practice has not been matchedby academic acknowledgment of the benefits of technical analysis. Academics have been slow tostudy technical analysis; most of the academic studies of technical analysis have lacked a thor-ough understanding of the actual practice of technical analysis. It is our hope not only to bringtogether a practitioner-academic author team but also to provide a book that promotes discussionand understanding between these two groups.

Whether you are a novice or experienced professional, we are confident that you will findthis book helpful. For the student new to technical analysis, this book will provide you with thebasic knowledge and building blocks to begin a lifelong study of technical analysis. For the moreexperienced technician, you will find this book to be an indispensable guide, helping you toorganize your knowledge, question your assumptions and beliefs, and implement new tech-niques.

We begin this book with a look at the background and history of technical analysis. In thispart, we discuss not only the basic principles of technical analysis but also the technical analysiscontroversy—the debate between academics and practitioners regarding the efficiency of finan-cial markets and the merit of technical analysis. This background information is especially use-ful to those who are new to technical analysis and those who are studying the subject in aneducational setting. For those with more experience with the field or with little interest in theacademic arguments about market efficiency, a quick reading of this first part will probably suf-fice.

In the second part of the book, we focus on markets and market indicators. Chapter 5, “AnOverview of Markets,” provides a basic overview of how markets work. Market vocabulary andtrading mechanics are introduced in this chapter. For the student who is unfamiliar with this ter-minology, a thorough understanding of this chapter will provide the necessary background forthe remaining chapters. Our focus in Chapter 6, “Dow Theory,” is on the development and prin-ciples of Dow Theory. Although Dow Theory was developed a century ago, much of modern-day

Chapter 1 Introduction to Technical Analysis 5

technical analysis is based on these classic principles. A thorough understanding of these time-less principles helps keep the technical analyst focused on the key concepts that lead to makingmoney in the market. In Chapter 7, “Sentiment,” we focus on sentiment; the psychology of mar-ket players is a major concept in this chapter. In Chapter 8, “Measuring Market Strength,” wediscuss methods for gauging overall market strength. Chapter 9, “Temporal Patterns and Cycles,”focuses on temporal tendencies, the tendency for the market to move in particular directions dur-ing particular times, such as election year cycles and seasonal stock market patterns. Because themain fuel for the market is money, Chapter 10, “Flow of Funds,” focuses on the flow of funds. Inthis chapter, we look at measures of market liquidity and how the Federal Reserve can influenceliquidity.

The third part of the book focuses on trend analysis. In many ways, this part can be thoughtof as the heart of technical analysis. If we see that the market is trending upward, we can prof-itably ride that trend upward. If we determine that the market is trending downward, we can evenprofit by taking a short position. In fact, the most difficult time to profit in the market is whenthere is no definitive upward or downward trend. Over the years, technical analysts have devel-oped a number of techniques to help them visually determine when a trend is in place. Thesecharting techniques are the focus of Chapter 11, “History and Construction of Charts.” In Chap-ter 12, “Trends—The Basics,” we discuss how to draw trend lines and determine support andresistance lines using these charts. In Chapter 13, “Breakouts, Stops, and Retracements,” wefocus on determining breakouts. These breakouts will help us recognize a trend change as soonas possible. We also discuss the importance of protective stops in this chapter. Moving averages,a useful mathematical technique for determining the existence of trends, are presented in Chap-ter 14, “Moving Averages.”

The fourth part of this book focuses on chart pattern analysis—the item that first comes tomind when many people think of technical analysis. In Chapter 15, “Bar Chart Patterns,” wecover classic bar chart patterns; in Chapter 16, “Point-and-Figure Chart Patterns,” we focus onpoint-and-figure chart patterns. Short-term patterns, including candlestick patterns, are coveredin Chapter 17, “Short-Term Patterns.”

Part V, “Trend Confirmation,” deals with the concept of confirmation. We consider priceoscillators and momentum measures in Chapter 18, “Confirmation.” Building upon the conceptof trends from earlier chapters, we look at how volume plays a role in confirming the trend, giv-ing us more confidence that a trend is indeed occurring. We also look at oscillators and indexesof momentum to analyze other means of confirming price trend.

Next, we turn our attention to the relationship between cycle theory and technical analysis.In Chapter 19, “Cycles,” we discuss the basic principles of cycle theory and the characteristics ofcycles. Some technical analysts believe that cycles seen in the stock market have a scientificbasis; for example, R. N. Elliott claimed that the basic harmony found in nature occurs in thestock market. Chapter 20, “Elliott, Fibonacci, and Gann,” introduces the basic concepts of ElliottWave Theory, a school of thought that adheres to Elliott’s premise that stock price movementsform discernible wave patterns.

Once we know the basic techniques of technical analysis, the question becomes, “Whichparticular securities will we trade?” Selection decisions are the focus of Chapter 21, “Selectionof Markets and Issues: Trading and Investing.” In this chapter, we discuss the intermarket rela-tionships that will help us determine on which market to focus by determining which market is

6 Part I Introduction

most likely to show strong performance. We also discuss individual security selection, measuresof relative strength, and how successful practitioners have used these methods to construct port-folios.

As technical analysts, we need methods of measuring our success. After all, our mainobjective is making money. Although this is a straightforward objective, determining whether weare meeting our objective is not quite so straightforward. Proper measurement of trading andinvestment strategies requires appropriate risk measurement and an understanding of basic statis-tical techniques. The last couple of chapters help put all the tools and techniques we presentthroughout the book into practice. Chapter 22, “System Design and Testing,” is devoted to devel-oping and testing trading systems. At this point, we look at how we can test the tools and indica-tors covered throughout the book to see if they will make money for us—our main objective—inthe particular way we would like to trade. Finally, Chapter 23, “Money and Risk Management,”deals with money management and avoiding capital loss.

For those who need a brushup in basic statistics or want to understand some of the statisti-cal concepts introduced throughout the book, Richard J. Bauer, Jr., Ph.D., CFA, CMT (Professorof Finance, Bill Greehey School of Business, St. Mary’s University, San Antonio, TX), providesa tutorial on basic statistical techniques of interest to the technical analyst in Appendix A, “BasicStatistics.”

For those who are unfamiliar with the terms and language used in trading, Appendix B,“Types of Orders and Other Trader Terminology,” provides brief definitions of specific ordertypes and commonly used terms in order entry.

As with all skills, learning technical analysis requires practice. We have provided a numberof review questions and problems at the end of the chapters to help you begin thinking about andapplying some of the concepts on your own. The extensive bibliography will direct you to furtherreadings in the areas of technical analysis that are of particular interest to you.

Another way of honing your technical skills is participating in a professional organizationthat is focused on technical analysis. In the United States, the Market Technicians Association(MTA) provides a wide variety of seminars, lectures, and publications for technical analysis pro-fessionals. The MTA also sponsors the Chartered Market Technician (CMT) program. Profes-sionals wanting to receive the prestigious CMT designation must pass three examinations andadhere to a strict code of professional conduct. More information about the MTA and the CMTprogram may be found at the Web site: www.mta.org. The International Federation of TechnicalAnalysts, Inc., (IFTA) is a global organization of market analysis societies and associations.IFTA, and its member associations worldwide, sponsor a number of seminars and publications.IFTA offers a professional certification, the Certified Financial Technician, and a masters-leveldegree, the Master of Financial Technical Analysis. The details of these certifications, along withcontact information for IFTA’s member associations around the world, can be found at their Website: www.ifta.org.

Technical analysis is a complex, ever-expanding discipline. The globalization of markets,the creation of new securities, and the availability of inexpensive computer power are openingeven more opportunities in this field. Whether you use the information professionally or for yourown personal trading or investing, we hope that this book will serve as a stepping-stone to yourstudy and exploration of the field of technical analysis.

Chapter 1 Introduction to Technical Analysis 7

www.mta.org

www.ifta.org

637

AA/D line. See advance-decline lineAA (Alcoa Corporation)

daily bar chart, 210daily candlestick chart, 212

line chart of daily closing prices, 207stock price data in tabular form, 203weekly bar chart, 211

AAPL (Apple Computer)alpha calculation, 518gaps and classic patterns, 368-370

ABC (American Bread Company), 63absolute breadth index, 144-145Aby, Carroll, 339academic criticisms of technical analysis

behavioral finance, 49-50EMH (Efficient Markets Hypothesis)

arbitrage and price equilibrium, 47-48economic theory of competitive markets,

41-42explained, 40-41new information, 42-46origins and development, 41rationality of investors, 46-47

explained, 33-34pragmatic criticisms, 50-51RWH (Random Walk Hypothesis)

drawdowns, 37-38explained, 35fat tails, 36origins and development, 35proportions of scale, 39-40

accelerating trend lines, 240-241Accumulation Distribution (AD), 419accuracy of cycles, 455-456

Achelis, Steven B., 420action points in one-box reversal point-and-

figure charts, 344-345AD (Accumulation Distribution), 419Adaptive Markets Hypothesis, 18The Adaptive Markets Hypothesis: Market

Efficiency from an Evolutionary Perspective(Lo), 46

adaptive stops, 575advance, 133advance-decline line (A/D line), 27, 134-136

advance-decline line to its 32-week simplemoving average, 139

advance-decline moving average, 138advance-decline ratio, 146-147traditional advance-decline methods, 138-139

advisory opinion polls, 103-105Advisory Service Sentiment survey, 103-105ADX, 290, 441-444AI (artifical intelligence), 603-604AIG, 31Alcoa Corporation. See AAAll or None (AON), 607alpha method, 519-520, 600alternation, 487American Association of Individual Investors

poll, 105American Bread Company (ABC), 63American Misery Index, 189Amibroker, 203amplitude, projecting, 454

commonality, 474-475FLD (Future Line of Demarcation), 471-472half-cycle reversal, 470-471Tillman method, 472-474

I N D E X

Amsterdam Exchange, 24analysis

confirmation analysisclassic patterns, 411crossovers, 411divergences, 409-410explained, 408failure swings, 409overbought/oversold, 408-409reversals, 410trend IDs, 410-411

cycle analysisaccuracy, 455-456centered moving averages, 463-464detrending, 461envelopes, 464-467Fourier analysis (spectral analysis), 458harmonics, 456-457inversions, 457Maximum Entropy Spectral Analysis

(MESA), 459observation, 460-461translation, 457-458

Anderson, John, 339Andrews pitchfork, 249-250Andrews, Alan, 249annualized rate of return, 550anticipating breakouts, 262AON (All or None), 607Appel, Gerald, 29, 432Apple Computer (AAPL)

alpha calculation, 518gaps and classic patterns, 368-370

arbitrage and price equilibrium, 47-48ARCH, 602-603Argus Research Group, 118arithmetic mean. See meanarithmetic moving averages, 278arithmetic scale, 213, 220Arms Index, 149-151Arms, Richard W. Jr., 149artificial intelligence (AI), 603-604ascending triangle pattern, 317

ascending triple top and descending triplebottom pattern, 350-351

ask price, 59assumptions of technical analysis, 3asymmetric information, 43ATR (Average True Range), 29, 259-260auction markets, 59autocorrelation, 590Average True Range (ATR), 29, 259-260averages

equally weighted (geometric) averages, 72market capitalization weighted averages,

71-72moving averages. See moving averagesprice-weighted averages, 70

Ayres, Leonard P., 27, 136

BBachelier, Louis, 35bands

Bollinger Bands, 292-293explained, 292Keltner Bands, 293STARC Bands, 293trading strategies, 294-295

Bandwidth Indicators, 295bank loans, 184bar charts

explained, 210-211patterns, 307-308

ascending triangle, 317broadening, 320descending triangle, 315-316diamond top, 321-322double top and double bottom, 309-310flags and pennants, 329-331head-and-shoulders, 326-329rectangle, 310-313rounding top and rounding bottom,

325-326standard triangle, 314-315symmetrical triangle, 317-318triple top and triple bottom, 313-314wedge and climax, 322-325

638 Index

bear markets, 80bearish resistance lines, 248“The Behavior of Stock Market Prices”

(Fama), 35Behavioral Finance, 30, 49-50, 304-305bell curve, 591-592Bergstresser, Charles, 26beta, 259, 519

average beta, 594defined, 599-600Treynor measure of performance, 600

Beyond Technical Analysis (Chande), 556bias and decision making, 92-94bid price, 59bid-ask spread, 59bids, 607bigcharts.com, 203Black Monday, 36-37Black-Scholes option-pricing model, 101Blumenthal, Earl, 218, 339Bollinger Bands, 292-293Bolton, Hamilton, 478, 496Bonacci, Guilielmo, 493bonds, 512Bosco, Bartolomo de, 24bounded oscillators, 408bowl pattern, 325-326box pattern, 310-313box size (point-and-figure charts), 217-218breadth. See market breadth, measuringbreak-even level, 574break-even stops, 574breakaway gaps, 364breakouts

anticipating, 262breakout gaps, 364breakout systems, 237, 536calculating risk/return ratio for breakout

trading, 271combining with stops, 269

confirmingclose filter, 256-257intra-bar breakouts, 256-257Pivot Point Technique, 260-262point or percent filter, 258time, 258volatility, 259-260volume, 259

explained, 255-256false (“specialist”) breakouts, 272-273false/premature breakouts, 311setting price targets with, 309volume spikes, 425

broadening pattern, 320brokered markets, 58Brown, Connie, 492bubbles, 94Buffett, Warren, 168Bulkowski ranking of candlestick patterns,

401-402Bulkowski, Thomas N., 302bull markets, 80bullish support lines, 248bullish triangle and bearish triangle

pattern, 352Burke, Gibbons, 438Burke, Michael, 339buyer expectations, 17

CCalahan, Edward A., 201candlestick patterns

Bulkowski ranking of candlestick patterns,401-402

dark cloud cover, 395-397doji, 391-392engulfing, 394-396evening star, 397-398explained, 211-213, 390-391hammer, 393hanging man, 393-394harami, 392-393inverted hammer, 394-395

Index 639

morning star, 397-398piercing line, 395-397shooting star, 394-395three black crows, 398-399three inside down, 399-400three inside up, 399-400three outside down, 400three outside up, 400three white soldiers, 398-399windows, 392

CANSLIM method, 521capital, initial, 568-569CAPM (Capital Asset Pricing Model), 571,

598-600Carroll, Paul, 141cash markets, 60-61catapult pattern (three-point reversal point-

and-figure charts), 354-355CBOT (Chicago Board of Trade), 63CCI (Commodity Channel Index), 441CDO (credit default options), 66centered moving averages, 463-464central limit theorem, 591central tendency, measuring, 583-585CFTC (Commodity Futures Trading

Commission), 122Chaikin Money Flow, 421Chaikin Oscillator, 422Chaikin, Marc, 419Chande, Tushar, 556channeling (EWT), 487-488channels, 237, 243-244, 295Chartcraft (Cohen and Blumenthal), 218Chartcraft Service, 339Chartered Market Technician (CMT), 7charts

bar charts. See bar chartsbenefits of, 200candlestick charts, 211-213data requirements, 204-205explained, 199-200history of, 201-204line charts, 207-209

patterns. See patternspoint-and-figure charts, 335

arithmetic scale, 220box size, 217-218continuous price flow, 336-337explained, 215-216history of, 337-339logarithmic scale, 220multibox reversal, 217-218old versus new methods, 337one-box reversal, 216-217, 339-345three-point reversal, 345-357time, 218time and volume omission, 336trend lines, 248

scalearithmetic scale, 213semi-logarithmic scale, 214

volumebar/candle charts, 412-413equivolume, 412-413point-and-figure, 414

Chesler, Daniel, 379Chi-Square distributions, 592Chicago Board of Trade (CBOT), 63Chicago Mercantile Exchange (CME

Group), 63Citigroup, 31CLB (Core Laboratories), 276-277climaxes, 107-108, 373, 426close breakouts, 256-257CME Group (Chicago Mercantile

Exchange), 63CMT (Chartered Market Technician), 7coefficient of determination, 589Cohen, Abe, 218, 339coil triangle pattern, 317-318cointegration, 602Colby, Robert, 156Collins, Charles, 478combinations, 583Commitment of Traders (COT) reports,

122-124

640 Index

Commodity Futures Trading Commission(CFTC), 122

commodity markets. See futures marketscommon gaps, 367Common Stocks as Long-Term Investments

(Smith), 168commonality, 474-475competitive markets, economic theory of,

41-42components, measuring for robustness, 549compound rate of return, 584computers and pattern recognition, 305-306CompuTrac, Inc., 438confirmation

analysis methodsclassic patterns, 411crossovers, 411divergences, 409-410explained, 408failure swings, 409overbought/oversold, 408-409reversals, 410trend IDs, 410-411

in Dow Theory, 82-83momentum (price confirmation)

Commodity Channel Index (CCI), 441determining trend and trading range,

441-444explained, 430-431Moving Average Convergence-Divergence

(MACD), 432-433Rate of Change (ROC), 434-435Relative Strength Index (RSI), 434-437similarities between oscillators, 441-442Stochastic oscillator, 437-440success of momentum indicators, 431-432Williams %R oscillator, 440-441

open interestexplained, 427-428indicators, 428-429

overview, 407-408volume confirmation. See volume

confirming breakoutsclose filter, 256-257intra-bar breakouts, 256-257Pivot Point Technique, 260-262point or percent filter, 258time, 258volatility, 259-260volume, 259

congestion areas. See trading rangesConnor, Larry, 382-386, 538Consensus Bullish Sentiment Index, 106consolidation areas. See trading rangesconstant forward contracts, 539Consumer Confidence Index, 106continuous contracts, 206, 539continuous price flow, 336-337contracts

cash markets, 60-61constant forward contracts, 539continuous contracts, 539derivative markets

counterparty risk, 62defined, 62futures markets, 63-65option markets, 65-66underlying, 62

explained, 59linked contracts, 205-206number of, 565perpetual contracts, 539swaps and forwards, 66

contrarian investing, 90-91contrary opinion, 96Cootner, Paul, 35Coppock, E. S. C., 29Core Laboratories (CLB), 276-277corrective waves, 483

flats, 485-486triangles, 486zigzags, 484

correlation, 586-590cosine waves, 452-455

Index 641

costsof funds, 185futures versus stock markets, 504

COT (Commitment of Traders) reports,122-124

countin one-box reversal point-and-figure charts,

341-343in three-point reversal point-and-figure charts,

347-348counterparty risk, 62countertrend systems, 538covariance

calculating, 586variance versus, 597

Cowles, Alfred III, 35, 76Crabel, Tony, 377, 388crashes, 94credit default options (CDO), 66criticisms of technical analysis

behavioral finance, 49-50EMH (Efficient Markets Hypothesis)

arbitrage and price equilibrium, 47-48economic theory of competitive markets,

41-42explained, 40-41new information, 42-43, 46origins and development, 41rationality of investors, 46-47

explained, 33-34pragmatic criticisms, 50-51RWH (Random Walk Hypothesis)

drawdowns, 37-38explained, 35fat tails, 36origins and development, 35porpotions of scale, 39-40

crossovers, 411crowd behavior and concept of contrary

opinion, 96cup pattern, 325-326current advances in technical analysis, 30-31curves, 302

cyclesaccuracy, 455-456amplitude, 470-475controversy about, 449-451cosine waves, 452-455defined, 452-455harmonics, 456-457identifying

centered moving averages, 463-464detrending, 461envelopes, 464-467Fourier analysis (spectral analysis), 458Maximum Entropy Spectral Analysis

(MESA), 459observation, 460-461

inversions, 457projections

amplitude, 470-475periods, 468-469

temporal patterns/cycles34-year historical cycles, 166-168decennial pattern, 168-169election year pattern, 171-172event trading, 175explained, 163-164four-year or presidential cycle, 170-171January barometer, 174January effect, 174Kondratieff waves (K-waves), 164-166seasonal patterns, 172-174

translation, 457-458Cycletrend, Inc., 472cyclical emphasis (ratio analysis), 510-511

bond market to stock market, 512gold to bonds, 512implications of intermarket analysis, 513-515stock market to U.S. dollar, 513-514U.S. dollar to gold, 511

Ddark cloud cover candlestick pattern, 395-397Davis, Robert Earl, 339day orders, 607

642 Index

DCB (Dead Cat Bounce), 371-373dealer markets, 58decelerating trend lines, 241-242decennial pattern, 168-169decision making

and sentiment. See sentimenteffect of bias on, 92

decline, 133deductive reasoning, 50The Definitive Guide to Futures Trading

(Williams), 536definition of technical analysis, 3degrees of freedom

defined, 585in probability distributions, 592-593

DeMark, Tom, 232DeMark-Williams reversal points, 232-233dependent variables, 590derivative markets


descending triangle pattern, 315-316descriptive statistics

central tendency measurement, 583-585defined, 583multiple variables, 586-590volatility measurement, 585-586

designing systemscountertrend systems, 538exogenous signal systems, 538initial systems, 534-535pattern recognition systems, 537-538reliability, 538requirements, 532-533risk, 533-534trend-following systems

breakout systems, 536explained, 535-536moving average systems, 536problems with, 536-537

Desmond, Paul F., 152determining

price extremes, 287support and resistance, 286trends, 227-229, 285

deterministic, 582detrending, 461Devoe, Raymond Jr., 371Dewey, Edward R., 164diagonals, 482diamond top pattern, 321-322direct search markets, 58directional movement

calculating, 288-289Directional Movement concept, 29DMIs (directional movement indicators),

289-291directional trends

defined, 238uptrends, identifying, 238

regression lines, 239trend lines, 239-244

discretionary systems, 530-531distributions, 582-583, 591-594divergence, 409-410

defined, 132-133double divergences, 137double negative divergence, 136-137negative divergence, 132positive divergence, 132reversal, 133

diversifiable risk, 571-572diversification, 595DJIA. See Dow Jones Industrial AverageDMIs (directional movement indicators),

289-291doji candlestick pattern, 391-392doji star, 397dollar stops, 573dollars

stock market to U.S. dollar ratio analysis,513-514

U.S. dollar to gold ratio analysis, 511

Index 643

Donchian channel, 295Donchian, Richard, 29, 237Dormier, Buff, 427Dorsey, Thomas, 218, 339double divergences, 137double negative divergence, 136-137double top and double bottom pattern,

309-310, 349Dow Jones Industrial Average

34-year historical cycle, 166-167historical drawdowns, 38history of, 26-27

Dow Theory, 225-226confirmation, 82-83criticisms of, 85economic rationale, 78history of, 27idea market picture, 78minor trends, 82origins and development, 76-78primary trends, 80-81secondary trends, 81theorems, 78-79volume of transactions, 84

The Dow Theory: An Explanation of ItsDevelopment and an Attempt to Define Its Usefulness as an Aid to Speculation(Rhea), 76

Dow, Charles H., 4, 16-17, 26, 70, 75-76, 230,337, 407

Dow, Jones & Company, 26Downs, Walter, 383downtick, 609

downtrends, 11. See also trendsdrawdowns, 37-38, 563Drew, Garfield, 29Dystant, Ralph, 438

Eearly financial markets and exchanges, 23-25Ease of Movement (EMV), 425eccentric sentiment indicators, 117economic rationale, 78

economic theory of competitive markets, 41-42Edison Telegraph Printer, 201Edison, Thomas, 201Edwards, Robert D., 3, 28efficiency factor, 550efficient frontier, 598Efficient Markets Hypothesis (EMH), 17, 30efficient set, 597-598EFI (Elder Force Index), 423-424Ehlers, John, 285EHM (Efficient Markets Hypothesis), 17, 3080/60 rule, 158Elder Force Index (EFI), 423-424election year pattern, 171-172Elliott Wave Theory. See EWTElliott, Ralph Nelson, 477-478EMA (Exponentially Smoothed Moving

Average), 282-285EMH (Efficient Markets Hypothesis)

economic theory of competitive markets,41-42

explained, 40-41new information, 42-43origins and development, 41

emotional feedback, 19emotions. See sentimentempirical support for technical analysis, 52EMV (Ease of Movement), 425Encyclopedia of Chart Patterns

(Bulkowski), 302The Encyclopedia of Technical Market

Indicators (Colby and Meyers), 156ending diagonals, 482engulfing candlestick pattern, 394-396Enron, 43-44entry (patterns), 302entry stops, 263-264entry strategies, 572envelopes, 464-467equality (EWT), 487equally weighted (geometric) averages, 72equity curve, 552equity lines, 142

644 Index

equivolume, 412-413error term, 590ETFs (exchange-traded funds), 61-62evening star candlestick pattern, 397-398event declines, 372event trading, 175EWT (Elliott Wave Theory)

alternation, 487alternatives to, 490-491channeling, 487-488corrective waves, 483

flats, 485-486triangles, 486zigzags, 484

equality, 487explained, 477-480impulse waves

basic rules, 480-481diagonals, 482impulse patterns, 481truncation, 483

origins and development, 478practical interpretation, 491-492projected targets, 488-490

ex-dividend gaps, 367exchange-traded funds (ETFs), 61-62execution risk strategies, 576exhaustion gaps, 367exit (patterns), 302exit stops, 263-264exit strategies, 573exogenous signal systems, 538expectations, 17expected return, 599expert systems, 603expiration

of futures, 65of options, 65

explanatory variables, 590explosion gap pivot, 364Exponentially Smoothed Moving Average

(EMA), 282-283

FF distributions, 593failure swings, 409, 436failures, 303false (“specialist”) breakouts, setting stops

for, 272-273false breakouts, 311FAMA (Following Adaptive Moving

Average), 285Fama, Eugene, 17, 35, 41fan lines

defined, 241Gann fan lines, 250-251

Fast Fourier Transforms (FFTs), 458fat tails, 36Federal Open Market Committee (FOMC),

191Federal Reserve System, 60

FOMC (Federal Open Market Committee), 191

monetary policyexplained, 190-191Fed policy futures, 191Three Steps and a Stumble indicator,

193-194valuation model, 192yield curve, 194

FFTs (Fast Fourier Transforms), 458Fibonacci sequence

explained, 493golden ratio, 493-495origins and development, 493price and time targets, 495-497

Fill or Kill (FOK), 607finance.yahoo.com, 203financial markets. See marketsFisher, Mark, 388fitness, 603-604flags and pennants pattern, 329-331flats, 485-486FLD (Future Line of Demarcation), 471-472

Index 645

flow of fundsbank loans, 184cost of funds, 185explained, 177-178Fed policy

explained, 190-191Fed policy futures, 191Three Steps and a Stumble indicator,


household financial assets, 182long-term interest rates, 187margin debt, 179-180Misery Index, 188-189money market funds, 178-179money supply, 183-184money velocity, 187, 189secondary offerings, 180-181short-term interest rates, 185-186

FOK (Fill or Kill), 607Following Adaptive Moving Average

(FAMA), 285FOMC (Federal Open Market Committee),

191formations. See patternsforward market, 24forwards, 664-week rule, 29four-year cycle, 170-171Fourier analysis, 458fractal nature of patterns, 18, 303fractal nature of trends, 15-16, 225freestockcharts.com, 203Frost, A. J., 478fulcrum in one-box reversal point-and-figure

charts, 344funds

bank loans, 184cost

long-term interest rates, 187Misery Index, 188-189money velocity, 187-189short-term interest rates, 185-186

ETFs (exchange-traded funds), 61-62

Fed policyexplained, 190-191Fed policy futures, 191Three Steps and a Stumble indicator,193-194valuation model, 192yield curve, 194

household financial assets, 182margin debt, 179-180money market funds, 178-179money supply, 183-184secondary offerings, 180-181

fungibility, 58funnel pattern, 320Future Line of Demarcation (FLD), 471-472futures markets, 63-65

choosing between futures markets and stock marketscosts, 504liquidity, 506risks, 505suitability, 505time horizon, 505-506volatility, 506volume, 506

data problems, 539-540Fed policy futures, 191

GGammage, Kennedy, 157Gann fan lines, 250-251Gann two-day swing method, 233-234Gann, William Delbert, 28, 233, 250, 497-498gaps

breakaway gaps, 364common gaps, 367ex-dividend gaps, 367exhaustion gaps, 367explained, 363-364opening gaps, 365-367pattern gaps, 367runaway gaps, 367stops and, 269-270suspension gaps, 367

646 Index

GARCH (generalized autoregressiveconditional heteroscedasticity), 602-603

Gartley, H. M., 415GAs (genetic algorithms), 603-604Gauss, Karl, 591Gaussian distributions, 591-592Gayer, Zoran, 490General Electric, 36generalized autoregressive conditional

heteroscedasticity, 602-603genetic algorithms (GAs), 603-604geometric averages, 72geometric mean, 584-585GMA (Geometric Moving Average), 284Goepfert, Jason, 108gold

gold to bonds ratio analysis, 512Hulbert Gold Sentiment Index, 128U.S. dollar to gold ratio analysis, 511

golden ratio, 493-495Good ’Til Canceled Order (GTC), 607Gould, Edson, 248Granville, Joseph, 28, 416Grossman, Stanford, 42GTC (Good ’Til Canceled Order), 607

HHadady, R. Earle, 429half-cycle reversal, 470-471Hamilton, William Peter, 17, 27, 76-77, 230hammer candlestick pattern, 393hanging man candlestick pattern, 393-394harami candlestick pattern, 392-393hard money stops, 573harmonics of cycles, 456-457Haurlan Index, 140-141Haurlan, Peter N., 140head-and-shoulders pattern, 326-329, 343hemlines as sentiment indicator, 117herding, 46Herrick Payoff Index (HPI), 428-429Herrick, John, 428High Growth Stock Investors, 203high volume method of identifying reversal

points, 234

high-low logic index, 156hikkake reversals, 379-380Hilbert’s Transform, 285Hill, John R., 538Hindenburg Omen, 157Hirsch, Yale, 171histograms, 591historical indicators, 117-118history

of charts, 201-204of EWT (Elliott Wave Theory), 478of point-and-figure charting, 337-339of technical analysis

early financial markets and exchanges,23-25

modern technical analysis, 26-30Hitschler, Fred, 29Holy Grail method, 444Honma, Sokyu, 24-25, 201hook reversals, 379horizontal count in three-point reversal

point-and-figure charts, 347horn pattern, 375household financial assets, 182HPI (Herrick Payoff Index), 428-429Hughes, James F., 136-137Hulbert Financial Digest, 128Hulbert Gold Sentiment Index, 128Hulbert, Mark, 128Hurst, James, 454, 460hyperbolic discounting, 47

Iideal market picture (Dow Theory), 78identifying

cyclescentered moving averages, 463-464detrending, 461envelopes, 464-467Fourier analysis (spectral analysis), 458Maximum Entropy Spectral Analysis

(MESA), 459observation, 460-461

Index 647

trends, 12-13linear least-squares regression, 12-13trend lines, 13-14

IFTA (International Federation of TechnicalAnalysts, Inc.), 7

Immediate or Cancel (IOC), 607implied volatility, 101impulse waves


independence, 582Independence Day pattern, 175independent variables, 590indexes

Accumulation Distribution (AD), 419Commodity Channel Index (CCI), 441explained, 408On-Balance-Volume (OBV), 416-417Price Volume Trend, 418Relative Strength Index (RSI), 434-437Williams Accumulation Distribution

(WAD), 420Williams Variable Accumulation Distribution

(WVAD), 418-419inductive reasoning, 50inferential statistics

defined, 583, 591probability distributions, 591-594

information, 42-43informed investors, 69informed players, sentiment of

explained, 91-92measuring, 118-124

initial capital, 568-569initial system design decisions, 534-535inside bars, 376-378insiders, measuring sentiment of


Investors Intelligence, 119-120large blocks, 121-122

secondary offerings, 119Sell/Buy ratio, 118-119

interest rateslong-term interest rates, 187short-term interest rates, 185-186

Intermarket Technical Analysis (Murphy), 507intermediate trends, 16, 81internal trend lines, 244International Federation of Technical

Analysts, Inc. (IFTA), 7intra-bar breakouts, 256-257intraday patterns, 386-389intraday trends, 16introduction to technical analysis, 3-5inversions of cycles, 457inverted hammer candlestick pattern, 394-395inverted triangle pattern, 320inverted yield curve, 194investment securities, 506-507investors

informed investors, 69investor psychology, 89, 226-227investors as their own worst enemies, 93liquidity players, 69noise players, 46, 69rationality of, 46-47sentiment

crowd behavior and concept of contraryopinion, 96

human bias and decision making, 92-94neurochemistry effect on human

thinking, 92short-term traders, 51

Investors IntelligenceAdvisory Service Sentiment survey, 103-105measuring sentiment with, 119-120

IOC (Immediate or Cancel), 607irrational exuberance, 48Irwin, Scott, 52island reversals, 373Isosceles triangle pattern, 317-318

648 Index

JJackwerth, Jens Carsten, 36January barometer, 174January effect, 174Japanese Candlestick Charting Techniques

(Nison), 211, 390Jegadeesh, Narishimhan, 517Jensen’s alpha, 600JNJ (Johnson & Johnson), 207-209Jones, Edward, 26Jones, Herbert E., 35

KK-waves (Kondratieff waves), 164-166Kahneman, Daniel, 47KAMA (Kaufman Adaptive Moving

Average), 285kasakasa pattern, 393Kato, Kosaku, 24Kaufman Adaptive Moving Average

(KAMA), 285Kelly formula, 567-568Keltner Bands, 293Keltner, Chester, 293Kepler, Johannes, 494key reversal bars, 373Kirkpatrick, Charles D., 522-523knockout pattern, 381knowledge of market, 571Kondratieff waves (K-waves), 164-166Kondratieff, Nicolas D., 164

LLambert, Donald, 441Landry, David, 364, 381Lane, George, 438large blocks, measuring sentiment with,

121-122large losses, 551leading diagonals, 482

Leading Sectors and World Powers: TheCoevolution of Global Economics andPolitics (Modelski and Thompson), 165

least-squares regression line, 588leaves, 607LeBeau, Chuck, 436legislation

Securities Act of 1933, 28Securities Exchange Act of 1934, 28

lengthof average winning trade, 550of moving averages, 279-280of trends, 15-16

leptokurtic distribution, 36leverage, 570Levy method, 520Levy, Paul, 35Levy, Robert, 308, 517, 520Lieber, Al, 450limits, 607Lindsay, George, 29line charts, 207-209line formation, 230line of best fit, 588linear regression, 239

linear regression least-squares fit, 12-13, 588probability distributions and, 593-594

Linearly Weighted Moving Average (LWMA), 282

linked contracts, 205-206liquidity

defined, 607futures versus stock markets, 506

liquidity players, 69, 91Lo, Andrew W., 18, 39, 46, 50loans, 184log-returns, 592logarithmic scale, 220long, 607long tail pattern (three-point reversal

point-and-figure charts), 355

Index 649

long-range bar, 370Long-Term Capital Management (LTCM),

48-49long-term interest rates, 187The Long Wave Cycle (Kondratieff), 164longest flat time, 551Lonja, 24LTCM (Long-Term Capital Management),

48-49LWMA (Linearly Weighted Moving

Average), 282

MMACD (Moving Average Convergence-

Divergence), 29, 432-433MacKinlay, A. Craig, 39Magee, John, 3, 28, 32Malkiel, Burton, 35MAMA (MESA Adaptive Moving

Average), 285management. See money managementMandelbrot, Benoit, 36manias

book recommendations, 95books about, 95defined, 94

margin balances, 110-111margin debt, 179-180market breadth, measuring

absolute breadth index, 144-145advance-decline line to its 32-week simple

moving average, 139advance-decline ratio, 146-147breadth line (advance-decline line), 134-136breadth thrust, 147-148definition of breadth, 133double negative divergence, 136-137Haurlan Index, 140-141McClellan Oscillator, 142-143McClellan Ratio-Adjusted Oscillator, 143McClellan summation index, 144overview, 148plurality index, 144

traditional advance-decline methods, 138-139unchanged issues index, 145

market capitalization weighted averages, 71-72Market on Close (MOC), 607market orders, 608market selection

explained, 503-504futures versus stock markets

costs, 504liquidity, 506risks, 505suitability, 505time horizon, 505-506volatility, 506volume, 506

investment securities, 506-507ratio analysis

bond market to stock market, 512cyclical emphasis, 510-511gold to bonds, 512implications of intermarket analysis,

513-515secular emphasis, 507-510stock market industry sectors, 515-516stock market to U.S. dollar, 513-514U.S. dollar to gold, 511

relative strengthacademic studies of, 517-518explained, 517measuring, 518-520

screening for favorable stocks: case studies, 520Charles D. Kirkpatrick method, 522-523James P. O’Shaughnessy method, 521-522Richard D. Wyckoff method, 522-524Value Line Ranking System, 522William O’Neil CANSLIM method, 521

market sentiment. See sentimentmarket strength, measuring

absolute breadth index, 144-145advance-decline line to its 32-week simple

moving average, 139advance-decline ratio, 146-147

650 Index

Arms Index, 149-151breadth and new highs to new lows, 159-160breadth line (advance-decline line), 134-136breadth thrust, 147-148double negative divergence, 136-137explained, 131-133Haurlan Index, 140-141high-low logic index, 156Hindenburg Omen, 157McClellan Oscillator, 142-143McClellan Ratio-Adjusted Oscillator, 143McClellan summation index, 144modified Arms Index, 151moving averages, 157-158net ticks, 160new highs versus new lows, 155NPDD (ninety percent downside days), 152plurality index, 14410-to-1 up volume days and 9-to-1 down

volume days, 153-154traditional advance-decline methods, 138-139unchanged issues index, 145

Market Vane polls, 106markets

auction markets, 59breadth. See market breadth, measuringbrokered markets, 58cash markets, 60-61dealer markets, 58defined, 58derivative markets


direct search markets, 58economic theory of competitive markets,

41-42history of, 23-25how markets work, 66-68knowledge of, 571market structure and pattern recognition, 306

measurementsequally weighted (geometric) averages, 72explained, 69-70market capitalization weighted averages,

71-72price-weighted averages, 70

players, 69selection. See market selectionsentiment. See sentimentstock market, 60strength. See market strength, measuringstructure

concepts of W. D. Gann, 497-498EWT (Elliott Wave Theory), 478-492

swaps and forwards, 66MarketWatch, 128Markowitz, Harry, 594Martin, Richard, 478martingale betting system, 563-564Mastering Elliott Wave (Neely), 490maximum adverse excursion method, 574maximum consecutive losses, 551maximum cumulative drawdown, 550maximum drawdowns (MDD), 563Maximum Entropy Spectral Analysis

(MESA), 459maximum favorable and adverse

excursions, 551maximum likelihood, 603maximum loss, 551maximum winning favorable excursion, 575McClellan Market Report, 123McClellan Oscillator, 142-143McClellan Ratio-Adjusted Oscillator, 143McClellan summation index, 144McClellan, Marian, 142-144McClellan, Sherman, 142-144McClellan, Tom, 123MDD (maximum drawdowns), 563mean

calculating, 583geometric mean versus, 584-585

mean-variance framework, 598

Index 651

measuringgaps, 367market movement

equally weighted (geometric) averages, 72explained, 69-70market capitalization weighted averages,

71-72price-weighted averages, 70

market strengthabsolute breadth index, 144-145advance-decline line to its 32-week simple

moving average, 139advance-decline ratio, 146-147Arms Index, 149-151breadth and new highs to new lows,

159-160breadth line (advance-decline line),

134-136breadth thrust, 147-148double negative divergence, 136-137explained, 131-133Haurlan Index, 140-141high-low logic index, 156Hindenburg Omen, 157McClellan Oscillator, 142-143McClellan Ratio-Adjusted Oscillator, 143McClellan summation index, 144modified Arms Index, 151moving averages, 157-158net ticks, 160new highs versus new lows, 155NPDD (ninety percent downside

days), 152plurality index, 14410-to-1 up volume days and 9-to-1 down

volume days, 153-154traditional advance-decline methods,

138-139unchanged issues index, 145

relative strengthalpha method, 519-520Levy method, 520

percentage change method, 518-519trend slope method, 520

sentiment of informed playersCOT (Commitment of Traders) reports,

122-124Investors Intelligence, 119-120large blocks, 121-122secondary offerings, 119Sell/Buy ratio, 118-119

sentiment of uninformed playersadvisory opinion polls, 103, 105American Association of Individual

Investors poll, 105buying and selling climaxes, 107-108combining put/call ratio and volatility, 102Consensus Bullish Sentiment Index, 106Consumer Confidence Index, 106eccentric sentiment indicators, 117historical indicators, 117-118margin balances, 110-111Market Vane polls, 106money market fund assets, 111-112mutual fund statistics, 108-109odd-lot short selling, 115option trading and sentiment, 97-98overview, 97put-call ratios, 98-100relative volume, 112-113Rydex funds, 109-110Sentix Index, 106uninformed short selling, 113-115unquantifiable contrary indicators,

116-117volatility, 100-101

system results for robustnesscomponents, 549profit measures, 549-550risk measures, 550-551smoothness and equity curve, 552

median, 584megaphone pattern, 320mercato a termine, 24Merrill, Arthur, 122, 139, 246, 308

652 Index

MESA (Maximum Entropy Spectral Analysis), 459MAMA (MESA Adaptive Moving

Average), 285Metastock, 203Meyers, Thomas, 156Mikkea, Jim, 157minor trends, 82miscalibration of probabilities, 47Misery Index, 188-189MOC (Market on Close), 607mode, 584Modelski, George, 164Modern Portfolio Theory (MPT), 594-600modified Arms Index, 151momentum

Commodity Channel Index (CCI), 441explained, 29, 430-431Moving Average Convergence-Divergence


moneybank loans, 184cost of funds, 185explained, 177-178Fed policy

explained, 190-191Fed policy futures, 191Three Steps and a Stumble indicator,


household financial assets, 182long-term interest rates, 187management. See money managementmargin debt, 179-180Misery Index, 188-189money market funds, 178-179

money stops, 269money supply, 183-184secondary offerings, 180-181short-term interest rates, 185-186velocity, 187-189

Money Flow Index (Oscillator), 422-424money management

determining optimal position sizeoptimal f and Kelly formula, 567-568Risk of Ruin (ROR) formula, 565-566theory of runs, 567

explained, 559-560, 564-565if everything goes wrong, 577monitoring systems and portfolios, 577risk strategies

execution, 576explained, 530, 572-573protective stops, 573-574signal stops, 576targets, 576time stops, 576trailing stops, 574-575

risksdiversifiable risk, 571-572drawdowns, 563explained, 560-561initial capital, 568-569knowledge of market, 571leverage, 570martingale betting system, 563-564maximum drawdowns (MDD), 563number of shares or contracts, 565optimal f and Kelly formula, 567-568position size, 564-568psychological risks, 570-571pyramiding, 570reward to risk, 564Risk of Ruin (ROR) formula, 565-566security quality, 572temporal, 572theory of runs, 563, 567trade frequency, 572

testing money management strategies,561-562

Index 653

money market funds, 111-112, 178-179money market managers, 126-127money point, 575money stops, 269money supply, 183-184monitoring systems and portfolios, 577Monte Carlo simulations, 562, 569Montgomery, Paul Macrae, 116morning star candlestick pattern, 397-398Most, Nathan, 61motive impulse wave, 479Moving Average Convergence-Divergence

(MACD), 432-433moving averages, 157-158, 536

advance-decline moving average, 138bands

Bollinger Bands, 292-293explained, 292Keltner Bands, 293STARC Bands, 293trading strategies, 294-295

calculating, 276-278centered moving averages, 463-464channels, 295defined, 275-276directional movement

calculating, 288-289DMIs (directional movement indicators),

289-291Exponentially Smoothed Moving Average

(EMA), 282-283Following Adaptive Moving Average

(FAMA), 285Geometric Moving Average (GMA), 284Kaufman Adaptive Moving Average

(KAMA), 285length of, 279-280Linearly Weighted Moving Average

(LWMA), 282MESA Adaptive Moving Average

(MAMA), 285multiple moving averages, 280-281

number of stocks above their 30-week movingaverage, 157-158

percentage envelopesexplained, 291-292trading strategies, 294-295

triangular moving averages, 285usage strategies

determining price extremes, 287determining support and resistance, 286determining trend, 285giving specific signals, 288

variable EMAs, 285Volume-Adjusted Moving Average, 285Wilder’s moving average, 284

moving averages crossovers, 29Moving-Average Convergence/Divergence

(MACD), 29, 432-433moving-average envelopes, 29MPT (Modern Portfolio Theory), 594-600MTA (Market Technicians Association), 7multibox reversal point-and-figure charts,

217-218multicollinearity, 590multiple bar patterns

knockout, 381Oops!, 382shark, 383-384trend correction, 380-381

multiple moving averages, 280-281multiple regression, 590multiple variables in descriptive statistics,

586-590Murphy, John, 507mutual funds

mutual fund cash as percentage of assets,108-109

statistics, 108

NNajarian, Jon, 537naked bar upward reversals, 379narrow-range bar, 385-386Nature’s Law—The Secret of the Universe

(Elliott), 478

654 Index

nearest future method, 205Neely, Glenn, 490negative divergence, 132, 410negative failure swings, 409negative reversals, 133, 410Nelson, A. C., 76Nelson, S. A., 27Nerves-of-Steel system

design, 541-545Monte Carlo simulation, 569upgrading based on results of initial testing,

553-555net profit to drawdown ratio, 551net ticks, 160neural networks, 603neurochemistry effect on human thinking, 92neurofinance, 17neutral areas, 225New Concepts in Technical Trading Systems

(Wilder), 288new highs versus new lows, 155A New Strategy of Daily Stock Market Timing

for Maximum Profit (Granville), 4169-to-1 down volume days, 153-154Nison, Steve, 30, 211, 390noise players, 46, 69nondiscretionary systems

benefits of, 531-532explained, 530-531pitfalls of, 532

nondiversifiable risk, 599nonrandom nature of price, 18normal distributions, 36, 591-592normal risks

initial capital, 568-569leverage, 570number of shares or contracts, 565optimal f and Kelly formula, 567-568position size

determining optimal position size, 565-568explained, 564-565final position size, 568

pyramiding, 570

Risk of Ruin (ROR) formula, 565-566theory of runs, 567

not held, 608NPDD (ninety percent downside days), 152number of shares or contracts, 565

OO’Neil, William, 521O’Shaughnessy, James P., 521-522observing cycles, 460-461OBV (On-Balance-Volume), 416-417odd lots, 608odd-lot short selling, 115offers, 608Okum, Arthur, 188On Balance Open Interest Indicator, 429On the Impossibility of Informationally

Efficient Markets (Grossman and Stiglitz), 42

On-Balance-Volume (OBV), 416-417one-box reversal point-and-figure charts,

216-217, 373action points, 344-345consolidation area, 340determining count in, 341-343explained, 339fulcrum, 344head-and-shoulders pattern, 343trend lines, 340-341

one-day change in advance-decline line, 138Oops! pattern, 382OOS (out-of-sample) optimization, 547-548open interest

explained, 427-428indicators, 428-429

open orders, 607opening gaps, 365-367OPG (Opening Only), 608optimal f, 567-568optimal position size, determining

optimal f and Kelly formula, 567-568Risk of Ruin (ROR) formula, 565-566theory of runs, 567

Index 655

optimizing systemsexplained, 546measuring system results for robustness

components, 549profit measures, 549-550risk measures, 550-551smoothness and equity curve, 552

out-of-sample (OOS) optimization, 547-548screening for parameters, 548-549walk forward optimization, 548whole sample, 547

option trading, 65-66, 97-98order tickets, 609-610oscillators

analysis methodsclassic patterns, 411crossovers, 411divergences, 409-410failure swings, 409overbought/oversold, 408-409reversals, 410trend IDs, 410-411

bounded/unbounded, 408Chaikin Money Flow, 421Chaikin Oscillator, 422defined, 139Ease of Movement (EMV), 425Elder Force Index (EFI), 423-424explained, 408Herrick Payoff Index (HPI), 428-429McClellan Oscillator, 142-143McClellan Ratio-Adjusted Oscillator, 143Money Flow Index (Oscillator), 422-424Moving Average Convergence-Divergence

(MACD), 432-433Rate of Change (ROC), 434-435similarities between, 441-442Stochastic oscillator, 437-440Twiggs Money Flow, 421volume oscillator, 420-421Volume Rate of Change, 425Williams %R oscillator, 440-441

out-of-sample (OOS) optimization, 547-548

outlier-adjusted profit, 550outside bars, 379-380overbought level, 408-409overconfidence, 46overreaction, 46oversold level, 408-409

Ppanics, 94-95paper umbrella pattern, 393Parabolic SAR, 267Parabolic System, 29parameters

screening for, 548-549test parameter ranges, 540

Park, Cheol-Ho, 52pattern gaps, 367pattern recognition systems, 537-538patterns

ascending triangle, 317ascending triple top and descending triple

bottom, 350-351assumptions about, 18bar charts and patterns, 307-308book recommendations, 307broadening, 320bullish triangle and bearish triangle, 352candlestick

Bulkowski ranking of candlestick patterns,401-402

dark cloud cover, 395-397doji, 391-392engulfing, 394-396evening star, 397-398explained, 390-391hammer, 393hanging man, 393-394harami, 392-393inverted hammer, 394-395morning star, 397-398piercing line, 395-397shooting star, 394-395three black crows, 398-399

656 Index

three inside down, 399-400three inside up, 399-400three outside down, 400three outside up, 400three white soldiers, 398-399windows, 392

catapult, 354-355characteristics of, 302-303construction and determination, 362Dead Cat Bounce (DCB), 371-373defined, 302descending triangle, 315-316diamond top, 321-322double top and double bottom, 309-310, 349entry/exit, 302existence of, 303-304failures, 303flags and pennants, 329-331fractal nature of, 18, 303fulcrum, 344gaps

Apple Computer (AAPL) case study,368-370

breakaway gaps, 364common gaps, 367ex-dividend gaps, 367exhaustion gaps, 367explained, 363-364opening gaps, 365-367pattern gaps, 367runaway gaps, 367suspension gaps, 367

head-and-shoulders, 326-329, 343intraday patterns, 386-389island reversals, 373multiple bar patterns


one- and two-bar reversal patternshikkake reversals, 379-380hook reversals, 379horn, 375

inside bars, 376-378naked bar upward reversals, 379one-bar reversals, 373outside bars, 379-380two-bar breakouts, 375two-bar reversals, 373-375

pattern recognitionbehavioral finance and, 304-305computers and, 305-306market structure and, 306

patterns with best performance and lowest riskof failure, 332

profitability of, 308-309pullbacks, 303rectangle, 310-313rising and declining trend lines, 352-354rising bottom and declining top, 349-350rounding top and rounding bottom, 325-326shakeout, 356-357short- versus long-term patterns, 359-362spikes, 355-356, 370-371spread triple top and spread triple bottom,

351-352standard triangle, 314-315symmetrical triangle, 317-318temporal patterns/cycles

decennial pattern, 168-169election year pattern, 171-172event trading, 175explained, 163-164four-year or presidential cycle, 170-171January barometer, 174January effect, 174Kondratieff waves (K-waves), 164-166seasonal patterns, 172-17434-year historical cycles, 166-168

throwbacks, 303triple top and triple bottom, 313-314, 350validity of, 303-304volatility patterns

narrow-range bar, 385-386VIX, 386wide-range bar, 384-385

wedge and climax, 322-325

Index 657

payoff ratio, 550, 564peaks, 228-229pegged market, 608pennants, 329-331percent breakout filter, 258percentage change method, 518-519percentage envelopes

explained, 291-292trading strategies, 294-295

percentage method of identifying reversalpoints, 233

percentage of gain, setting trailing stops with, 268

percentage winning trades, 550performance measurement statistics, 600-601periods, 454, 468-469permutations, 582perpetual contracts, 205, 539piercing line candlestick pattern, 395-397pipe formation, 373-375Pisano, Leonardo (“Fibonacci”), 493Pivot Point Technique, 260-262pivots, 364Plato, 494players

informed players, 69, 92investor psychology, 89, 226-227investors as their own worst enemies, 93liquidity players, 69noise players, 69

Plessis, Jeremy du, 339Plummer, Tony, 456, 491plurality index, 144plus tick, 609POI (Price and Open Interest Index), 429Poincare, Henri, 35Point and Figure Charting (Dorsey), 218The Point and Figure Method of Anticipating

Stock Price Movements (De Villiers), 338point-and-figure charts

arithmetic scale, 220box size, 217-218continuous price flow, 336-337

explained, 215-216, 335, 414history of, 337-339logarithmic scale, 220multibox reversal, 217-218old versus new methods, 337one-box reversal

action points, 344-345consolidation area, 340determining count in, 341-343explained, 216-217, 339fulcrum, 344head-and-shoulders pattern, 343trend lines, 340-341

three-point reversalascending triple top and descending triple

bottom, 350-351bullish triangle and bearish triangle, 352catapult, 354-355double top and double bottom, 349explained, 345horizontal count, 347rising and declining trend lines, 352-354rising bottom and declining top, 349-350shakeout, 356-357spike, 355spread triple top and spread triple bottom,

351-352trend lines, 346-347triple top and triple bottom, 350vertical count, 348

time, 218time and volume omission, 336trend lines, 248

point breakout filter, 258polls, 102

advisory opinion polls, 103-105American Association of Individual

Investors, 105Consensus Bullish Sentiment Index, 106Consumer Confidence Index, 106Market Vane polls, 106Sentix Index, 106

Poor, Henry, 27

658 Index

popsteckle, 443-444population, 585portfolios, monitoring, 577Poser, Steven, 492position sizing. See money managementpositive divergence, 132, 410positive failure swings, 409positive reversals, 133, 410pragmatic criticisms of technical analysis,

50-51Prechter, Robert, 483predictive technical analysis, 4premature breakouts, 311presidential (four-year) cycle, 170-171price

arbitrage and price equilibrium, 47-48ask price, 59bid price, 59confirmation. See price confirmationas determined by supply and demand, 17history of price reporting, 27nonrandom nature of, 18normal distributions and, 591price discount assumption, 17price extremes, 287price flow, 336-337price targets, setting with breakout price, 309returns versus, 581-582, 586standard deviation of price, 259trends. See trends

Price and Open Interest Index (POI), 429price confirmation

determining trend and trading range, 441-444momentum

Commodity Channel Index (CCI), 441explained, 430-431Moving Average Convergence-Divergence


Price Volume Trend, 418price-weighted averages, 70primary bear markets, 80primary bull markets, 80primary dealer positions (Treasury Bonds),

125-126primary trends, 16, 80-81Pring, Martin, 510probability distributions, 582-583, 591-594profit

measuring profitability of systems, 549-550profit factor, 549, 564profit/loss ratio, 564profitability of patterns, 308-309profiting from technical analysis, 10-11trends as key to profits, 224-225

The Profit Magic of Stock Transaction Timing(Hurst), 454, 460

program trading, 412progressive stops. See trailing stopsprojected targets (EWT), 488-490projecting

amplitudecommonality, 474-475FLD (Future Line of Demarcation),

471-472half-cycle reversal, 470-471Tillman method, 472-474

periods, 468-469proportions of scale, 39-40protective stops, 264-265

hard money or dollar stops, 573maximum adverse excursion method, 574

Pruitt, George, 538psychological accounting, 46psychological risks, 570-571pullbacks, 247, 303, 608put/call ratio

measuring sentiment with, 98-102Treasury Bond COT data, 125Treasury Bond futures put/call ratio, 124

pyramiding, 570

Index 659

Qquadratic equation, standard deviation as, 595Quantitative Analysis Services, Inc., 100quotes, 608

Rr-squared, 589random, deterministic versus, 582The Random Character of Stock Market Prices

(Cootner), 35A Random Walk Down Wall Street

(Malkiel), 35Random Walk Hypothesis (RWH)


range trading, 236-237ranges

defined, 210True Range, 420

Raschke, Linda Bradford, 386, 444, 538RASI (ratio-adjusted summation index), 144rate of change (ROC), 29, 133, 434-435ratio analysis, 517

bond market to stock market, 512cyclical emphasis, 510-511gold to bonds, 512implications of intermarket analysis, 513-515secular emphasis, 507-510stock market industry sectors, 515-516stock market to U.S. dollar, 513-514U.S. dollar to gold, 511

ratio-adjusted summation index (RASI), 144rationality of investors, 46-47reactive technical analysis, 4recovery ratio, 551rectangle formation. See trading rangesrectangle pattern, 310-313Redmont, Richard, 438

regressioncalculating, 588-590linear regression, 239, 593-594regression lines, 239

relative strengthacademic studies of, 517-518explained, 517, 608measuring

alpha method, 519-520Levy method, 520percentage change method, 518-519trend slope method, 520

RSI (relative strength index), 29, 434-437relative volume, 112-113reports, COT (Commitment of Traders)

reports, 122-124Research Driven Investor (Hayes), 451residual, 590resistance

causes of, 230-232determining, 286resistance points, 230resistance zones, 230, 234-236

retracementsexplained, 245-246waiting for, 270

return on investment (ROI), 564Return Retracement ratio, 551returns

expected return, 599normal distributions and, 591prices versus, 581-582, 586risk versus return, 597ROI (return on investment), 564stationarity of, 602

Returns to Buying Winners and Selling Losers:Implications for Stock Market Efficiency(Levy), 517

reversalsexplained, 133, 410hikkake reversals, 379-380hook reversals, 379

660 Index

horn pattern, 375inside bars, 376-378island reversals, 373naked bar upward reversals, 379one-bar reversals, 373outside bars, 379-380reversal points, determining

DeMark or Williams method, 232-233Gann two-day swing method, 233-234high volume method, 234percentage method, 233

reversal amount, 337reversal bars, 373reversal size, 337two-bar breakouts, 375two-bar reversals, 373-375

reverse triangle pattern, 320reward to risk, 564, 597, 600-601Rhea, Robert, 17, 27, 76, 478rising and declining trend lines pattern,

352-354rising bottom and declining top pattern,

349-350rising wedge pattern, 323Risk of Ruin (ROR) formula, 565-566risk/return ratio, 271, 595risks. See also volatility

beta, 599-600counterparty risk, 62diversifiable risk, 571-572drawdowns, 563explained, 560-561futures versus stock markets, 505initial capital, 568-569knowledge of market, 571leverage, 570martingale betting system, 563-564maximum drawdowns (MDD), 563measuring, 550-551money-management risk strategies

execution, 576explained, 530, 572-573

if everything goes wrong, 577monitoring systems and portfolios, 577protective stops, 573-574signal stops, 576targets, 576time stops, 576trailing stops, 574-575

nondiversifiable risk, 599number of shares or contracts, 565optimal f and Kelly formula, 567-568patterns with best performance and lowest risk

of failure, 332position size

determining optimal position size, 565-568explained, 564-565final position size, 568

psychological risks, 570-571pyramiding, 570reward to risk, 564, 597, 600-601Risk of Ruin (ROR) formula, 565-566risk/return ratio, 271, 595security quality, 572and system design, 533-534temporal, 572theory of runs, 563, 567trade frequency, 572

robustness, measuring system results forcomponents, 549profit measures, 549-550risk measures, 550-551smoothness and equity curve, 552

ROC (rate of change), 29, 133, 434-435ROI (return on investment), 564ROR (Risk of Ruin) formula, 565-566Rotnem, Ralph, 117round lots, 608round numbers in trading ranges, 232rounding top and rounding bottom pattern,

325-326Rouwenhorst, K. G., 518RSI (relative strength index), 29, 434-437Rubenstein, Mark, 36

Index 661

rules of trading, 297runaway gaps, 367RWH (Random Walk Hypothesis)


Rydex Global Advisors, 109

Ssample, population versus, 585Samuelson’s Dictum, 42Samuelson, Paul, 35, 42saucer pattern, 325-326scale

arithmetic scale, 213, 220defined, 608logarithmic scale, 220proportions of scale, 39-40scale orders, 608semi-logarithmic scale, 214trend lines, 240

Schabacker, Richard W., 28Schumpeter, Joseph A., 164Schwager on Futures: Technical Analysis, 540Schwager, Jack, 200screening for parameters, 548-549seasonal patterns, 172-174seats, 608secondary offerings, 119, 180-181secondary trends, 16, 81secular emphasis (ratio analysis), 507-510Securities Act of 1933, 28Securities and Exchange Commission, 60Security Analysis (Graham and Dodd), 28security quality, 572selecting markets

explained, 503-504futures versus stock markets

costs, 504liquidity, 506risks, 505suitability, 505

time horizon, 505-506volatility, 506volume, 506

investment securities, 506-507ratio analysis

bond market to stock market, 512cyclical emphasis, 510-511gold to bonds, 512implications of intermarket analysis,

513-515secular emphasis, 507-510stock market industry sectors, 515-516stock market to U.S. dollar, 513-514U.S. dollar to gold, 511

relative strengthacademic studies of, 517-518explained, 517measuring, 518-520

screening for favorable stocks: case studies, 520Charles D. Kirkpatrick method, 522-523James P. O’Shaughnessy method, 521-522Richard D. Wyckoff method, 522-524Value Line Ranking System, 522William O’Neil CANSLIM method, 521

Sell/Buy ratio, 118-119seller expectations, 17semi-logarithmic scale, 214sentiment

crowd behavior and concept of contraryopinion, 96

defined, 89Hulbert Gold Sentiment Index, 128human bias and decision making, 92-94of liquidity players, 91measuring for informed players, 118-124


explained, 91-92Investors Intelligence, 119-120large blocks, 121-122secondary offerings, 119Sell/Buy ratio, 118-119

662 Index

measuring for uninformed playersadvisory opinion polls, 103-105American Association of Individual

Investors poll, 105buying and selling climaxes, 107-108combining put/call ratio and volatility, 102Consensus Bullish Sentiment Index, 106Consumer Confidence Index, 106eccentric sentiment indicators, 117explained, 91historical indicators, 117-118margin balances, 110-111Market Vane polls, 106money market fund assets, 111-112mutual fund statistics, 108-109odd-lot short selling, 115option trading and sentiment, 97-98overview, 97put-call ratios, 98-100relative volume, 112-113Rydex funds, 109-110Sentix Index, 106uninformed short selling, 113-115unquantifiable contrary indicators,

116-117volatility, 100-101

neurochemistry effect on human thinking, 92T-bill rate expectations by money market fund

managers, 126-127theory of contrarian investing, 90-91Treasury Bond COT data, 125Treasury Bond futures put/call ratio, 124Treasury Bond primary dealer positions,

125-126Sentix Index, 106serial dependence, 590shadows, 213shakeout pattern (three-point reversal

point-and-figure charts), 356-357shares, number of, 565shark pattern, 383-384Sharpe ratio, 551, 600Sharpe, William, 598, 600

Sherwell, Chris, 371Shiller, Robert, 48shock spiral, 427shooting star candlestick pattern, 394-395short, 608short covering, 608Short Interest Ratio, 113short selling

defined, 608odd-lot short selling, 115uninformed short selling, 113-115

short-term interest rates, 185-186short-term patterns

Dead Cat Bounce (DCB), 371-373explained, 359-362gaps

Apple Computer (AAPL) case study,368-370

breakaway gaps, 364common gaps, 367ex-dividend gaps, 367exhaustion gaps, 367explained, 363-364opening gaps, 365-367pattern gaps, 367runaway gaps, 367suspension gaps, 367

intraday patterns, 386-389island reversals, 373multiple bar patterns


one- and two-bar reversal patternshikkake reversals, 379-380hook reversals, 379horn pattern, 375inside bars, 376-378naked bar upward reversals, 379one-bar reversals, 373outside bars, 379-380two-bar breakouts, 375two-bar reversals, 373-375

Index 663

pattern construction and determination, 362spikes, 370-371volatility patterns


short-term traders, 51signal stops, 576Skinner, B. F., 304Slater, Tim, 438slippage, 573Smith, Edgar Lawrence, 168“Some A Posteriori Probabilities in Stock

Market Action” (Cowles and Jones), 35Sornette, Didier, 36Sortino ratio, 551SPDR (Standard & Poor’s Depository

Receipt), 61specialist breakouts, setting stops for, 272-273spectral analysis, 458speed lines, 248-249spikes, 355, 370-371

climaxes, 426explained, 425-426on breakout, 425shock spiral, 427volume dips, 427Volume Price Confirmation Indicator

(VPCI), 427spread triple top and spread triple bottom,

351-352Spyder, 61Stack, John, 139stagflation, 188Standard & Poor’s Depository Receipt

(SPDR), 61Standard and Poor’s, 27standard deviation

calculating, 585-586normal distributions and, 591of price, 259as quadratic equation, 595

standard normal variables, 592

Standard Statistics, 27standard triangle pattern, 314-315Star, Barbara, 441STARC Bands, 293stationarity of returns, 602statistical significance, 590statistics

advanced statistics overview, 602-603descriptive statistics

central tendency measurement, 583-585defined, 583multiple variables, 586-590volatility measurement, 585-586

inferential statisticsdefined, 583, 591probability distributions, 591-594

MPT (Modern Portfolio Theory), 594-600for performance measurement, 600-601probability and, 582-583returns versus prices, 581-582statistical significance, 590volume statistics

Accumulation Distribution (AD), 419Chaikin Money Flow, 421Chaikin Oscillator, 422climaxes, 426Ease of Movement (EMV), 425Elder Force Index (EFI), 423-424interpreting, 415-416Money Flow Index (Oscillator), 422-424On-Balance-Volume (OBV), 416-417Price Volume Trend, 418Twiggs Money Flow, 421value of, 414-415volume oscillator, 420-421Volume Rate of Change, 425volume spikes, 425-427Williams Accumulation Distribution

(WAD), 420Williams Variable Accumulation

Distribution (WVAD), 418-419Steckler, David, 152, 443Sterling ratio, 551

664 Index

Stiglitz, Joseph, 42Stochastic oscillator, 437-440stock ahead, 608The Stock Market Barometer (Hamilton), 76“Stock Market Prices Do Not Follow Random

Walks: Evidence from a SimpleSpecification Test” (Lo and MacKinlay), 39

Stock Market Profits (Schabacker), 28Stock Market Techniques No. 2 (Wyckoff), 338Stock Market Theory and Practice

(Schabacker), 28Stock Market Trading (Blumenthal), 339stock markets, 60

bond market to stock market ratio analysis, 512

choosing between futures markets and stock marketscosts, 504liquidity, 506risks, 505suitability, 505time horizon, 505-506volatility, 506volume, 506

industry sectors, 515-516stock market to U.S. dollar ratio analysis,

513-514StockCharts.com, 203StockCube Ltd, 339Stoller Average Range Channel (STARC), 293Stoller, Manning, 293stops

calculating risk/return ratio for breakouttrading, 271

changing stop orders, 264combining with breakouts, 269defined, 263, 609entry stops, 263-264exit stops, 263-264gaps and, 269-270money stops, 269placing for false (“specialist”) breakouts,

272-273

protective stops, 264-265hard money or dollar stops, 573maximum adverse excursion method, 574

signal stops, 576stop limit orders, 608time stops, 268-269, 576trailing stops

adaptive stops, 575break-even level and break-even stops, 574defined, 265-266maximum winning favorable

excursion, 575setting with Parabolic SAR, 267setting with percentage of gain, 268setting with trend lines, 266-267technical point versus money point, 575trend line stops, 575volatility stops, 575

waiting for retracement, 270Stowell, Joe, 379strength of market, measuring. See market

strength, measuringStrong, Robert, 34Student’s t distributions, 593Study Helps in Point and Figure Technique

(Whelan), 216suitability, futures versus stock markets, 505supply and demand, 14-17support

causes of, 230-232determining, 286support points, 230support zones, 234-236

suspension gaps, 367Swannell, Richard, 483swaps, 66symmetrical triangle pattern, 317-318systematic risk, 599systems

Chande’s Cardinal Rules for a good tradingsystem, 556

designcountertrend systems, 538exogenous signal systems, 538

Index 665

initial systems, 534-535Nerves-of-Steel system case study, 541-545pattern recognition systems, 537-538reliability, 538requirements, 532-533risk, 533-534trend-following systems, 535-537

discretionary, 530-531monitoring, 577necessity of, 530nondiscretionary

benefits of, 531-532explained, 530-531pitfalls of, 532

optimizationexplained, 546measuring system results for robustness,

549-552out-of-sample (OOS) optimization,

547-548screening for parameters, 548-549walk forward optimization, 548whole sample, 547

overview, 529testing

methods and tools, 540overview, 538-539special data problems for futures systems,

539-540test parameter ranges, 540

Tt distributions, 593T-bill rate expectations by money market fund

managers, 126-127Tabell, Edmund, 29targets, 576Tarkany, Frank, 456Taylor, Owen, 338Technical Analysis (Schwager), 200Technical Analysis and Market Profits

(Schabacker), 28Technical Analysis from A to Z (Achelis), 420

Technical Analysis of Stock Trends (Edwardsand Magee), 3, 28

technical point, 575temporal patterns/cycles

decennial pattern, 168-169election year pattern, 171-172event trading, 175explained, 163-164four-year or presidential cycle, 170-171January barometer, 174January effect, 174Kondratieff waves (K-waves), 164-166seasonal patterns, 172-17434-year historical cycles, 166-168

temporal risk, 57210-to-1 up volume days, 153-154terminal wealth, 584testing money management strategies, 561-562testing systems

methods and tools, 540Nerves-of-Steel system case study, 541-545overview, 538-539special data problems for futures systems,

539-540test parameter ranges, 540

theorems of Dow Theory, 78-79A Theory of Adaptive Economic Behavior

(Cross), 43theory of contrarian investing, 90-91Theory of Contrary Opinion, 96theory of runs, 563, 567“The Theory of Speculation” (Bachelier), 35thepatternsite.com, 30234-year historical cycles, 166-168Thompson, William, 164three black crows candlestick pattern, 398-399three inside down candlestick pattern, 399-400three inside up candlestick pattern, 399-400three outside down candlestick pattern, 400three outside up candlestick pattern, 400three-point reversal point-and-figure charts

ascending triple top and descending triplebottom, 350-351

bullish triangle and bearish triangle, 352

666 Index

catapult, 354-355double top and double bottom, 349explained, 345horizontal count, 347rising and declining trend lines, 352-354rising bottom and declining top, 349-350shakeout, 356-357spike, 355spread triple top and spread triple bottom,

351-352trend lines, 346-347triple top and triple bottom, 350vertical count, 348

Three Steps and a Stumble indicator, 193-194three white soldiers candlestick pattern,

398-399throw-overs, 482throwbacks, 247, 303thrust, 147-148ticker tape, 202ticks, 160, 202Tides and the Affairs of Men (Smith), 168Tillman method, 472-474Tillman, Jim, 472time

omission from point-and-figure charts, 336point-and-figure charts, 218time stops, 268-269

time breakout filter, 258time horizon, 505-506time in force, 609time series modeling, 602time series variables, 587time stops, 268-269, 576Titman, Sheridan, 517Tower, Ken, 100trade frequency, 572TradeStation, 203Trading Classic Chart Patterns

(Bulkowski), 302trading ranges. See also rectangle pattern

breakout trading, 237defined, 225

determining, 441-444explained, 230in one-box reversal point-and-figure

charts, 340range trading, 236-237reversal points, determining

DeMark or Williams method, 232-233Gann two-day swing method, 233-234high volume method, 234percentage method, 233

round numbers, 232support and resistance

causes of, 230-232resistance points, 230resistance zones, 230, 234-236support points, 230support zones, 234-236

trading rules, 297trading systems. See systemstrailing stops

adaptive stops, 575break-even level and break-even stops, 574defined, 265-266maximum winning favorable excursion, 575setting with Parabolic SAR, 267setting with percentage of gain, 268setting with trend lines, 266-267technical point versus money point, 575trend line stops, 575volatility stops, 575

transaction volume, 84translation in cycles, 457-458Treasury Bonds

COT data, 125futures put/call ratio, 124primary dealer positions, 125-126

trend correction patterns, 380-381trend-following systems


trend IDs, 410-411

Index 667

trend lines, 13-14accelerating trend lines, 240-241Andrews pitchfork, 249-250channels, 243-244decelerating trend lines, 241-242Gann fan lines, 250-251identifying uptrends with, 239-240internal trend lines, 244in one-box reversal point-and-figure charts,

340-341on point-and-figure charts, 248rules for, 242scale, 240setting trailing stops with, 266-267speed lines, 248-249stops, 575in three-point reversal point-and-figure charts,

346-347trend slope method, 520trends. See also cycles; moving averages

breakoutsanticipating, 262calculating risk/return ratio for breakout

trading, 271combining with stops, 269confirming, 256-262explained, 255-256false/premature breakouts, 311setting price targets with, 309

defined, 11, 79determining, 227-229, 285, 441-444directional trends, 238Dow Theory, 225-226downtrends, 11effect of investor psychology on, 226-227explained, 9-10, 227fractal nature of, 15-16, 225identifying, 12-13

linear least-squares regression, 12-13trend lines, 13-14

importance of, 10-11intraday trends, 16

as key to profits, 224-225minor trends, 82neutral areas, 225peaks and troughs, 228-229primary trends, 16, 80-81pullbacks, 247relationship with supply and demand, 14-15retracements, 245-246secondary trends, 16, 81throwbacks, 247trading ranges

breakout trading, 237defined, 225explained, 230range trading, 236-237resistance zones, 234-236reversal points, determining, 232-234round numbers, 232support and resistance, 230-232support zones, 234-236

trend lengths, 15-16trend correction patterns, 380-381trend-following systems


trend IDs, 410-411trend lines

accelerating trend lines, 240-241Andrews pitchfork, 249-250channels, 243-244decelerating trend lines, 241-242Gann fan lines, 250-251identifying uptrends with, 239-240in one-box reversal point-and-figure

charts, 340-341in three-point reversal point-and-figure

charts, 346-347internal trend lines, 244on point-and-figure charts, 248rules for, 242

668 Index

scale, 240setting trailing stops with, 266-267speed lines, 248-249

uptrends, identifying, 238defined, 11regression lines, 239trend lines, 239-244

William Hamilton’s thoughts on, 79Treynor measure of performance, 600triangle patterns, 486

ascending triangle, 317descending triangle, 315-316standard triangle, 314-315symmetrical triangle, 317-318trading triangles, 319

triangular moving averages, 285triple top and triple bottom pattern,

313-314, 350troughs, 228-229True Range, 420truncation, 483Tulip Bulb Mania, 24Tversky, Amos, 47Twain, Mark, 18Twiggs Money Flow, 421two-bar breakouts, 375two-bar reversals, 373-375Two Tumbles and a Jump indicator, 193Tyco, 31

UThe Ultimate Trading Guide (Hill, Pruitt, and

Hill), 532unbiased estimate, 585unbounded oscillators, 408unchanged issues index, 145unchanged stock, 133underlying, 62underwater curve, 552uninformed players, measuring sentiment of

advisory opinion polls, 103-105American Association of Individual

Investors poll, 105

buying and selling climaxes, 107-108combining put/call ratio and volatility, 102Consensus Bullish Sentiment Index, 106Consumer Confidence Index, 106eccentric sentiment indicators, 117explained, 91historical indicators, 117-118margin balances, 110-111Market Vane polls, 106money market fund assets, 111-112mutual fund statistics, 108-109odd-lot short selling, 115option trading and sentiment, 97-98overview, 97put-call ratios, 98-100relative volume, 112-113Rydex funds, 109-110Sentix Index, 106uninformed short selling, 113-115unquantifiable contrary indicators, 116-117volatility, 100-101

uninformed short selling, 113-115unit root tests, 602unquantifiable contrary indicators, 116-117unusual risks

diversifiable risk, 571-572knowledge of market, 571psychological risks, 570-571security quality, 572temporal, 572trade frequency, 572

unweighted index, 72up and down volume indicators

Arms Index, 149-151explained, 149modified Arms Index, 151NPDD (ninety percent downside days), 15210-to-1 up volume days and 9-to-1 down

volume days, 153-154uptick, 609

Index 669

uptrends, identifying, 238. See also trendsregression lines, 239trend lines, 239-240

accelerating trend lines, 240-241decelerating trend lines, 241-242internal trend lines, 244rules for, 242scale, 240

Vvaluation model (Federal Reserve), 192Value Line averages, 72Value Line Ranking System, 522VaR (Value-at-Risk) method, 601variable EMAs, 285variables

dependent variables, 590explanatory variables, 590independent variables, 590multiple variables, 586-590standard normal variables, 592time series variables, 587

variancecalculating, 585-586covariance versus, 597

variation, 455velocity of money, 187, 189vertical count, 348Vickers Stock Research Corporation, 118Villiers, Victor De, 338VIX pattern, 386volatility. See also risks

breakout filter, 259-260estimating, 602-603futures versus stock markets, 506implied volatility, 101measuring, 585-586measuring sentiment with, 100-102volatility patterns


volatility stops, 575

volumedefined, 411-412futures versus stock markets, 506high volume method of identifying reversal

points, 234indexes

Accumulation Distribution (AD), 419On-Balance-Volume (OBV), 416-417Price Volume Trend, 418Williams Accumulation Distribution

(WAD), 420Williams Variable Accumulation

Distribution (WVAD), 418-419interpreting changes in volume, 415-416omission from point-and-figure charts, 336oscillators

Chaikin Money Flow, 421Chaikin Oscillator, 422Ease of Movement (EMV), 425Elder Force Index (EFI), 423-424Money Flow Index (Oscillator), 422-424Twiggs Money Flow, 421volume oscillator, 420-421Volume Rate of Change, 425

portrayal in chartsbar/candle charts, 412-413equivolume, 412-413point-and-figure, 414

transaction volume, 84up and down volume indicators

Arms Index, 149-151explained, 149modified Arms Index, 151NPDD (ninety percent downside

days), 15210-to-1 up volume days and 9-to-1 down

volume days, 153-154value of volume statistics, 414-415volume breakout filter, 259volume dips, 427volume oscillator, 420-421

670 Index

volume spikesclimaxes, 426explained, 425-426on breakout, 425shock spiral, 427volume dips, 427Volume Price Confirmation Indicator

(VPCI), 427VPCI (Volume Price Confirmation

Indicator), 427VWAP (Volume Weighted Average Price), 609

Volume-Adjusted Moving Average, 285volume breakout filter, 259volume oscillator, 420-421Volume Price Confirmation Indicator

(VPCI), 427Volume Rate of Change, 425Volume Weighted Average Price (VWAP), 609VPCI (Volume Price Confirmation

Indicator), 427VWAP (Volume Weighted Average Price), 609

WWAD (Williams Accumulation

Distribution), 420waiting for retracement, 270walk forward optimization, 548Ward, Kenneth, 29The Wave Principle (Collins), 478waves (EWT)

corrective waves, 483flats, 485-486triangles, 486zigzags, 484

defined, 478explained, 479-480impulse waves


motive impulse wave, 479wedge and climax pattern, 322-325

Whelan, Alexander, 216whipsaw, 263whole sample optimization, 547Why Stock Markets Crash: Critical Events in

Complex Financial Systems (Sornette), 36wide-range bar, 370, 384-385Wilder’s moving average, 284Wilder, J. Welles Jr., 29-30, 284, 288, 420, 434Williams %R oscillator, 440-441Williams Accumulation Distribution

(WAD), 420Williams, Larry, 232, 379, 382, 428, 439,

536, 538windows candlestick pattern, 392women’s hemlines as sentiment indicator, 117Worden, D. G., 29WVAD (Williams Variable Accumulation

Distribution), 418-419Wyckoff, Richard D., 27, 498, 522-524

X-Y-Zyield curve (Federal Reserve), 194

zigzags, 484Zweig, Martin, 29, 148

Index 671

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