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Technical analysis provides vital information as long as it is recognized for what it is: a method of characterizing recurring patterns of price movements. These patterns result from a predominantly similar psychological tendency of market participants in making decisions. The greatest value of technical analysis is that it provides a method of measuring the tendency of the market to react in a particular way under similar conditions throughout history.

Given this recognition, technical analysis adds a valuable dimension to market analysis and economic forecasting that is often overlooked by speculators and investors. If understood and concretely defined, technical observations add to the sum of ones knowledge about the nature of the markets and provide an opportunity to identify profitable opportunities that would otherwise go unseen.

The fastest and most risk-free way to make money in the markets is to identify a change of trend in a market as early as possible, take your position (long or short), ride the trend, and close your position before or shortly after the trend reverses again. Any market professional will tell you that it is impossible to buy at the lows and sell at the highs (or sell at the highs and buy at the lows) consistently: but with practice, it is very possible to catch 60 to 8017c of many intermediate -term and long-term market movements.

To be able to do this, you first have to know what the different markets are. what market instruments are available, where and how they are traded, what the margin requirements are, and so forth. Given this information, the next step is to identify a way to find specific markets that may be good investment opportunities.

To do this, you could go to the library and do three or four years of research on all the markets in the world, but by the time you finished your research, you would have forgotten half of what you leamed and still have been broke. The other altemative is to leam to look at charts.

To a practiced observer, using bar charts is the simplest and most effective way to pick potential buys and sells in any of the various markets. By teaming a few simple techniques, you can look through as many as two or three hundred charts in an hour and pull out the roses from the slop. Then, with a more careful examination, you can pick the best of the best, and be left with a choice of five or ten markets that are worth doing some research on. When you go through these charts, what you a re looking for is evidence of whether a specific stock, an index, or a commodity is likely to encounter a change of trend.

In the last chapter, I lambasted aspects of technical analysis, but I also said that I thought it was too useful to pass up as an aide in speculation. Now, I want

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to present my favorite technical methods for identifying a change of trend. Theyre my favorites for one reason: they have consistently made me money year after year. They are also very simple, easy to remember, and after you apply them for a while, you dont even have to put pencil to paper to "see" whats on the charts.

Interpreting data from charts-recognizing price pattems and inferring future price movements from them-is the province of technical analysis. If you read books on technical methods, you will find countless pattems that have been identified: triangles, head-and-shoulders formations, lines, wedges, bear flags, bull flags, 7-mountains, and many more. I employ very few of these, and attempt to keep my technical methods to certain minimum essentials that stand the test of time and change.

I divide my technical observations into two groups. The first group, which is included in this chapter, deals with the principles of a trend and the change of trend, and I weigh them quite heavily before taking any position in the markets. The second group, presented in the next chapter, deals with auxiliary factors which often accompany a change in trend; and I use them to add or subtract support for my decisions, as the case may be.

The methods I present in this chapter are derived from both my knowledge of Dow Theory and years of experience in evaluating market trends and tuming points. Like Dow Theory, they are not infallible and are intended for use as supplemental tools in a broader market forecasting picture. A nice thing about them is that they apply to every market, without exception: stocks, indexes, commodities.

Where Fortunes Are Made: Identifying a Change of Trend

bondsevetything. They give results that are right more often than no t, and if applied carefully, they will always allow you to retreat from an incorrect decision without suffering heavy losses.

There are two important, and often overlooked, advantages in using charts for making speculative and investment decisions. First, it is easier for most people to think in terms of visual images. Second, by setting concrete points of entry and exit according to the charts, you can more easily remain aloof from the emotional pressures which are so often confusing when money is at stake.

Bear in mind that the technical consistency of charts is best in the long term, slightly worse in the intermediate term, and the most variable in the short term. Patterns on charts exist because market participants respond to similar conditions in similar ways. The mind of the investor works differently than the mind of the speculator, but they do have much in common; and those similarities are reflected in patterns on the charts. But the minds of those that trade on the intraday markets operate by a substantially different set of rules, and the patterns they create must therefore be characterized separately. It is fortunate that intraday traders exist, for they provide invaluable liquidity to the market which is essential for successful speculation and investment; but other than providing liquidity, their involvement does little to affect the intermediate-term and long-term trends.

Although these chart reading methods are "technical" observations, they are technical in the broadest sense; that is, they capture visually a character of human

action that has been recurrent throughout the recorded history of market price movements. DETERMINING THE TREND-DRAWING THE TRENDLINE

From preceding chapters, we already know what a trend is. But to review, a tren d is the prevailing direction of price movements within a given time period. In an upward trend, prices rise consistently over time interrupted only by temporary selloffs, which do not make lower lows than the previous sell-off. A downward trend is the converse of the upward trend-prices move consistently downwards interrupted by temporary rallies that do not make higher highs than the previous rallies. On the chart, trends appear as a sort of saw blade pattem, where prices make higher highs intermpted by higher lows on sell-offs during an uptrend, and lower lows interrupted by lower highs on rallies in a downtrend.

In analyzing a trend on the charts, the most useful tool is the trendline. One of the biggest mistakes made by amateurs and professionals alike is inconsistently defining and drawing the trendline. To be useful, the trendline must accurately reflect the definition of the trend. The method I have devised is very simple and very consistent. It fits both the definition of a trend and the inferences draw from

Dow Theory pertaining to the elements of a change in trend:

1. Select the period of consideration: the long term (months to years), the intermediate term (weeks to months), or short term

(days to weeks). It can also be a smaller segment of any of these where a change of slope of the trendline is apparent.

2. For an uptrend within the period of consideration, draw a line from the lowest low, up and to the highest minor low point preceding the highest high so that the line does not pas s through prices in between the two tow points (Figures 7.1 and 7.2). Extend the line upwards past the highest high point. It is possible that the line will go through prices past the highest minor high point. In fact, this is one indication of a change in trend, as will be demonstrated shortly.

3. For a downtrend within the period of consideration, draw a line from the highest high point to the lowest minor high point preceding the lowest low so that the line does not pass through prices in between the two high points. Extend the line past the lowest high point downward (Figures 7.3 and 7.4).

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