How Results Compare With Prediction

the third week after purchase, you had an indication that the stock was going to do even better than anticipated (puncture of the mner envelope on the upside and prematurely). The next week the outer envelope was also violated. Since it was far too early for a peak of the 19-week cycle, you would have re-estimated channel bounds at this point. Your new selling target would have become . on this basis. Your net return on the transaction is 62% in eight weeks or an equivalent compounded yield of 2313% per year. And remember-you arrived at the conclusions necessary to do this without any knowledge whatsoever of fundamentals- in fact, without even knowing the name of the issue. You should be able to gain a good feeling for the power of the technique by comparing final analysis conclusions with the opinions you wrote down for yourself during the early part of the example.

HOW TO GENERATE GRAPHIC "BUY" SIGNALS

The identification and analysis of status of cyclic components are basic to the generation and interpretation of specific action signals. You must practice the curvilinear envelope techniques diligently until you have mastered and thoroughly understand all of the variations from nominality to be expected from individual issues. While cyclic status is an essential first step on the road to improved transaction timing, it should be noted that by itself this type of analysis provides only crude timing information. We will now see how knowledge of the price-motion model, cyclic status analysis, and conventional chart patterns can be combined to refine timing criteria-all by use of graphical methods.

WHAT TO LOOK FOR

Let us consider the characteristics we desire in a "buy" signal.

• A buy signal must be capable of being set up in advance of actual price action. We must be able to say: "For these logical reasons, if the stock behaves in the future in a certain, specific manner, this action will be interpreted as a signal to buy."

• Having caused us to buy the stock, the buy signal must have the characteristic of assuring us the highest possible probability that the stock will immediately proceed to make us the largest possible profit in the shortest possible length of time.

Envelope analysis meets some of these requirements, but not all. To improve the situation, we recall how the price-motion model explains the regular and periodic formation of common chart patterns. It has been noted that cyclic analysis can often remove the doubt from chart pattern interpretation. Such chart patterns serve a very-definite purpose" in calling attention to specific cyclic conditions. When combined with the predictive capabilities of envelope analysis, some of these patterns can provide accurate and totally objective transaction timing signals. The two that are the most useful for this purpose are the triangle and the trend line. Now let us add the concept of a "valid trend line" to our bag of techniques and methods!

RECOGNIZING THE "VALID TREND LINE"

Remember in Chapter Three how it w-3S shown that several trend lines can be in existence and force at the same time in the same stock? It was shown there that these were simply straightened-out segments of curvilinear channels, several of which always exist simultaneously. The nature of these channels is always such that those enclosing shorter duration cyclic components move both upward and downward more steeply than those enclosing longer duration periodicities. Therefore the straightened-out segments that we know as "trend lines" become increasingly steep as the component duration enclosed within the associated channel shortens.

Keeping this in mind, recall now the results of envelope analysis on Gruen Industries. We knew approximately when and where prices were going to stop going down and start upward. We knew that components of several different durations were going to bottom out-about three weeks from the time of the analysis.

• Each such component has a real or theoretical channel which can enclose it.

• Each such channel has an associated dovmtrend line.

• Each such downtrend line gets steeper as component duration diminishes.

• The valid downtrend line is the steepest one formed which leads into the time period in which a muhjplicity of cyclic lows is expected!

Now lets stop and examine whats just been said. Envelope analysis tells us approximately when and where to expect price turns of the magnitude on which we wish to trade. But we do not wish simply to buy at about this time and price for several reasons. The stock may take off sooner than we expect and leave us uninvested (after all there is a variation of fluctuation duration to contend with). Or, we may have mis-analyzed and find our error only after having made a purchase. Again,

fundamentals may enter the picture to the detriment of profit. For these reasons we would like the stock to demonstrate to us that what we expect to happen has started before we commit hard-earned dollars. Still, we do not wish to wait too late and find ourselves "chasing" the stock. So we need an accurate, sensitive, positive indication in the way of a buy signal that assures us that the right time is now.

The valid trend line accomplishes these objectives for us. General cyclic analysis plus the envelope capability to predict turns allow us to select that one of all possible trend lines through which a break is a valid indication that one or more of the expected lows has been formed-and that the time is right to buy!

Why is this a particularly low-risk buy point? Remember that you have already picked a particulariy propitious time to buy. The stock has been going down-and no stock go down forever. Buying always occurs somewhere along the line with an attendant price rise. You have carefully analyzed the issue and find that a number of cyclic lows should occur in a certain tirae intervaL The result of all these lows forming more or less simultaneously is going to turn the sum of all components of duration longer than your trading cycle upward. It is even going to cause the price of the stock to fluctuate above this by the sum of your trading cycle move plus that of all components of still shorter duration! You are now using trend lines as a means of tracking the activity of each component as it nears a low. As each low is reached, by defimtion, the associated trend line must be broken-and the first one to do so will be that which is part of the channel enclosing the shortest significant component But this one cannot break the trend Une until the next longer duration component has rounded its low, etc. All of this is probabilistic, of course, but you are beginning to get a lot of the odds in your favor at this point!

"EDGE-BAND" TRANSACTION TIMING

Lets start where we left off with Gruen Industries. In Figure IV-6 the results of the channel analysis are shown. This time the plot is of daily data, with the envelopes developed on the weekly plots superimposed. The shaded area represents a spread of uncertainty over time and price as to when we expect prices to turn up. The center lines in this area represent a time and price target-essentially our best estimate of each. Now start looking at the price motion for peaks along which to draw trend lines. The first peak of the current downtrend occurred two and a half weeks ago. This will be one point on one downtrend line. A second peak appears to be in the making as of two days ago. However, it is not certain as yet since a lower low has not followed. So at this point in time we cannot draw any downtrend Une with confidence.

Now let uvo more days pass as in Figure IV-7. Two solid peaks are now evident, and an iniri-jl downtrend line is drawn which leads directly into the heart of our price turn zone. If no other trend lines form before, we determine that we will buy the stock as soon as wci": within the time boundaries of the turn zone and prices break through this trend line on the upside.

Two inore days pass, putting us into the time region of interest. As shown in Figure IV-8, a still shorter duration peak has formed, establishing a second and steeper downtrend line. If no other trend lines form before, we will now buy the stock at any