TECHNICAL ANALYSIS OF STOCK

TRENDS
NINE EDITION, EDWARDS, ROBERT D. AND
MAGEE, JOHN.
SUMMARY

1
 INDEX
PART ONE............................................................................................................................ 6
CHAPTER ONE: THE TECHNICAL APPROACH TO TRADING AND INVESTING ............ 7
CHAPTER THREE: THE DOW THEORY.............................................................................. 7
Principle of confirmation .............................................................................................................9
CHAPTER FIVE: THE DOW THEORY´S DEFECTS ............................................................ 9
The Dow theory is not infallible ..................................................................................................9
CHAPTER SIX-SEVEN-EIGHT-NINE: IMPORTANT REVERSAL PATTERNS ................. 10
The head and shoulders ...........................................................................................................10
The Measuring formula .........................................................................................................11
Multiple head and shoulders patterns .....................................................................................13
Rounding tops and bottoms .....................................................................................................14
The Dormant bottom variation .................................................................................................15
Triangles .....................................................................................................................................15
Symmetrical Triangles ..........................................................................................................15
The three tricky features .......................................................................................................16
Breakout..................................................................................................................................16
The right-angle triangles .......................................................................................................17
Measuring of triangles ...........................................................................................................17
Rectangle....................................................................................................................................18
Double and Triple pattern .........................................................................................................19
A little summary .........................................................................................................................20
CHAPTER 10: OTHER REVERSAL PHENOMENA............................................................ 20
Broadening formation ................................................................................................................20
Orthodox broading top ..............................................................................................................22
The diamond ..............................................................................................................................23
Wedge formation .......................................................................................................................24
The one-day reversal ................................................................................................................25
CHAPTER TEN.ONE: SHORT-TERM PHENOMENA OF POTENTIAL IMPORTANCE ... 26
Spike ...........................................................................................................................................26
Runway day................................................................................................................................26
Key reversal day ........................................................................................................................27
CHAPTER ELEVEN: CONSOLIDATION FORMATION ...................................................... 27

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 Flags ............................................................................................................................................27
Pennant.......................................................................................................................................28
Measuring formula .....................................................................................................................28
Rectangular consolidation ........................................................................................................29
Head and shoulders consolidation ..........................................................................................29
Scallops ......................................................................................................................................29
CHAPTER TWELVE: GAPS ................................................................................................ 29
The common or area gap .........................................................................................................29
Breakaway gaps ........................................................................................................................30
Continuation or runway gap .....................................................................................................30
Exhaustion Gap .........................................................................................................................30
The island reversal ....................................................................................................................30
CHAPTER THIRTEEN: SUPPORT AND RESISTANCE .................................................... 31
CHAPTER FOURTEEN: TRENDLINES AND CHANNELS ................................................ 32
Double trendlines and trend ranges ........................................................................................33
The fan principle ........................................................................................................................33
CHAPTER FIFTEEN: MAJOR TRENDLINES ..................................................................... 34
CHAPTER SIXTEEN: TECHNICAL ANALYSIS OF COMMODITY CHARTS .................... 34
CHAPTER SEVENTEEN.TWO: ADVANCEMENTS IN INVESTMENT TECHNOLOGY ... 35
Modern Portfolio Theory (MPT) ...............................................................................................35
Differences between cash and futures ...................................................................................35
Dow index in the future .............................................................................................................35
Options on Dow index Futures ................................................................................................35
Option Premiums .......................................................................................................................36
Volatility .......................................................................................................................................36
Exercising the option .................................................................................................................37
PART TWO TRADING TACTICS ................................................................................... 38
CHAPTER EIGHTEEN: THE TACTICAL PROBLEM .......................................................... 39
CHAPTER EIGHTEEN.ONE: STRATEGY AND TACTICS FOR THE LONG-TERM
INVESTOR ........................................................................................................................... 39
CHAPTER TWENTY-ONE: SELECTION OF STOCKS TO CHART .................................. 39
CHAPTER TWENTY-FOUR: THE PROBABLE MOVES OF YOUR STOCK ..................... 40
CHAPTER TWENTY-FIVE: TWO TOUCHY QUESTIONS ................................................. 40
Short selling................................................................................................................................40

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CHAPTER TWENTY-SEVEN: STOP ORDERS .................................................................. 41
The progressive stop.................................................................................................................42
CHAPTER TWENTY-EIGHT: WHAT IS A BOTTOM-WHAT IS A TOP? ............................ 42
Basing points ..............................................................................................................................42
CHAPTER TWNETY-NINE: TRENDLINES IN ACTION ..................................................... 44
Buying stock, “Going long” .......................................................................................................44
Liquidating or selling a long position .......................................................................................45
Selling stock short .....................................................................................................................48
Covering short sales .................................................................................................................48
CHAPTER THIRTY: USE OF SUPPORT AND RESISTANCE ........................................... 49
CHAPTER THIRTY-THREE: TACTICAL REVIE OF CHART ACTION .............................. 50
Head and shoulders top............................................................................................................50
Rounding tops and bottoms .....................................................................................................50
Symmetrical triangles (all type of tringles) .............................................................................50
Broadening tops.........................................................................................................................50
Rectangles..................................................................................................................................51
Double tops and bottom............................................................................................................51
Diamond......................................................................................................................................51
Wedges .......................................................................................................................................51
One day reversal .......................................................................................................................51
Trendlines ...................................................................................................................................52
CHAPTER THIRTY-FOUR: A QUICK SUMMATION OF TACTICAL METHODS .............. 52
Get out of present commitments .............................................................................................52
Make new commitments ...........................................................................................................53
CHAPTER THIRTY-SIX: AUTOMATED TRENDLINE: THE MOVING AVERAGE ............ 54
Sensitizing Moving Average .....................................................................................................54
Crossovers and Penetrations...................................................................................................54
CHAPTER THIRTY-EIGHT: BALANCE AND DIVERSIFIED .............................................. 55
CHAPTER FOURTY: HOW MUCH CAPITAL TO USE IN TRADING ................................ 56
CHAPTER FOURTY-TWO: PORTFOLIO RISK MANAGEMENT ....................................... 58
Risk of a single stock ................................................................................................................58
Risk of a portfolio .......................................................................................................................58
Risk and trend ............................................................................................................................58
VAR procedure ..........................................................................................................................58

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 Determining the risk of one stock ............................................................................................59
Pragmatic portfolio risk measurement ................................................................................59
Determining the risk for a portfolio ..........................................................................................59
Measuring maximum drawdown or maximum retracement .................................................59
Portfolio ordinary, or operational risk ......................................................................................60
Portfolio Risk Over time ............................................................................................................60
Portfolio extraordinary or catastrophic risk .............................................................................60
Summary of risk and money management procedures ........................................................60
APPENDIX A ........................................................................................................................ 61
APPENDIX C ........................................................................................................................ 61
Commodities futures .................................................................................................................61
Dual moving average ................................................................................................................61
Reversal ......................................................................................................................................63
Bollinger Bands (BB) .................................................................................................................63
Stochastics .................................................................................................................................64
Open interest..............................................................................................................................64
Wilder Relative Strength Index (RSI) ......................................................................................65
Important concepts in commodities/derivative trading..........................................................66

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PART ONE

6
CHAPTER ONE: THE TECHNICAL APPROACH TO
TRADING AND INVESTING

• Two methods:
o Fundamental
o Technical: study of the action of the market itself
• Fundamental always required a forecast of fundamental data
• Fundamental is usually applicate in estimating company’s earrings

CHAPTER TWO: CHARTS

• The closing price represents the final evaluation of the stock in a
day
• Two types of scale:
o Arithmetic paper: equal distance on the vertical scale
o Semilogarithmic scale permits direct comparison of high-
and low-priced stock

CHAPTER THREE: THE DOW THEORY

• The Dow Theory was designed by Charles H. Dow

• William P. Hamilton formulated the Dow Theory as we know it
today
• Three trends:
o Primary trends: extensive up or down movements which
usually last for a year or more
o Secondary trends: they swing in opposite direction of
primary trends
o Minor trends: they composed the secondary trends. They
are the day to day fluctuations. They are not important for
Dow Theory
• Secondary trends normally retrace from one third to two thirds of
the gain (or loss). Many of them stop at 50%

7
• The minor trend is the only one of the three trends which can be
manipulated
• Major trends phases:
o Bull market

Phase 3: The market

boils

Phase 2: Fairly Advance -Financial news are

very good
-Increase activity

Phase 1: Accumulation
-Finance reports are bad
-Depressed investors

Phase 1: Distribution
• Bear market -Very high trading activity

Phase 2: Panic phase

-Buyers begin to thin out

Phase 3
-News begin to be bad

8
 • A few major advances have passed from the first to the third
phase
• A few bear markets have developed no market panic phase and
others have ended with it
Principle of confirmation
• The two averages must confirm (industrial and rail average)
• It is not needing that two averages confirm on the same day
• Volume goes with the tend
o In a bull market volume increase when prices rise
o In a bear market volume increases when prices drop
• Lines may substitute for secondaries
• Line is a sideways movement
• The formation of line signifies that pressure of buying and selling
is in balance
• Only closing price used
• A tend should be assumed to continue in effect until such time as
its reversal has been definitely signaled
o A reversal in trend can occur anytime after the trend has
been confirmed

CHAPTER FIVE: THE DOW THEORY´S DEFECTS

The Dow theory is not infallible

• It is too late
• It frequently leaves the investor in doubt
• The Dow theory was designed to tell the direction of the primary
trend, so it does not help the intermediate or intraday investor
• An important way to reduce the risk is to be right the trend

9
CHAPTER SIX-SEVEN-EIGHT-NINE: IMPORTANT
REVERSAL PATTERNS

• A big reversal formation suggests a big move and a small pattern

a small move
• One day reversal is a reversal pattern that appears and completed
within a single day
• Distribution is the process of supply overcoming demand
The head and shoulders
• It is one of the more common and the most reliable of the major
reversal pattern
• It consists of:

-Rally that reached the

higher level with a good
volume but less than the rally
1(left shoulder)

-Third rally but with a less volume and the

decline of this third phase finally breakout
A strong rally
the neckline and the head and shoulders
-volume is very heavy are complete

Neckline

• Symmetry is not essential to a significant head and shoulders

development. The neckline may slope up or down
• A pullback is a move that consist in a weak rally to the neckline
then turn down quickly

10
The Measuring formula

Neckline

Minimum probable objective

decline

Neckline

Minimum probable objective

decline
11
 Weaker situation than
an up sloping

Neckline

Minimum probable objective

decline

• A head and shoulders bottom are usually called “Kilray bottom”

• The essential difference between top and bottom patterns is that
bottoms pattern lies in their volume
• Any price break through the NL or the head-shoulders top is valid.
But a breakthrough the NL of a kilray bottom is definitely attended
by high volume
• A low volume breakout forma a kilray bottom may be premature or
false move

12
Multiple head and shoulders patterns
• The multiple head and shoulders bottoms and tops are known as
complex formation
• A common form consists:

S S S S

NL

H H

S S

NL

13
 • These types of pattern show a strong urge toward symmetry,
except in volume
• During the earlier stage of multiple formation development, the
volume shows much irregularity

Rounding tops and bottoms

• It is producing by a gradual shift in the balance of power between
buying and selling
• Rounding bottoms are commonly referred to as bowl or saucer
patterns
• They appear frequently in the charts of high-grade preferred
stocks and quite naturally
• When they occur after an extensive decline are very important
because denote a change in primary trend
• Trading volume should ebb to an extreme at the bottom of a bowl
pattern

14
The Dormant bottom variation
• Dormant bottom it is a extended flat bottomed form
• It appears in thin stock where the number of shares is very small
• There is not measuring formula which can be applied to rounding
turns

Triangles
Symmetrical Triangles
• It is composed by series of price fluctuation, each of which is
smaller than its predecessor
• It is sometimes referred to as a “coil”
• There´s any clue that tell you in which direction price are going to
break the triangle
• The odds are that the previous trend will continue

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The three tricky features
1. Before you can conclude that a symmetrical triangle is building,
there´s must be four reversals within the triangle

1 3

4
2

2. The further out into the apex of the triangle prices pus without
bursting it´s boundaries, the less force the pattern has
a. The best moves (up or down) occur between half and three
quarters of the horizontal distance from the base
3. It necessary sometime to redraw one or both boundaries before
the triangle is complete

Breakout
• A upside breakout is necessary that confirmed by increase in
trading volume
• A down breakout doesn´t require confirmation by volume
• Symmetrical triangles suggest more than two third of them
produce no false signal
• A high and irregular volume within a triangle is not characteristic
of valid triangle

16
The right-angle triangles
• The ascending and descending are bullish and bearish
manifestation respectively
• Right angle triangles are distinguished by the fact that one of their
boundaries is horizontal while the other slants toward it
• Volume´s features it´s the same respect to volume of symmetrical
triangles

Ascending triangle
Descending triangle

Measuring of triangles

Ascending triangle
Minimum objective (upside
breakout) Minimum objective (upside
breakout)

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 Minimum objective (upside
breakout)

Descending triangle

Rectangle
• A rectangle consists of series of sideways price fluctuations
• It be called a picture of conflict because represents two groups of
approximately equal strength
• Nobody can tell where the breakout will occur
• Volume gradually diminishing as the rectangle lengthens
• False and premature breakouts return inside the pattern
• It´s more often a consolidation than a reversal
• Appear more often at bottom than tops

Minimum objective (upside

breakout)

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Double and Triple pattern
• It´s formed when a high volume and a rally (or decline) approach
to the top(or bottom) figure then retreats (or rally) with diminishing
activity, then comes up(or down) again to the same level
• Triple pattern has three tops or downs instead of two
• If two tops appear at the same level but quite close together in time
and with only a minor reaction between them, the chances are that
they are part of a consolidation area instead of a top pattern
• It´s a reversal pattern
• Doble bottoms occur sometimes at the end of intermediate
corrections in a major uptrend
• The rally up from the second bottom show shows an increase in
volume
• The triple tops are widely spaced with quite deep and usually
rounding reactions
• The tops or bottoms don´t have to be at the same level but they
have to be closer
• The three tops are sometime called “W” and double tops are called
“M” formations

Minimum objective

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A little summary
1. The head and shoulders
2. Multiple or complex head and shoulders
3. Rounding turns
4. Symmetrical triangles
5. Right-angle triangles
6. Rectangles
7. Double and triple tops and bottoms
8. One day reversal

• 1,2,3 and 7 develop most often at major turns

• 4,5 and 6 occur more frequently at intermediate stages
• 8 appears typically after out of control moves

CHAPTER 10: OTHER REVERSAL PHENOMENA

Broadening formation
• It´s called inverted triangles
• It´s starting with narrow fluctuations and then, they wide out
• It suggests a market lacking intelligent and out of control
• It formation appears only at the end or in the final phase of a long
bull market
• It is definitely bearish
• There are three type of broadening formation like triangle:
o Symmetrical
o Descending
o Ascending

Symmetrical Descending Ascending

20
• The rallies and declines usually don´t all stop at clearly marked
boundary lines
• Volume usually is high and irregular throughout its construction

If the trend is going to break

down, the last rally fails to rise
the boundary line

If the trend is going to break up,

the last decline fails to rise the
boundary line

21
Orthodox broading top
• It has three peaks at successively higher levels and, between
them, two bottoms with the second bottom lower than the first
• It´s a five-point reversal
• It can be called a head shoulders with a higher right shoulder and
a down-slopping neckline
5
3 3
2
1
1

1 The breakout at this level

2 2 the pattern it´s complete

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The diamond
• It can be described as a complex head and shoulders with v-
shaped neckline, or as a broadening formation which reverts into
a regular triangle
• It´s natural habitat is major tops and the high-volume tops

Minimum objective

23
Wedge formation
• It´s a pattern which the price is confined within converging straight
lines
• In a rising wedge, both boundary lines slant up
• Trading volume tends to follow the regular triangle pattern
• The difference between a rising wedge and a uptrend channel is
that the wedge stop the advance
• Rising wedge is a quite characteristic pattern for a bear market
rallies
• A shorter pattern of this shape is classified as a pennant

Rising wedge
Falling wedge

24
The one-day reversal
• It may appear at the very peak of a long advance
• On the downside, it pattern mean the end of a panic sell off, it can
be called selling climax or climax day
• It comes after a long and steady advance (or decline) on which
volume has been increasing gradually
• Don´t carry major trend implication
• One day reversal top appears quite often in stocks which are thin
(low volume)
• The climax comes after a decline approaching panic proportions
• Selling climax doesn’t normally occur at the final bottoms of bear
market

On day reversal
bottoms

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CHAPTER TEN.ONE: SHORT-TERM PHENOMENA OF
POTENTIAL IMPORTANCE

Spike
• It might also be a one-day reversal
• Is not immediately identifiable
• The importance of the spike is highlighted
o The strength and length of the action which preceded it
o The close of the day, whether up or down, or down on a top
Runway day
• It is a day that stands out on the chart as having an unusually long
range, often opening at the low and closing at the high or vice
versa for bears runaways

Runaway
day

26
Key reversal day
• It pattern occurs when one sees a new high in a up move and then
close below the close of the previous day

Tuesday
Wednesday

Monday
• All the very short-term patterns: gaps, one day reversal, key
reversal day, spike and runway day, should be noted that return of
prices to the origination of the formation marks the formation as a
false signal

CHAPTER ELEVEN: CONSOLIDATION FORMATION

Flags
• They are consolidation
• Flag is a small rectangle which slopes back moderately against the
prevailing trend
• Trading volume diminishes during their formation and increases
again as price break away from them

27
Pennant
• The difference between a pennant and a flag is that the former is
bounded by converging boundary lines rather than parallel
• It´s a small compact, sloping triangle or wedge against the
prevailing trend
• Characterized by market diminution of activity

Measuring formula
• The same approximate measuring formula applies to the pennant
as the flag

Minimum objective

• These two forms are the most dependable of chart formation

• They pattern should occur after a straight-line move
• If volume remains high instead diminishing, they are more apt to
be a quick reaction against
• They are typically last stage bull market

28
Rectangular consolidation
• It is often in the earlier phases of a bull trend
• In major bear moves, rectangles may develop in the first stage just
before a panic decline
Head and shoulders consolidation
• Price construct a sort of inverted head and shoulders picture
• The volume doesn´t follow the rule for a reversal head and
shoulders
• The measure formula of reversal head and shoulder doesn´t apply
for this pattern
H
S S
S S
H

Scallops
• It´s a rounding pattern

CHAPTER TWELVE: GAPS

• Represents a price range at which no share changed hand
• A gap is closed when a subsequent price trend comes back and
retraces to the range of the gap
• Four classes of gaps: common or area gaps, breakout gaps,
continuation or runaway gaps and exhaustion gaps
The common or area gap
• It occurs within a trading area or price congestion pattern
• Sometimes it occurs just before a breakout
• Tends to be concentrated at near the top and bottom
• There is any forecasting for this type of gap

29
Breakaway gaps
• Any breakout through a congestion formation with a gap is a
breakout gap
• It´s a strong breakout
• It usually isn´t filled
Continuation or runway gap
• It has sometimes been called “measuring gap”
• It affords a rough indication of the probable extent of the move in
which they occur
• The measure rule works well on semilogarithmic scale charts
• Measure rule: “prices will go as much farther beyond the gap as
they already have gone between the beginning of the move and
the gap, as measured directly (and vertically) on the chart.
Minimum
objective

Gap

Exhaustion Gap
• It appears at the end of the trend
• If volume is extraordinary height during the session following the
gap and the previous trend doesn´t appear to be with that volume,
the gap is probably of the exhaustion class
• It is referred as wide gaps
• Exhaustion gaps are quickly closed, this is a signal that the trend
has run out
The island reversal
• It it’s a compact trading range separated from the move by an
exhaustion gap and from the opposite direction a breakaway gap
• Its volume is relatively high
• It develops frequently within larger patterns

30
 • Sometime, the second gap (breakaway) that completes the island
is closed by a pullback or reaction

CHAPTER THIRTEEN: SUPPORT AND RESISTANCE

• Any sort of rise tends to increase supply and diminish demand

• Support is a level where are enough volume (demand) to stop a
downtrend in price for a period
• Resistance is a level where are enough volume (supply) to stop an
uptrend for a period
• Support range represents a concentration of demand
• Resistance range represents a concentration of supply
• These levels switch their roles from support to resistance and
resistance to support
• A former top, once it has been surpassed becomes a bottom zone
in a subsequent downtrend, and an old bottom once it has been
penetrated becomes a top zone in a subsequent uptrend
• There are three criterions for support and resistance named:
volume, distance away and time elapsed
o Volume is the first criterion in estimating the power of a
resistance range
o Another crierion is the extent of the subsequent decline (or
rally), the greater the distance, the greater the resistance (or
support)
o A third criterion is the length of the time that has elapsed
since it was formed and the “test” that the market has done
in that level
▪ The older the resistance or support, the less power
they have
• Breaking of a minor support is the first step (or should be) in the
reversal of the intermediate trend
• The breaking of an intermediate support range is frequently the
first sign of a reversal in the major trend
• The volume comes after the resistance or support has been
penetrated
31
CHAPTER FOURTEEN: TRENDLINES AND CHANNELS

• Prices move in trend: up, down or horizontal

Down
Trendline

Up
Trendline

These are the basic trendlines

• The trendlines are always broken

• There have to be three points for draw a trendline and three for
confirmation
• A series of points which fall on a perfectly straight, up-sloping line
on an arithmetic chart paper, when transferred to a
semilogarithmic sheet, produce a curved line that rises sharply at
first and gradually rounds over
• Points which fall on a straight line on a curve on a semilogarithmic
sheet produce an accelering curve on a arithmetic sheet, a line
which slants up more and more steeply
• The more test the trendline has, the significance of it is increased
• The longer it has held without being penetrated, the greater its
technical significance
• A very steep line can easily be broken
• The more nearly horizontal the trendline, the more important it is
technically
32
Double trendlines and trend ranges
• Two trendlines, the original and its parallel called return line
compose the trend channel
• Any failure to reach the return line is taken as a sing of
deterioration in the trend. By the same token to any failure to reach
the original trendline
• Return line doesn´t function as a support against a throwback or
pullback

Trend channel

Original
Return trendline
trendline
The fan principle
• Consist in three trendlines that has been broken
• It´s a reversal
• The rule is that when the third fan line is broken a new trend begins
• It is usually applied only to corrective moves to determine the end
of intermediate reaction in the market

2
1
33
CHAPTER FIFTEEN: MAJOR TRENDLINES

• Many stocks that show accelerating curves on arithmetic paper

produce straight trends on a logarithmic scale. The logarithmic
scale gives a better trend signal for that stocks. Other stocks tend
to advance in straight arithmetic trends
• The best trendline are drawn not from the absolute low or high,
rather from the next bottom or high

CHAPTER SIXTEEN: TECHNICAL ANALYSIS OF

COMMODITY CHARTS

• The contracts for future have a limited life

• Support and resistance levels have relatively less potency than
with the stocks
• Transaction in commodity futures represents hedging rather
speculation (Most of the time)
• The interpretation of volume is complicated because there is not
limit number of contracts
• Certain kinds of news can change the trend of futures market
immediately and drastically
• Head and shoulders, rounding tops and bottoms, and trendlines
are more useful in commodities than stocks, the other pattern are
less useful
• Fungibility: any future contract is substitute for another of the same
commodity

34
CHAPTER SEVENTEEN.TWO: ADVANCEMENTS IN
INVESTMENT TECHNOLOGY
Modern Portfolio Theory (MPT)
• Is a procedure and process whereby a portfolio manager may
classify and analyze the components of his portfolio in such a way
as to be aware of and control risk and return
• MPT attempts to determine the statically relationships among the
members of the portfolio and their relationship to the market
• The process:
1. Portfolio valuation: describe the portfolio in terms of risk and
return
2. Asset allocation: determine how capital is to be allocated
among the classes of instruments
3. Optimization
4. Performance measurement: the division of each stocks risk
into systematic and security related classes
Differences between cash and futures
• The main two differences between the cash and the futures
transaction are:
o In cash, the value of the portfolio must be paid up or financed
in a stock margin account
o The owner of the cash portfolio receives cash dividends
Dow index in the future
• The price of the future and the price of the index are not exactly
the same because the futures contract value must reflect the cost
of short-term financing of stocks and the dividends paid by index
stocks until futures expiration. This is known as “the cost of carry”
• The “Theoretical value” of the future should equal the price of the
index
Options on Dow index Futures
• There are two kinds of option:
o Call (buy)
o Put (sell)

35
Option Premiums
• The purchase price of the option is called the option premium.
Each point being worth $100
• Options premiums consist of two elements:
o Intrinsic value
o Time value
• The strike price is the price at which the owner of the option can
buy or sell
• Intrinsic value is the price an investor is willing to pay for an
investment
• If the futures price is greater than the strike price of a call, the call
is said to be “in the money”
• If the futures price is smaller than the strike price, the call is “out
the money”
• If two are equal, the call is “at the money”
• A put is “in the money” if the future price is less than the strike price
• A put is “out the money” if the future price is greater than the strike
price
• The difference between the future rice and the strike price is the
intrinsic value
• The difference between the option price and the intrinsic value
represents the time value of the option
• The time value reflects the possibility that exercise will become
more profitable if the future price moves farther away from the
strike price
• At expiration, the time value is zero and the option price equals the
intrinsic value
Volatility
• Is the degree of fluctuation in the price
• The greater the volatility of the future, the higher the option
premium
• Implied volatility of the option measures the market´s average
expectation of what the volatility of the underlying futures return
will be until the expiration of the option

36
Exercising the option
• The profit on long options is the difference between the expiration
value and the option premium
• The profit on short position is the expiration value plus the option
premium

37
 PART TWO
TRADING TACTICS

38
CHAPTER EIGHTEEN: THE TACTICAL PROBLEM

• There are some basic differences between the investment point of

view and the speculative:
o As a speculator, you are dealing with stock as such
o The investor is supposed to consider only the return in his
investment in cash dividends

CHAPTER EIGHTEEN.ONE: STRATEGY AND TACTICS FOR

THE LONG-TERM INVESTOR

• The strategy of the long-term investor is to catch the long trends

• Portfolios are liquidated or hedged when bear market signals are
received
• Rhythmic investing is a type of investing that roll a portfolio form
long to shorty gradually in natural rhythm

CHAPTER TWENTY-ONE: SELECTION OF STOCKS TO

CHART

• In choosing the stock, you will want to consider the kind of stock
and its character and habits in the market, rather than the business
of the concern it represents
• Many stocks in a particular industrial group will show the same or
similar patterns as the entire industry
• In general, the lower priced issues make much larger percentage
moves than the higher priced stocks
• Low priced stocks not only go up much faster, but also come down
much faster than the high-priced stocks
• It not recommended take very lowest priced issues of the group
and the highest priced

39
 • The same stocks which make only moderate corrections on
declines will make only moderate advances on rises, and the ones
that go down sharply, will also go up sharply
• The interest is in the stock that make wide moves not substantial
moves
• Will have eliminated from list stocks at the wrong price level and
stocks without enough swing power

CHAPTER TWENTY-FOUR: THE PROBABLE MOVES OF

YOUR STOCK

• Stocks which habitually move in a narrow range aren´t good

trading stocks
• By examining the record of a certain stock for a number of years
back, and comparing the percentage moves it has made with the
percentage moves of the market as a whole, we can obtain a
picture of its volatility

CHAPTER TWENTY-FIVE: TWO TOUCHY QUESTIONS

• The effect of margin use is simply to accentuate or increase the

sensitivity of a situation. It is a mechanism for assuming more risk
and, therefore, more opportunities for faster gains
• The margin transaction is simply a matter of buying or selling more
stocks than you have money to pay for in full
Short selling
• Stocks, in general, advance about two thirds of the time, and go
down only about one third of the time
• Furthermore, most of the news prove more newsworthy than less
optimistic reports
• Examination of the long-term charts, will show you that through
these long periods, the levels rise and fall about the same amount

40
 • Profits can be made faster on the downside of the market than on
the upside
• Most short sellers are glad to cover and take profits on a relatively
minor decline. Consequently, if there is a big short interest at any
given time in a particular issue, that means that there are many
people waiting to buying that stock when it goes down. This
situation tends to cushion bad breaks.
• A short sale is the same thing than long purchase with actually
somewhat greater chance of quick profit and differing only in
details of execution
• A commitment in commodity futures contracts no actual sales take
places, ad no loan of either cash or the commodity is involved.
Such a contract is simply a binding legal agreement to accept
delivery a certain commodity at a certain price at a certain time. In
this respect it´s different from a short sale of a stock but is similar
in it is necessarily a margin transaction and it creates an “opens”
or incomplete transaction which must eventually be liquidated

CHAPTER TWENTY-SEVEN: STOP ORDERS

• Stop orders are used dor emergency rescue

• You will set it at a safe distance under a certain bottom
• It the stop is too closes; you will take unnecessary losses but less
losses in cash
• If the stops are too wide, you will take larger losses than necessary
• In the case of purchases, the stop level ordinarily will be at the
indicated distance below the last previous minor bottom. In the
case of short sales, it ordinarily would be at the indicates distance
above the last minor top

41
The progressive stop
• The progressive stop is uses to close out a stock that has made a
profitable move or where a stock has given a danger signal before
either completing a profitable move or violating a previous minor
bottom
• The stocks that may develop exceptional volume means one of
two things:
o It means that the minor move has come to an end, this is the
top of the rise for the moment
o It may signal the stars of a breakaway move that may run up
several points, almost vertically
• The buy stop is used the same way as sell stop
• The use of progressive stop orders is indicated wherever a stock
has reached its objective or if it has exceeded its objective
• The progressive stop is intended to take short term gains or to
close out an exceptionally profit

CHAPTER TWENTY-EIGHT: WHAT IS A BOTTOM-WHAT IS

A TOP?

• Stop orders levels, trendlines, objective, supports and resistance

are determined by minor tops and bottom
• A good rule for setting stops levels is to consider that a bottom has
been made when the stock has moved three day away form the
day marking the suspected low of the bottom
• A stop level is never to be move down and a buy stop to be move
up
Basing points
• In a bull market move, we will consider the bottom of each minor
reaction as a basing point and each minor top, from which we will
figure our stop order level.
• In a bear market, we will consider the tops of each rally and each
minor bottom as basing points for the protective stops
• Moves back at least 40% of the distance that surely give us a
basing point
42
• There are three times at which you may look for exceptionally
heavy volume:
1. On the day of breakout from a pattern or a period of inaction,
especially if the breakout is on the upside
2. On the day on which the stock goes into new ground in the
primary or intermediate direction, that is, the last minor top
in a bull market or below the last minor bottom in a bear
market
3. The day on which the minor move is completed or nearly
completes, that is, the new minor top in a bull market and the
minor bottom in a bear market
• We add extra heavy volume on any other day during a move in the
primary direction is likely to indicate that the moves are at an end
and will not complete the hoped for advanced or decline
• Where there is a downward correction it is likely to come down to
or near the top of the last previous minor high (support)
• The corrective move will carry down to the basic trendline drawn
through two or more previous minor bottoms or to a trendline
drawn through the last minor bottoms or to a trendline drawn
through the last two or more previous minor tops. If the corrective
move is horizontal, it is likely to run out until it meets one of these
lines
• If the volume shrinks, perhaps irregularly, but on the whole,
steadily after a new top has been made, you are justified in
considering this as a minor correction
• From period of vacillating moves our basing point at the low point
immediately preceding this signal. There will usually be such a
point on one of the low volume days just before the breakout
• The importance of finding your basing point is to enable you to get
out
• Blow off of a trend will usually show more volume than any of the
minor blow offs along the way
• A pattern of lower highs and lower lows means inevitably that
trendline has been broken
• Flags and pennants are messages that the market has heated up
and now wants close watching a flag can serve as a basing point

43
 CHAPTER TWNETY-NINE: TRENDLINES IN ACTION

• The parallel suggest the approximate objective of the next move if

the stock continues in trend
• The parallel is useful in determining a buying point in trends of
rapidly changing
• The same way to downtrends

Parallel line

Original Original trendline

trendline
Parallel line

• The most difficult times to determine minor trends are during

reversals
• So long as a stock persist in a parallel trend channel, it is perfectly
clear that you should buy near the bottom of the channel and sell
near the top

Buying stock, “Going long”

• Preparatory buying signals the simple breaking of a descending
blue trendline, where no other pattern or indication is present, is
not sufficiently conclusive evidence of a reversal to justify
commitments
o Contact with ascending blue trend if red trend is also
ascending, provided the trend does not converge (parallel or
divergent trend channel)

44
 o Contact with horizontal blue trend if red trend is also
horizontal or ascending (rectangle, ascending triangle)
o Penetration of descending blue trend on volume if red trend
is ascending (symmetrical triangles)
• Execution of buys (after preparatory signal)
o In case the previous blue trend has been ascending draw
the blue parallel and buy at or near this line
o In case the previous blue trend has bene horizontal or
descending, buy on a reaction of 40 to 45% of the distance
from the last previous minor bottom to the extreme top of the
most recent move
Liquidating or selling a long position
• If the stock closes below a previous minor bottom (thus setting up
a descending red trend), sell on tight progressive stops
• If the stock advances on moderate volume and the develops
unusually high volume on any day during the advance before
either the blue trend is broken or before the stock has made a new
high closing over the last minor top, close out the transaction on
tight progressive stop
• In many cases, the heavy volume signal will develop on near the
red parallel. This volume indication as a sign of good profit-taking
point. If the volume signal does not show up, your selling point or
objective is this red parallel, at a limit or on tight progressive stops.

45
46
47
Selling stock short
• Preparatory selling signals
o Penetration of red trend to a new low closing (The simple
breaking of an ascending red trendline where no other
pattern or indication is present is not sufficiently conclusive
evidence of reversal to justify commitments)
o Contact with descending red trend if blue trend is also
descending, provided the trends do not converge (parallel or
divergent trend channels
o Contact with horizontal red trend if blue trend is also
horizontal or descending (rectangle or descending triangle)
o Penetration of ascending red trend (with or without volume)
if blue trend is descending (symmetrical triangles)
• Execution of short sales:
o In case the previous red trend has been descending draw
the red parallel and sell at or near this line
o In case the previous red trend has been horizontal or
ascending, sell on a rally of 40-45% of the distance from the
last previous minor top to the extreme bottom the most
recent move
Covering short sales
• If the stock closes above a previous minor top (thus setting up an
ascending blue trend), buy to cover on tight progressive stops.
• If the stock declines on moderate volume and then develops
unusually high volume on any day during the decline before either
the red trend is broken or before the stock has made a new low
closing under the last minor bottom, close out the transaction on
tight progressive stops.
• If the stock develops high volume on the day on which it either
breaks and closes below the red trend or makes a new low closing
under the previous minor bottom, hold it short. If heavy volume
again occurs on the following day or any subsequent day,
however, buy to cover on tight progressive stops.
• In many cases the heavy volume signal will develop (sometimes
with also a one-day reversal or an exhaustion gap) on or near the
blue parallel. This volume indication as a sign of a good profit

48
 taking point. If the volume single doesn´t show up, your buying
objective is the blue parallel, at limit or on tight progressive stops.

CHAPTER THIRTY: USE OF SUPPORT AND RESISTANCE

• If the move is upward, the reaction after each advance tends to

stop at the level of the preceding peak
• If the move is downward, the rally after each decline tends to stop
at the level of the preceding bottom
• Intermediate secondary moves will frequently stop at or close to
the previous intermediate top or bottom
• Its fair rule that after a stock has made three such moves in the
primary direction, it´s time to look for an intermediate correction, or
at least an important period of consolidation
• If the stock remains at the support or resistance level for many
days or reversal week, and then penetrates that level, closing at a
price that is clearly through it, get out at once
• If the stocks make a small move in the right direction and returns
to the support or resistance, prepare to get out if there is a define
penetration
• If the move is in the right direction, watch for volume indication,
and prepare to set tight stops to take profits as soon as heavy
volume appears
• Support and resistance action in the minor trend are shown clearly
in daily charts, the intermediate and major support and resistance
are most easily recognized on weekly or monthly charts

49
CHAPTER THIRTY-THREE: TACTICAL REVIE OF CHART
ACTION

• When a trend of enough importance gives a major signal that the

average is under way, there will be a greater likelihood of finding
profitable situation among individual stock moving in that trend
than among those moving in the reverse trend
• During periods of potential reversal, gradually reduce your long
holdings, and more short sales to limited amount in weak stocks
Head and shoulders top
• If you are long a stock, should a breakout down through the
neckline occur, place a stop below the last close
• Short sales may be made after a breakout, on a recovery of 40%
of the distance from the top of the right shoulder to the bottom of
the breakout move or on a pullback to the neckline
The same way to head and shoulders bottom
Rounding tops and bottoms
• In the case of rounding tops, if one is long the stock suggest
getting out of the stock
• A short sale of a rounding top could be very profitable; but not
exact rule could be stated. It also needs to be protected with a
stop above the top of the curve
Symmetrical triangles (all type of tringles)
• If you don´t have a position; stay away from any stocks making
symmetrical triangles until a clear and define breakout close has
been made. After such a breakout, if on the upside, buy on the
next reaction if the major trend is up, or if the downside, sell short
on the next rally if the major trend is down
Broadening tops
• After its completion offer excellent opportunities for a short sale
• After a downside penetration and close below the fourth point of
reversal in the pattern, you are justified in selling short on a rally
of about 40% of the distance covered form the extreme top (fifth
point of reversal) and the lowest point reached on the breakout
50
 move. The stop would be placed at the paper distance above the
fifth reversal.
Rectangles
• In the case of a breakout in the right direction, you would dispone
of your commitment
• If the breakout is in the wrong direction, use a tight progressive
stop
Double tops and bottom
• If you are not committed in the stock: consider a penetration and
close beyond the limit of the correction between the tops (or
bottoms) as a signal of reversal, and make new commitments on
rallies or reaction
Diamond
• The same way like triangles
Wedges
• Notably increased volume on an upside breakout from a falling
wedge: less pronounced volume action on the first stages of
breakout from an arising wedge
• New commitments may be placed on rallies or reactions after a
clear breakout occur
One day reversal
• They are mainly useful as a gauge in helping to find the precise
top or bottom of a minor move in order to protect profits on
commitments
• The one-day reversal, the exhaustion gap and the day of
exceptionally heavy volume following several days of movement
in a minor trend are strong indications that the move may have
run out

51
Trendlines
• In the absence of clear indication during the reaction and also
during the preceding large upward move, your stop would be
placed at a computed distance below the top of the preceding rise
• The points of contact with the basic trendline can serve as a fair
emergency substitute for minor bottom. Your stop level should,
therefore, be placed at the computed distance below the last point
at which the stock made contact with the bottom trendline and
moved decisively up away from it
• The reverse of this rule would apply to the same type of situation
in a bear market, where stops for sort sales would be placed at the
computed distance above the point at which the stock made
contact with and fell away from the upper trendline

CHAPTER THIRTY-FOUR: A QUICK SUMMATION OF

TACTICAL METHODS

• There are three types of tactical operations:

1. Getting a new commitment
2. Getting out of commitments which have moved as expected
and show profit
3. Getting out of commitments which have not moved as
expected, whether the transaction shows a profit or loss
• The signal that show weakness or failure of a move in one trend is
not always a signal to make new commitments on the opposite
direction
Get out of present commitments
• On adverse breakout form head and shoulder formation
• On adverse breakout from symmetrical triangle
• On adverse breakout from rectangles
• On establishment of new minor low or new minor high in adverse
direction
• On adverse breakout form diamond
• On adverse breakout form wedge

52
 • On one-day reversal if marked by heavy volume or a gap
• On adverse breakout from flag or pennant
• On clear penetration of any resistance or support level in the
adverse direction
• On an adverse breakaway gap
• On the appearance of and island after a move in the favorable
direction
• On a penetration of basic trendline in the absence of pattern or
other favorable criteria
Make new commitments
• On breakout from head and shoulder pattern
• On breakout form symmetrical triangle, provided it is not working
into the final third of its length toward the apex
• On breakout form right angle triangle
• On breakout from rectangle, or an points of contact beginning with
the sixth reversal
• On breakout from a broadening top
• On breakout form double or multiple top or bottom
• On breakout form wedge or commitment within the wedge in the
last third of its length as it approaches its apex
• On flags and pennants, after sufficient secondary or corrective
move by the pattern, or within the pattern, provided that volume
and all other indications trend strongly to confirm the pattern
• On clear penetration of well-defined support or resistance are
• On breakaway gap
• After formation of an important and well-defined island flowing a
considerable move
• On contact with, or penetration of, the favorable trendline if both
trendlines are moving in the major trend direction

53
CHAPTER THIRTY-SIX: AUTOMATED TRENDLINE: THE
MOVING AVERAGE

• The trouble with a moving average is that it cannot entirely escape

from its past
• The smoother the curve (longer cycles one has), the more inhibited
it is in responding to recent important changes of trend
• The moving average shows the trend of and irregular series of
figures more clearly
• Moving average can be classified:
o Simple moving average
o Weighted or exponential moving average
o Linear moving average
• The simple moving average most common are the 50-day, and the
200-day moving average
• To increase the sensitivity of moving average, short-term the
moving average
Sensitizing Moving Average
• The shorter the time period, the greater the sensibility you will
develop in the moving average
• The problem with short term moving average is that it can have a
greater number of false moves
• It´s often better to use two moving averages, one of shorter
duration and on of longer duration
Crossovers and Penetrations
• Uptrends: long position are retained as long as the price trend
remains above the moving average line
a) When the price line intersects or penetrates the moving
average line on the upside, it activates a buy signal
b) When the price line goes above the 200-day moving
average, but falls sharply toward it without penetration, it´s a
buy signal
c) When the price falls below the moving average line while the
line is still rising, it could be a buy signal

54
 d) When the price line spike down too fast and far below a
declining moving average line, a short-term rebound toward
the line may be expected a possible whipsaw trap
• Downtrends: short positions are held as long as the price trend
remains below the moving average. When the price trend reaches
a bottom and turns upward, a penetration of the moving average
is a buy signal
a) When the price line moves above the average line while the
average line is still failing, it´s a sell signal
b) When the stock price line moves below the average line and
rises toward it, but fails to penetrate and breaks down again,
it is a sell signal
c) If the price line rises too fast above the rising average line, a
short-term reaction may be expected: could be a whipsaw
d) Occasionally, penetration of the moving average line will
occur in close conjunction with the penetration of a trendline,
then according to its direction, it´s a buy or sell signal
• Horizontal, diagonal or sideways movement: if the fluctuations are
broad in comparison to the length of the moving average being
used, the price trend will fluctuate back and forth as the moving
average, true to its character or purpose, move horizontal
• Gaps: moving average, depending on their length, may have a
tendency to be penetrated in close proximity to a breakaway gap,
particularly at the beginning of a major phase of an intermediate
cycle, and also in such cases where breakaway gaps occur at the
beginning of correction phase

CHAPTER THIRTY-EIGHT: BALANCE AND DIVERSIFIED

• Evaluative index will also indicate approximately the degree of

strength. It gives only an approximate picture of the state of the
market; it gives no positive signals
• If the average is making new highs, you will expect that evaluative
index will range well above 50%. In an obvious bear market, the
index will stand considerably lower than 50%. With the index

55
 standing in the vicinity of 50% you can then select several strong
stocks to buy and several candidates for short sale
• As the evaluative index advances, the proportion of short positions
would gradually be reduced, and the long position increased. As
the index declines, the reverse would happen

CHAPTER FOURTY: HOW MUCH CAPITAL TO USE IN

TRADING

• The important thing at the start is not how many dollars you can
make, but what percentage of increase per year you can average
with the capital you are using

CHAPTER FOURTY-ONE: APPLICATION OF CAPITAL IN PRACTICE

• Major trend ordinarily run for long periods of time, covering a

tremendous number of points in total advance or decline
• Almost unbelievable profits could be made by one who could buy
stocks at the extreme bottom of a bear market and sell at the
extreme top of the following bull market and vice versa
• It is possible to avoid becoming trapped in purchases made at or
near the extreme bull market top so that losses become dangerous
or ruinous in a major reversal, and vice versa
• It is possible to make profits by trading in line with the major trend,
and in some cases, by trading on the intermediate corrections to
the major trend, or, occasionally on the individual behavior of a
stock which is moving contrary to the major trend
• The greater and most dependable profits may be made along the
major trend during the principal period of advance (or decline, in
the case of short sale), but not during the earliest phases when the
movement first gets under way, nor during the rounding off or
reversal phenomena near the end of the movement

56
• The amount of margin you are using will have an effect on the
degree of risk
• Sensitivity, price and margin can be combined into one figure,
which we are going to call the composite leverage index
• It is perfectly true that you must vary your composite leverage (risk
exposure) so as to take advantage of the fast moving central
portions of important moves, using a lower composite leverage at
the beginning of such moves, and during the tapering-off or turning
periods near the end
• Bull markets normally rise through a series of irregular advance
and declines, starting with moderate upward trend, and gradually
accelerating as the market approaches its ultimate top
• Bear markets are likely to move fastest at the star, and taper off
gradually toward the end
• Bear markets are steeper than bull markets
• High grade issues, the active market leaders, and perhaps some
stocks of a more conservative nature will tend to start their moves
in a bull market fairly early and to continue their advance at a fairly
steady pace
• Low priced and low grade issues tend to be slow in getting started,
will remain dormant during the early phases of a bull market, and
will the suddenly and spectacularly sky rocket in a series of moves
that is likely to be reached at a later point than the point at which
many of the more conservative stocks topped out.
• You will do well to concentrate your bull market trading in the early
stages in the higher-grade stocks and in the later stages in the
lower grade stocks

57
CHAPTER FOURTY-TWO: PORTFOLIO RISK
MANAGEMENT

• It´s indispensable to maintain a regular periodic review of portfolio

statistic to assure oneself that excessive risk are not being
undertaken heedlessly. These important number include:
o Original risk per trade
o Actual realized loss
o Average loss and profit per trade and their relationship
(average profit divided by average lost)
o Number of winning losing trades and their ratio
o Costs and expenses, summation, and per trade
Risk of a single stock
• The beginning of conventional, or academic, analysis of risk is the
examination of vitality
Risk of a portfolio
• You may also dramatize the volatility of the portfolio by preparing
a frequency distribution
• The dispersion of the returns would certainly highlight
characteristics of your trading or style
• Sharpe ratio compares the performance of two systems or
competing money managers and has severe deficiencies in
analyzing portfolio risk
Risk and trend
• Risk of a portfolio and risk of a stock are affected by being the right
way in the trend
• Risk is diminished to a portfolio and a stock when it is with the
trend
VAR procedure
• The width of the frequency distribution measure the riskiness of
the portfolio
• A frequency distribution doesn´t give a common measure for two
different portfolios. That is done by determining the volatility of the
portfolio

58
 • The volatility measures the deviation of return from the mean and
is indicated by Ꝺ
Determining the risk of one stock
Pragmatic portfolio risk measurement
• Theorical risk= volatility x position x price (T$Risk=VxPoxPr)
• Another measurement which is more meaningful is “operational
risk” that refers to the specific instance of the particular trade
• Operational risk= market price-stop price x position
(O$Risk=(Mp-S)xPo)
Determining the risk for a portfolio
• Computing the theorical risk, it involves finding the volatility for the
portfolio as a whole, and multiplying the portfolio market value by
the portfolio volatility
• The volatility in this case is not determined by simply adding
together volatilities of individual securities. Rather, correlations
between instrument return must be computed, and variance and
covariance of securities must be determined as steps along the
way
• The theorical risk of portfolio= volatility x market value
(TP$Risk=MvxV)
• The operational risk of a simple portfolio may be calculated by first
taking the sum of the operational risk figures for each stock held
long. Then the sum of operational risk for short position is
subtracted from the first figure:
PO$Risk=(sum of 0$Risklongs)-(sum of O$Riskshorts)
In the situation of perfect negative correlation, the two factors would
be summed
Measuring maximum drawdown or maximum retracement
• A wave chart is constructed by statistics about the trading method
and is one way to look the experience of it method. It also gives us
a vivid depiction of our results
• Measuring from the top of the wave to the bottom gives us our
maximum drawdown and an idea of what amount of capital we
need and how much reserves to main train

59
 • If constructing a system without actual market experience, one
should multiply maximum drawdown by 3 or 4 to get a reasonable
amount of capital to back the system with
Portfolio ordinary, or operational risk
• Our ordinary risk today is easily computed by taking the stop price
from the market price on each position and summing the
differences (POR=sum of difference)
• Dividing this figure by the allocated capital (total capital, TC) will
give us a portfolio risk factor (PRF). And that is the risk factor the
trader is willing to assume for one day (PRF=PO$Risk/TC}9
Portfolio Risk Over time
• The number can be annualized to give us a number for risk over
time. It may be collected by taking each day´s ordinary risk,
summing and dividing for the desired time period
• It may also be computed by taking the average return and the
variances therefrom and calculating the standard deviation
Portfolio extraordinary or catastrophic risk
• Is the risk of market collapse or panic on any given day
Summary of risk and money management procedures
• Trade size is the basic unit for controlling risk. To determine trade
size, take the difference between the entry price and the stop price
• Divide operational risk by total capital to determine portfolio
operational risk
TS= Trade size
EP-SP=$R1
EP= Entry Price
RCFXTC=RpT
SP= Stop price
$R1/RPT=TS
$R1= Dollar risk 1
RCF=Risk control
factor
TC= Total capital
RPT=Risk-Per-Trade

60
APPENDIX A

• Examining the record of a certain stock and comparing the

percentage moves it has made with the percentage moves of the
market as a whole, obtain a fair picture of that stock´s habit
• Sensitivity runs from over 2.00(200%) in the case of highly
speculative issues, down to .20(20%) or less on ultraconservative
investment stock. Stock with sensibility index of 50% or less are
extremely conservative, 50% to 100% moderately conservative,
100% to 150% speculative and anything over 150% highly
speculative

APPENDIX C

Commodities futures
• The futures industry began in the united states in the early 1800´s
as a way to stabilize crop producers´ and buyers’ incomes by
locking in a current commodity price for delivery at later date
• Limited life: one of the most prominent differences is the fact that
commodity futures have a limited life. The limited life has
consequences of long-term support and resistance levels which
have les value for analysis
• Hedging: many investors are using futures for hedging, a
conservative strategy, rather than speculating
• Volume: with futures, there is virtually no limit to the total number
of contracts which can be bought or sold for future delivery on any
one commodity
• Weather: can impact the commodity crop and change the trend of
the futures market immediately and dramatically
Dual moving average
• Moving average can become more powerful when multiple moving
average are plotted
• Research shows using two average tend to be the most effective

61
 • Falsa signals can be given when price fluctuate in a broad sideway
pattern
• One combination is to plot a 9-day moving average and 18-day on
the same chart. A buy signal is given when the 9-day crosses
above the 18-day and both are in an upward direction. A sell signal
is given when 9-day crosses below the 18-day and both are
declining
Weighted an exponential moving average
• In a weighted moving average, the data are weight in favor of the
more recent data. Reverses the direction more quickly than a
simple moving average
• With a weighted moving average, a buy or sell signal is given when
the weighted moving average change direction
• An exponential moving average is a form of a weighted moving
average
• The average itself can act as an area of support and resistance.
The more times a moving average is touched, the greater the
significance of a violation
• A penetration of a moving average is signal that a chance in trend
may be taking place but should be confirmed from alternative
source
• The longer the time frame of the moving average, the greater the
significance of a crossover
Moving average convergence divergence (MACD)
• Is an oscillator that is derived by dividing one moving average into
two lines
• The equilibrium line is important. When the two moving average
crosses below the equilibrium line, it means that the shorter EMA
has a value less than the longer EMA. This is a bearish signal
• When the EMAs are above the equilibrium line, it means that the
shorter EMA has a value greater than the longer EMA. This is a
bullish signal
• Buy signals are generated when the faste lie crosses the sower
line frm below

62
 • Sell signals are generated when the faster line crosses the slower
line from the above
• Gerald Appel develop MACD in 1974
• Overbought and oversold singles for the S&P index as a pus or
minus 2.50 on the MACD scale. When the differential line crosses
into these areas, a signal is generated for buy or sell
• MACD is best used as a long-term analysis tool
• Drawing a trendline along the MACD and trading when the
trendline is violated can often precede a change in the market
• Combining crossovers with other technical pattern can make the
MACD system more reliable as a system for trading
• Major trends are identified by using a long-term MACD to confirm
the shorter-term
Reversal
• Reversals in the direction of a moving average are usually more
reliable than a moving average crossover
Bollinger Bands (BB)
• Develop by John Bollinger
• Bollinger bands are alpha-beta band positioned two standers
deviation from a 20-day moving average.
• They were developed in a attempt to improve on the concept of
fixed-width trading bands
• The primary purpose of the developed Bollinger bands is to
indicate whether prices are relatively too high or too low
• BB do not generated buy or sell signals alone, they are used with
other indicators
• When price touches one of the bands, it can indicate a continuation
of the trend or a reversal
• When the price touches the upper Bollinger bando and RSI is
below 70, it´s an indication that the trend will continue
• When price touches the lower Bollinger band and RSI is above 30,
it indicates the trend should continue
• If price touches the upper Bollinger band and RSI is above 70, the
trend may reverse and decline

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 • If price touches the lower Bollinger band and RSI is below 30, it
indicates the trend may reverse and move upward
Stochastics
• Was developed by George Lane
• Compares a security´s price closing level to its price range over a
specific period of time
• In an upward-trending market, prices tend to be close near their
high
• During a downward-trending market, price tend to be closed their
low
• The stochastic indicator attempts to determine when prices start
to cluster around their low in an upending market and cluster
around their high in a downtrend market
• The stochastics indicator is plotted as two lines, the %D line and
%K line
• %D line is more important than %K line
• The value can never fall below 0 or above 100
• Reading above 80 are considered strong and indicated a price is
closing near its high
• Reading below 20 are strong and indicate prices are closing near
their low
• When %D line changes direction prior to the %K line a slow and
steady reversal is often indicated
• A powerful move is under way when the indicator reaches its
extremes around 0 and 100
• Many times, when %K or %D lines begin to flatten out, the action
becomes and indication the trend will reverse during the next
trading range
• For commodities, the number of periods to use in stochastics is
based on the cycle of the commodity being traded
Open interest
• Open interest measures the amount of money flowing into and out
of the futures market
• When both sides of a trade are new to the market, the open
interest increase

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 • If one side is new and the other is old, open interest is unchanged
• When both sides close out, open interest declines

Price action Open volume Interest Market

1 up up up strong
2 up down down weak
3 down up up weak
4 down down down strong
• Open interest and price will rise as new money flows into the
market
• When prices rise and open interest decline, there are few new
buyers and money is leaving the market. Rallies can be caused by
the covering of short position exiting the market
• When prices are falling and open interest is rising and new money
is coming into the market and there is selling pressure, it is
considered bearish
• Price falls and open interest falls is the opposite of situation. Short
sellers are staying in the market and long position holders are
closing, there is little new money coming into the market and the
situation is initially bearish but can turn bullish
• Futures are dependent on new money for price stability and grow,
because for every buyer there is a seller. With stocks it Is possible
to have pressure situations with more buyers than seller or the
other way around
• It is the new money in futures that creates the rising prices in an
uptrend
• New money coming in will cause the open interest and volume to
rise, but to be a truly bullish indicators they must be accompanied
by rising prices
Wilder Relative Strength Index (RSI)
• Was developed by J. Welles Wilder as a system for giving actual
buy and sell signals in a changing market
• RSI is often used to identify price tops and bottoms by keying on
specific levels (usually 30 and 70) on the RSI chart

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 • RSI can be useful to show
o Movement which might not be as readily apparent on the bar
chart
o Swing failures above 70 or below 30, warning of coming
reversals
o Support and resistance levels appear with greater clarity
o Divergence between the RSI and price can often be a useful
reversal indicator
• The most popular timer period is 14-day relative strength index
• The shorter RSI is more responsive in showing a pause in the
current trend
• RSI is based on the difference between the average of the closing
price on the up days vs the average closing price on the down days
Important concepts in commodities/derivative trading
• Price are influenced by external factors such as weather changes,
supply and demand
• Futures trading is mostly made up of headers and speculators in
for a shorter period of time than with stock trading
• Futures can have an unlimited number of contracts open
• Stop-loss orders are essential
• Make use of more than one indicator to make a buy or sell decision
• Trendlines are the most important patterns and can be drawn on
the indicators as well as on the prices
• Divergence is one of the more reliable signals
• Chart patterns can be used in combination with other indicators
• Trades are made on price, not on indicators
• Time periods can be altered to give a more sensitive picture of
smoother picture

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