Saturday, 3 March 2012

ANALYSIS STOCK TRENDS, Chapter 2 , Charts

ANALYSIS STOCK  TRENDS

By
Robert D. Edwards
and
John Magee



Chapter 2




Charts


Charts are the working tools of the technical analyst. They have
been developed in a multitude of forms and styles to represent
graphically almost anything and everything that takes place
in the market, or to plot an "index" derived therefrom. They may be monthly charts on which an entire month's trading record is condensed into a single entry, or weekly, daily, hourly, transaction,
"point-and-figure," etc. They may be constructed on arithmetic,
logarithmic or square-root scale, or projected as "oscillators."
They may delineate moving averages, proportion of
trading volume to price movement, average price of "most active" issues, odd-lot transactions, the short interest, and an infinitude of other relations, ratios and indexes—all technical in the sense that they are derived, directly or indirectly, from what has actually
been transacted on the exchange.
With most of these, fortunately, we shall not need to concern
ourselves at all; they are of interest only to the full-time economic
analyst.* Many of them have derived from a (so far, at least) completely
futile endeavor to discover some one "mechanical" index
or combination of indexes which will always, automatically,
without ever failing or going wrong, give warning of a change in
trend; such, in our experience, are often confusing and sometimes
downright deceptive at a most critical juncture. This book, however, is designed for the layman, the business or professional man

who cannot spend all his hours on his investing or trading operations,
but to whom these operations are, nevertheless, of sufficient
* An exception should perhaps be made for the Odd-Lot Indexes developed by
G.A. Drew. The reader who wishes to delve deeper in market technics will find
these explained in Drew's book New Method* for Profit in the Stock Market, the
latest edition of which was published in 1955 by The Metcalf Press



importance or interest to warrant his devoting at least a few
minutes a day to their study and management. The theories and
methods outlined herein will require only the simplest form of
stock chart—a record of the price range (high and low), closing
price and volume of shares traded each day. These daily graphs
will be supplemented, for certain purposes which will be discussed
farther on, by weekly or monthly charts, which for most
stocks can be purchased ready-made.
Nearly all the illustrations throughout the following pages are
examples of such daily charts. They are easy to make and maintain,
requiring only a supply of graph or cross-section paper (almost
any kind can serve), a daily newspaper which gives full and
accurate reports on stock exchange dealings, a sharp pencil and a

few minutes of time.
It is customary in preparing ordinary daily stock charts to let
the horizontal axis represent time, with the vertical cross-lines (or
as some prefer, the spaces between them) from left to right thus
standing for successive days. The vertical scale is used for prices,
with each horizontal cross-line then representing a specific price
level. Space is usually provided at the bottom of the sheet to plot
volume, i.e., the number of shares which change hands each day.
The newspapers publishing complete stock market reports give
the day's turnover or volume (exclusive of odd-lot transactions
which may for our present purpose be disregarded), the highest
and lowest price at which each stock sold during the day, the closing
price (which is the price at which the last sale effected during
the day was made) and usually the opening or first sale price. On our charts, the daily price range is plotted by drawing a vertical
line connecting the points representing the high and the low. Then a short horizontal "tick" is added, either crossing the vertical range
line or extending out to the right from it, at the level of the closing price. Sometimes all transactions in a stock during a day take place
at one and the same price; the high, low and close are thus all on a level and the only mark on our chart will then be the horizontal
dash representing the closing figure. Volume is depicted by drawing a vertical line up from the base line of the chart.

that it seldom, if ever, has any significance in estimating future
developments, which is all that ordinarily should interest us. The
closing price is important, however. It is, in fact, the only price
which many casual readers of the financial pages ever look at. It
represents the final evaluation of the stock made by the market
during the day. It may, of course, be registered in the first hour of trading, provided no other sales are subsequently effected, but, it becomes, nevertheless, the figure upon which a majority of
prospective traders base their plans for the following day. Hence, its technical significance, which will appear in various connotations
in later chapters.
I

 

Different Types of Scales


 
Many specific suggestions as to the details of charting are
deferred for discussion in the second section of this book, but there is one chart feature which may well be considered here. Until
recent years, nearly all stock price charts were kept on the common form of graph paper ruled to what is known as plain or arithmetic scale. But more and more chartists have now come to use what is
known as semilogarithmic paper, or sometimes as ratio or percentage paper. Our own experienced indicates that the semilogarithmic
scale has definite advantages in this work; most of the charts
reproduced in this book employ it. The two types of scale may be
distinguished at a glance by the fact that on arithmetic paper,
equal distances on the vertical scale (i.e., between horizontal lines) represent equal amounts in dollars, whereas on the semilogarith-
I mic paper, they represent equal percentage changes. Thus, on arith-
1 metic paper the distance between 10 and 20 on the vertical scale is exactly the same as that from 20 to 30 and from 30 to 40. On the logarithmic scale the difference from 10 to 20, representing an increase
of 100%, is the same as that from 20 to 40 or from 40 to 80, in
each case representing another 100% increase.
Percentage relations, it goes without saying, are important in
trading in securities. The semilogarithmic scale permits direct


comparison of high- and low-priced stocks and makes it easier to
choose the one offering the greater (percentage) profit on the funds to be invested. It facilitates the placing of stop-loss orders. Area
patterns appear much the same on either type of paper but certain trend lines develop more advantageously on the ratio scale. Almost anyone can quickly become accustomed to making entries on
semilogarithmic paper. We recommend its use. However, its advantages
are not so great as to require one to change, who, because
of long familiarity and practice, prefers tan arithmetic sheet. Such percentage calculations as may seen to be required can, after all, be
made on another sheet or in the head and the results then entered on the arithmetic chart if a record is desired.
Several firms specializing in the manufacture of graph paper
and other engineers' and architects' supplies now offer sheets
specifically designed for stock charting, on which heavier lines to define the business week mark each sixth day on the time scale,
and the price scale is subdivided into eighths to represent the
standard fractions of the dollar in which stocks are traded on all
American exchanges. These sheets are available in various sizes
and with either arithmetic or logarithmic price and volume scales.

On weekly charts, each vertical line represents a week's trading.
The price range for the week is plotted thereon and usually
the total volume, but the closing price may be omitted. The range extends, of course, from the highest price at which the stock sold
on any day during the week to the lowest price at which it sold on any day; these two extremes might, and sometimes do, occur on the same day, but the weekly chart makes no distinction as to day.
Monthly charts are prepared in the same way but do not, as a rule,
record volume. These two—often referred to as long-term or major charts—are used chiefly for determining important support and
resistance levels and marking long-term trends. Weekly charts—if
the reader prefers to keep his own—can be posted easily from the Sunday morning editions of those daily newspapers (e.g., the The New York Times or Barron's Business and Financial Weekly) which
publish a summary therein of the previous week's transactions.

In concluding this chapter on the construction of the charts
which we shall study in succeeding chapters, it can well be said
that there is no special virtue, certainly no magic, in the chart itself.
It is simply a pictorial record of the trading history of the stock or stocks in which we may be interested. To the man possessed of a
photographic memory, no chart work is necessary; his mind
records all the necessary data—he carries his charts in his head.
Many of the expert "tape-readers" who have no use for charts are gifted with that rare memory talent which renders reference to graphic records unnecessary. But most of us are not so blessed; to use the chart is necessary and useful because it lends itself conveniently to the type of analysis which indicates future probabilities.
There is a saying in Wall Street to the effect that "there is nothing wrong with charts—the trouble is with the chartists." Which is simply another way of expressing the truth that it is not the chart itself but its interpretation that is important. Chart analysis is certainly neither easy nor foolproof. Yet it is not at all uncommon for some casual investor who has no idea whatever of market technics to pick up a chart by chance and see in it something which he had not hitherto suspected—something perhaps which saves him from making an unfavorable commitment.
If you have never used stock charts, never paid much attention
to them, you may be surprised at some of the significant things
you will quickly detect as soon as you begin to study them serious-

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