`
`TRADING FOR
`
`A LIVING
`
`Psychology '
`Trading Tactics
`Money Management
`
`Dr. Alexander Elder
`
`Director,
`
`elder.c0m
`
`WILEY
`
`John Wiley & Sons, Inc.
`
`BLOOMBERG ET AL EXH BIT 1017
`BLOOMBERG ET AL - EXHIBIT 1017
`
`0001
`!!!"
`
`
`
`
`
`CompuTraC” is a trademark of Compu'l‘ra‘c Software Inc.
`PageMaker® is a registered trademark of Aldus Corporation.
`
`In recognition of the importance of preserving what has been written, it is a policy
`of John Wiley & Sons, Inc., to have books of enduring value printed on acid-free
`paper, and we exert our best efforts to that end.
`
`Copyright © 1993 by Dr. Alexander Elder
`Published by John Wiley & Sons, Inc.
`
`All rights reserved. Published simultaneously in Canada.
`
`Reproduction or translation of any part of this work beyond that permitted by
`Section 107 or 108 of the 1976 United States Copyright Act without the permission
`of the copyright owner is unlawful. Requests for permission or further information
`should be addressed to the Permissions Department, John Wiley & Sons, Inc.
`
`This publication is designed to provide accurate and authoritative information in
`regard to the subject matter covered. It is sold with the understanding that the pub—
`lisher is not engaged in rendering legal, accounting, or other professional service. If
`legal advice or other expert assistance is required, the services of a competent pro‘
`fessional person should be sought. From a Declaration of Principles jointly
`adapted by a Committee of the American Bar Association and a Committee of
`Publishers.
`
`Library of Congress Cataloging-in-Publication Data
`
`Elder, Alexander
`Trading for a living : psychology, trading tactics, money
`management / Alexander Elder.
`
`cm.
`p.
`Includes bibliographical references and index.
`ISBN 0—471-59224—2
`
`1. Stocks.
`I~IG4661.E43
`
`2. Futures.
`1992
`
`32.64’5 —— d020
`
`3. Options (Futures)
`
`I. Title.
`
`92—35165
`
`Printed in the United States of America
`
`32
`
`0002
`!!!"
`
`
`
`
`
`[11
`
`Classical Chart Analysis
`
`
`
`18. CHARTING
`
`Chartists study market action, trying to identify recurrent price patterns.
`Their goal is to profit from trading when patterns recur. Most chartists work
`with bar graphs showing high, low, and closing prices and volume. Some
`also watch opening prices and open interest. Point—and-figure chartists track
`only price changes and ignore time, volume, and open interest.
`Classical charting requires only a pencil and paper. It appeals to visually
`oriented people. Those who plot data by hand often develop a physical feel
`for prices. Computers speed charting at a cost of losing some of that feel.
`The biggest problem in charting is wishful thinking. Traders often con-
`vince themselves that a pattern is bullish or bearish depending on whether
`they want to buy or to sell.
`Early in this century Herman Rorschach, a Swiss psychiatrist, designed a
`test for exploring a person’s mind. He dropped ink on 10 sheets of paper and
`folded each in half, creating a symmetrical inkblot. Most people who peer at
`these sheets describe what they see: parts of the anatomy, animals, buildings,
`and so on. In reality, there are only inkblots! Each person sees what’s on his
`mind. Most traders use charts as a giant Rorschach test. They project their
`hopes, fears, and fantasies onto the charts. '
`
`Brief History
`
`The first chartists in the United States appeared at the turn of the century.
`They included Charles Dow, the author of a famous stock market theory, and
`
`69
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`!!!"
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`70
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`CLASSICAL CHART ANALYSIS
`
`William Hamilton, who succeeded Dow as the editor of the Wall Street
`Journal. Dow’s famous maxim was “The averages discount everything.” He
`meant that changes in the Dow Jones Industrial and Rail Averages reflected
`all knowledge and hopes about the economy and the stock market.
`Dow never wrote a book, only the Wall Street Journal editorials.
`Hamilton took over the job after Dow died and struck a blow for charting
`when he wrote “The Turn of the Tide,” an editorial following the 1929 crash.
`Hamilton laid out the principles of Dow theory in his book, The Stock
`Market Barometer. Robert Rhea, a newsletter publisher, brought the theory
`to its pinnacle in his 1932 book, The Dow Theory.
`The decade of the 19303 was the Golden Age of charting. Many innovators
`found themselves with time on their hands after the crash of 1929. Schabaker,
`Rhea, Elliott, Wyckoff, Gann, and others published their research during that
`decade. Their work went in two distinct directions. Some, such as Wyckoff
`and Schabaker, saw charts as a graphic record of supply and demand in the
`markets. Others, such as Elliott and Gann, searched for a perfect order in the
`markets — a fascinating but futile undertaking (see Section 6).
`In 1948, Edwards (who was a son—in-law of Schabaker) and Magee pub—
`lished Technical Analysis of Stock Trends. They popularized such concepts
`as triangles, rectangles, head-and-shoulders, and other chart formations, as
`well as support and resistance and trendlines. Other chartists have applied
`these concepts to commodities.
`Markets have changed a great deal since the days of Edwards and Magee.
`In the 19405, daily volume of an active stock on the New York Stock
`Exchange was only several hundred shares, while in the 19908 it often
`exceeds a million. The balance of power in the stock market has shifted in
`favor of bulls. Early chartists wrote that stock market tops were sharp and
`fast, while bottoms took a long time to develop. That was true in their defla~
`tionary era, but the opposite has been true since the 1950s. New bottoms
`tend to form quickly while tops tend to take longer.
`
`The Meaning of a Bar Chart
`
`Chart patterns reflect the tides of greed and fear among traders. This book
`focuses on daily charts, but you can apply many of its principles to other
`data. The rules for reading weekly, daily, hourly, or intraday charts are very
`similar.
`
`Each price is a momentary consensus of value of all market participants
`
`
`
`!!!"
`
`
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`
`
`18. CHARTING
`
`71
`
`Max power of bulls (high)
`
`Amateurs (open)
`
`Professionals (close)
`
`short bars.
`
`Max power of bears (low)
`
`Figure 18—1. The Meaning of a Bar Chart
`
`Opening prices are set by amateurs, whose orders accumulate overnight
`and hit the market in the morning. Closing prices are largely set by mar~
`ket professionals, who trade throughout the day. Note how often open-
`ing and closing prices are at opposite ends of a bar.
`The high of each bar marks the maximum power of bulls during that
`bar. The low of each bar marks the maximum power of bears during that
`bar. Slippage tends to be less when you enter or exit positions during
`
`expressed in action. Each price bar provides several pieces of information
`about the balance of power between bulls and bears (Figure 18-1).
`The opening price of a daily or a weekly bar usually reflects the ama~
`tears’ opinion of value. They read morning papers, find out what happened
`the day before, and call their brokers with orders before going to work.
`Amateurs are especially active early in the day and early in the week.
`Traders who researched the relationship between opening and closing prices
`for several decades found that opening prices most often occur near the high or
`the low of the daily bars. Buying or selling by amateurs early in the day creates
`an emotional extreme from which prices recoil later in the day.
`In bull markets, prices often make their low for the week on Monday or
`
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`!!!"
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`
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`72
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`CLASSICAL CHART ANALYSIS
`
`Tuesday on profit taking by amateurs, then rally to a new high on Thursday
`or Friday. In bear markets, the high for the week is often set on Monday or
`Tuesday, with a new low toward the end of the week, on Thursday or Friday.
`The closing prices of daily and weekly bars tend to reflect the actions of
`professional traders. They watch the markets throughout the day, respond to
`changes, and become especially active near the close. Many of them take
`profits at that time to avoid carrying trades overnight.
`Professionals as a group usually trade against the amateurs. They tend to
`buy lower openings, sell short higher openings, and unwind their positions as
`the day goes on. Traders need to pay attention to the relationship between
`opening and closing prices. If prices closed higher than they opened,
`then
`market professionals were probably more bullish than amateurs. If prices
`closed lower than they Opened, then market professionals were probably
`more bearish than amateurs. It pays to trade with the professionals and
`against the amateurs.
`The high of each bar represents the maximum power of bulls during that
`bar. Bulls make money when prices go up. Their buying pushes prices
`higher, and every uptick adds to their profits. Finally, bulls reach a point
`where they cannot lift prices“ not even by one more tick. The high ,of a daily
`bar represents the maximum power of bulls during the day, and the high of a
`weekly bar marks the maximum power of bulls during the week; the high of
`a 5—minute bar reflects the maximum power of bulls during that 5-minute
`period. The highest point of a bar represents the maximum power of bulls
`during that bar.
`The low of each bar represents the maximum power of bears during that
`bar. Bears make money when prices go down. They keep selling short, their
`selling pushes prices lower, and every downtick adds to their profits. At
`some point they run out of either capital or enthusiasm, and prices stop
`falling. The low of each bar shows the maximum power of bears during that
`bar. The low of a daily bar marks the maximum power of bears during that
`day, and the low of a weekly bar identifies the maximum power of bears dur-
`ing that week.
`The closing tick of each bar reveals the outcome of a battle between
`bulls and bears during that bar. if prices close near the high of the daily bar,
`it shows that bulls won the day’s battle. If prices close near the low of the
`day, it shows that bears won the day. Closing prices on daily charts of the
`futures markets are especially important. The amount of money in your
`account depends on them because your account equity is “marked to market”
`each night.
`7
`The distance between the high and the low of any bar reveals the inten-
`
`
`
`!!!"
`ooo,
`
`
`
`
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`l8. CHARTINC
`
`73
`
`sity of conflict between bulls and bears. An average bar marks a relatively
`cool market. A bar that is only half as long as average reveals a sleepy, disin-
`terested market. A bar that is two times taller than average shows a boiling
`market where bulls and bears battle all over the field.
`Slippage (see Section 3) is usually lower in quiet markets. It pays to enter
`your trades during short or normal bars. Tall bars are good for taking profits.
`Trying to put on a position when the market is running is like jumping on a
`moving train. It is better to wait for the next one.
`
`Japanese Candlesticks
`
`Japanese rice traders began using candlestick charts some two centuries
`before the first chartists appeared in America. Instead of bars, these charts
`have rows of candles with wicks at both ends. The body of each candle rep-—
`resents the distance between the opening and closing prices. If the closing
`price is higher than the opening, the body is white. If the closing price is
`lower, the body is black.
`_
`The tip of the upper wick represents the high of the day, and the bottom of
`the lower wick represents the low of the day. The Japanese consider highs and
`lows relatively unimportant, according to Steve NiSOn, author of Japanese
`Candlestick Charting Techniques. They focus on the relationship between
`opening and closing prices and on patterns that include several candles.
`The main advantage of a candlestick chart is its focus on the struggle
`between amateurs who control openings and professionals who control clos-
`ings. Unfortunately, most candlestick chartists fail to use many tools of
`Western analysts. They ignore volume and have no trendlines or technical
`indicators. These gaps are being filled by modern American analysts such as
`Greg Morris, whose Candlepower software combines Western technical
`indicators with classical candlestick patterns.
`
`Market Profile
`
`This charting technique for tracking accumulation and distribution during
`each trading session was developed by J. Peter Steidlmayer. Market Profile
`requires access to real~time data—— a constant flow of quotes throughout the
`day. It assigns one letter of the alphabet to each half-hour of trading. Each
`price level reached during that half—hour is marked with its own letter.
`As prices change, more and more letters fill the screen, creating a bell-
`
`/fillbI-‘C-‘fiVr-KJvm-‘nmzi-
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`myrrh-u
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`0007
`!!!"
`
`
`
`
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`
`74
`
`CLASSICAL CHART ANALYSIS
`
`shaped curve. When prices erupt in a trend, Market Profile reflects that by
`becoming elongated. Market Profile is sometimes combined with Liquidity
`Data Bank. It tracks intraday volume of trading by several groups-ufloor
`traders, hedgers, and off-the—floor traders.
`
`Efficient Markets, Random Walk, and Nature’s Law
`
`Efficient Market theory is an academic notion that nobody can outperform
`the market because any price at any given moment incorporates all available
`information. Warren Buffet, one of the most successful investors of our cen—
`tury, commented: “I think it’s fascinating how the ruling orthodoxy can
`cause a iot of people to think the earth is flat. Investing in a market where
`people believe in efficiency is like playing bridge with someone who’s been
`told it doesn’t do any good to look at the cards.”
`The logical flaw of Efficient Market theory is that it equates knowledge
`with action. People may have knowledge, but the emotional pull of the
`crowd often leads them to trade irrationally. A good analyst can detect repet—
`itive patterns of crowd behavior on his charts and exploit them.
`Random Walk theorists claim that market prices change at random. Of
`course, there is a fair amount of randomness or “noise” in the markets, just
`as there is randomness in any other crowd milling around. An intelligent
`observer can identify repetitive behavior patterns of a crowd and make sensi-
`ble bets on their continuation or reversal.
`People have memories, they remember past prices, and their memories
`influence their buying and selling decisions. Memories help create support
`under the market and resistance above it. Random Walkers deny that memo-
`ries of the past influence our behavior in the present.
`As Milton Friedman has pointed out, prices carry information about the
`availability of supply and the intensity of demand. Market participants use
`that information to make their buying and selling decisions. For example,
`consumers buy more merchandise when it is on sale and less when prices are
`high. Financial traders are just as capable of logical behavior as homemakers
`in a supermarket. When prices are low, bargain hunters step in. A shortage
`can lead to a buying panic, but high prices choke off demand.
`Nature’s Law is the rallying cry of a clutch of mystics who oppose
`Random Walkers in the financial markets. Mystics claim that there is a per-
`fect order in the markets, which they say move like clockwork in response to
`immutable natural laws. R. N. Elliott even titled his last book Nature ’5 Law.
`
`
`
`0008
`!!!"
`
`
`
`19. SUPPORT AND RESISTANCE
`
`75
`
`The “perfect order” crowd gravitates to astrology and looks for links
`between prices and the movements of the planets. Most mystics try to hide
`their astrological bent, but it is easy to draw them out of a shell. Next time
`someone talks to you about natural order in the markets, ask him about
`astrology. He will probably jump at the chance to come out of the closet and
`talk about the stars.
`Those who believe in perfect order in the markets accept that tops and
`bottoms can be predicted far into the future. Amateurs love forecasts, and
`mysticism provides a great marketing gimmick. It helps sell courses, trading
`systems, and newsletters.
`Mystics, Random Walk academics, and Efficient Market theorists have
`one trait in common. They are equally divorced from the reality of the mar-
`kets. Extremists argue with one another but they think alike.
`
`19. SUPPORT AND RESISTANCE
`
`A ball hits the floor and bounces. It drops after it hits the ceiling. Support
`and resistance are like a floor and a ceiling, with prices sandwiched between
`them. Understanding support and resistance is essential for understanding
`price trends and chart patterns. Rating their strength helps you decide
`whether the trend is likely to continue or to reverse.
`Support is a price level where buying is strong enough to interrupt or
`reverse a downtrend. When a downtrend hits support, it bounces like a
`diver who hits the bottom and pushes away from it. Support is represented
`on a chart by a horizontal or near-horizontal line connecting several bot—
`toms (Figure 19-1).
`Resistance is a price level where selling is strong enough to interrupt or
`reverse an uptrend. When an uptrend hits resistance, it stops or tumbles
`down like a man who hits his head on a branch while climbing a tree.
`Resistance is represented on a chart by a horizontal or near~horizontal line
`connecting several tops.
`It is better to draw support and resistance lines across the edges of conges-
`tion areas instead of extreme prices. The edges show where masses of traders
`have changed their minds, while the extreme points reflect only panic among
`the weakest traders.
`Minor support or resistance causes trends to pause, while major support or
`resistance causes them to reverse. Traders buy at support and sell at resis~
`tance, making their effectiveness a self~fulfilling prophecy.
`
`
`
`0009
`!!!"
`
`
`
`76
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`CLASSICAL CHART ANALYSIS
`
`British Pound
`
`Support and resistance zones
`often change their roles
`
`F
`
`
`resistance.
`
`Figure 19-4.
`
`SuppOrt and Resistance
`
`Draw horizontal lines through the upper and lower edges of congestion
`areas. The bottom line marks the support—the level at which buyers over-
`power sellers. The upper line identifies resistance, where sellers over-
`power buyers. Areas of support and resistance often switch their roles.
`Note how the level of support in March became the line of resistance in
`May. The strength of these barriers increases each time prices touch
`them and bounce away.
`Beware of false breakouts from support and resistance. The letter F
`marks false breakouts on this chart. Amateurs tend to follow breakouts,
`while professionals tend to fade (trade against) them. At the right edge of
`the chart, prices are hitting strong resistance. This is the time to look for
`a shorting opportunity, with a protective stop slightly above the line of
`
`Memories, Pain, and Regret
`
`Support and resistance exist because peeple have memories. Our memories
`prompt us to buy and sell at certain levels. Buying and selling by crowds of
`traders creates support and resistance.
`_
`If traders remember that prices have recently stopped falling and, turned
`up from a certain level, they are likely to buy when prices approach that
`
`!!"!
`
`
`
`77
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` l9. SUPPORT AND RESISTANCE
`
`level again. If traders remember that an uptrend has recently reversed after
`rising to a certain peak, they tend to sell and go short when prices approach
`that level again.
`For example, all major rallies in the stock market from 1966 until 1982
`ended whenever the Dow Jones Industrial Average rallied to 950 or 1050.
`The resistance was so strong that traders named it “A Graveyard in the Sky.”
`Once the bulls rammed the market through that level, it became a major sup-
`port area.
`Support and resistance exist because masses of traders feel pain and
`regret. Traders who hold losing positions feel intense pain. Losers are deter—
`mined to get out as soon as the market gives them another chance. Traders
`who missed an opportunity feel regret and also wait for the market to give
`them a second chance. Feelings of pain and regret are mild in trading ranges
`where swings are small and losers do not get hurt too badly. Breakouts from
`trading ranges create intense pain and regret.
`When the market stays flat for a while, traders get used to buying at the
`lower edge of the range and shorting at the upper edge. In uptrends, bears
`who sold short feel pain and bulls feel regret that they did not buy more.
`Both feel determined to buy if the market gives them a second chance. The
`pain of bears and regret of bulls make them ready to buy, creating support
`during reactions in an uptrend.
`Resistance is an area where bulls feel pain, bears feel regret, and both are
`ready to sell. When prices break down from a trading range, bulls who
`bought feel pain, feel trapped, and wait for a rally to let them get out even.
`Bears regret that they have not shorted more and wait for a rally to give them
`a second chance to sell short. Bulls’ pain and bears’ regret create resis-
`tance—-a ceiling above the market in downtrends. The strength of support
`and resistance depends on the strength of feelings among masses of traders.
`
`Strength of Support and Resistance
`
`A congestion area that has been hit by several trends is like a cratered battle-
`field. Its defenders have plenty of cover, and an attacking force is likely to
`slow down. The longer prices stay in a congestion zone, the stronger the
`emotional commitment of bulls and bears to that area. When prices approach
`that zone from above, it serves as support. When prices rally into it from
`below, it acts as resistance. A congestionarea can reverse its role and serve
`as either support or resistance.
`
`
`
`!!""
`
`
`
`78
`
`CLASSICAL CHART ANALYSIS
`
`The strength of every support or resistance zone depends on three factors:
`its length, its height, and the volume of trading that has taken place in it. You
`can visualize these factors as the length, the width, and the depth of a com
`
`gestion zone.
`The longer a support or resistance area — its length of time or the number
`of hits it tookmthe stronger it is. Support and resistance, like good wine,
`become better with age. A 2—week trading range provides only minimal sup.
`port or resistance, a 2—month range gives people time to become used to it
`and creates intermediate support or resistance, while a 2-year range becomes
`accepted as a standard of value and offers major support or resistance.
`As support and resistance levels grow old, they gradually become weaker.
`Losers keep washing out of the markets, replaced by newcomers who do not
`have the same emotional commitment to old price levels. People who lost
`money only recently remember full well what happened to them. They are
`probably still in the market, feeling pain and regret, trying to get even.
`People who made bad decisions several years ago are probably out of the
`markets and their memories matter less.
`The strength of support and resistance increases each time that area is hit.
`When traders see that prices have reversed at a certain level, they tend to bet
`on a reversal the next time prices reach that level.
`The taller the support and resistance zone, the stronger it is. A tall con-
`gestion zone is like a tall fence around a property. A congestion zone whose
`height equals 1 percent of current market value (four points in the case of the
`S&P 500 at 400) provides only minor support or resistance. A congestion
`zone that is 3 percent tall provides intermediate support or resistance, and a
`congestion zone that is 7 percent tall or higher can grind down a majortrend.
`The greater the volume of trading in a support and resistance zone, the
`stronger it is. High volume in a congestion area shows active involvement
`by traders - a sign of strong emotional commitment. Low volume shows that
`traders have little interest in transacting at that level—— a sign of weak support
`
`
`
`
`
`or resistance.
`
`Trading Rules
`
`1. Whenever the trend you are riding approaches support or resistance,
`tighten yourprotective stop. A protective stop is an order to sell below
`the market when you are long or to cover shorts above the market
`when you are short. This stop protects you from getting badly hurt by 001
`
`!!"#
`
`
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`19. SUPPORT AND RESISTANCE
`
`.
`
`79
`
`an adverse market move. A trend reveals its health by how it acts
`when it hits support or resistance. If it is strong enough to penetrate
`that zone, it accelerates, and your tight stop is not touched. If a trend
`bounces away from support or resistance, it reveals its weakness. In
`that case, your tight stop salvages a good chunk of profits.
`
`2. Support and resistance are more important on long-term charts than on
`short~term charts. Weekly charts are more important than dailies. A
`good trader keeps an eye on several timefrarnes and defers to the
`longer one. If the weekly trend is sailing through a clear zone, the fact
`that the daily trend is hitting resistance is less important. When a
`weekly trend approaches support or resistance, you should be more
`inclined to act.
`
`3. Support and resistance levels are useful for placing stop-loss and pro-
`tect-profit orders. The bottom of a congestion area is the bottom line
`of support. If you buy and place your stop below that level, you give
`the uptrend plenty of room. More cautious traders buy after an upside
`breakout and place a stop in the middle of a congestion area. A true
`upside breakout should not be followed by a pullback into the range,
`just as a rocket is not supposed to sink back to its launching pad.
`Reverse this procedure in downtrends.
`
`
`
`Many traders avoid placing stops at round numbers. This superstition
`began with off-the—cuff advice by Edwards and Magee to avoid placing stops
`at round numbers because “everybody” was placing them there. Now, if
`traders buy copper at 92, they place a stop at 89.75 rather than 90. When
`they sell a stock short at 76, they place a protective stop at 80.25 rather than
`80. These days there are fewer stops at round numbers than at fractional
`numbers. It is better to place your stops at logical levels, round or not.
`
`True and False Breakouts
`
`Markets spend more time in trading ranges than they do in trends. Most
`breakouts from trading ranges are false breakouts. They suck in trend-fol»-
`lowers just before prices return into the trading range. A false breakout is the
`bane of amateurs, but professional traders love them.
`_
`Professionals expect prices to fluctuate without going very far most of the
`time. They wait until an upside breakout stops reaching new highs or a
`
`
`
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`30
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`CLASSICAL CHART ANALYSIS
`
`
`
`
`
`downside breakout stops making new lows. Then they pouncewthey fade
`the breakout (trade against it) and place a protective stop at the latest
`extreme point. It is a very tight stop, and their risk is low, while there is a big
`profit potential from a pullback into the congestion zone. The risk/reward
`ratio is so good that professionals can afford to be wrong half the time and 3
`still come out ahead of the game.
`The best time to buy an upside breakout on a daily chart is when your
`analysis of the weekly chart suggests that a new uptrend is developing. True
`breakouts are confirmed by heavy volume, while false breakouts tend to
`have light volume. True breakouts are confirmed when technical indicators
`reach new extreme highs'or lows in the direction of the trend, while false
`breakouts are often marked by divergences between prices and indicators.
`
`20. TREND AND TRADING RANGE
`
`Traders try to profit from changes in prices: Buy low and sell high, or sell
`short high and cover low. Even a quick look at a chart reveals that markets
`spend most of their time in trading ranges. They spend less time in trends.
`A trend exists when prices keep rising or falling over time. In an
`uptrend, each rally reaches a higher high than the preceding rally and each
`decline stops at a higher level than the preceding decline. In a downtrend,
`each decline falls to a lower low than the preceding decline and each rally
`stops at a lower level than the preceding rally. In a trading range, most ral-
`lies stop at about the same high and declines peter out at about the same low.
`A trader needs to identify trends and trading ranges. it is easier to trade
`during trends (Figure 20-1). It is harder to make money when prices are flat
`unless you write options, which requires a special skill.
`Trading in trends and in trading ranges calls for different tactics. When
`you go long in an uptrend or sell short in a downtrend, you have to give that
`trend the benefit of the doubt and not be shaken out easily. It pays to buckle
`your seat belt and hang on for as long as the trend continues. When you trade
`in a trading range, you have to be nimble and close out your position at the
`slightest sign of a reversal.
`'
`Another difference in trading tactics between trends and trading ranges is
`the handling of strength and weakness. You have to follow strength during
`trends—ubuy in uptrends and sell short in downtrends. When prices are in a
`trading range, you have to do the opposite -— buy weakness and sell strength.
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`001
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`20. TREND AND TRADING RANGE
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`81
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`Soybeans
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`blowoff action.
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`Figure 20—1.
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`Trend and Trading Range
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`A pattern of lower bottoms and lower tops defines downtrends.
`Soybeans declined from November until the middle of January. Bottom
`4 was lower than bottom 2, and peak 3 lower than peak 1. The break of
`the downtrendline at point 5 signaled the end of the downtrend. A bro-
`ken downtrend can lead to either a trading range or an uptrend.
`The November—January downtrend has dissolved into a trading range,
`defined by horizontal lines drawn through the low 4 and highs 3 and 6.
`When the decline from high 6 stopped at a higher low 7 without reach-
`ing the bottom of the range, you could draw a preliminary uptrendline.
`A breakout from the range at point 8 confirmed the beginning of a new
`uptrend.
`At the right edge of the chart, prices are hovering just above their
`uptrendline. It is a buying opportunity because the trend is up. The
`downside risk of a trade can be limited by placing a stop either below
`the latest low or below the trendline. Notice that daily trading ranges
`(the distances from highs to lows) are relatively narrow. This is typical of
`a healthy trend. Trends often end after several wide-range daysma sign of
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`ll
`3:.
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`82
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`CLASSICAL CHART ANALYS
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`Mass Psychology
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`An uptrend emerges when bulls are stronger than bears and their buying forces'
`prices up. If bears manage to push prices down, bulls return in force, break the
`decline, and force prices to a new high. Downtrends occur when bears are
`stronger and their selling pushes markets down. When a flurry of buying lifts
`prices, bears sell short into that rally, stop it, and send prices to new lows.
`When bulls and bears are equally strong or weak, prices stay in a trading
`range. When bulls manage to push prices up, bears sell short into that rally
`and prices fall. Bargain hunters step in and break the decline; bears cover
`shorts, their buying fuels a minor rally, and the cycle repeats.
`A trading range is like a fight between two equally strong gangs. They
`push one another back and forth on a street corner but neither can control the
`turf. A trend is like a fight where a stronger gang chases the weaker gang
`down the street. Every once in a while the weaker gang stops and puts up a
`fight but then is forced to turn and run again.
`Prices in trading ranges go nowhere, just as crowds spend most of their
`time in aimless milling. Markets spend more time in trading ranges than in
`trends because aimlessness is more common among people than purposeful
`action. When a crowd becomes agitated, it surges and creates a trend.
`Crowds do not stay excited for long—they go back to meandering.
`Professionals tend to give the benefit of the doubt to trading ranges.
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`The Hard Right Edge
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`Identifying trends and trading ranges is one of the hardest tasks in technical
`analysis. It is easy to find them in the middle of a chart, but the closer you
`get to the right edge, the harder it gets.
`Trends and trading ranges clearly stand out on old charts. rExperts show
`those charts at seminars and make it seem easy to catch trends. Trouble is,
`your broker does not allow you to trade in the middle of the chart. He says
`you must make your trading decisions at the hard right edge of the chart!
`The past is fixed and easy to analyze. The future is fluid and uncertain. By
`the time you identify a trend, a good chunk of it is gone. Nobody rings a bell
`when a trend dissolves into a trading range. By the time you recognize that
`change, you will lose some money trying to trade as if the market was still
`trending.
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` 20. TREND AND TRADING RANGE
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`83
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`Many chart patterns and indicator signals contradict one another at the
`right edge of the chart. You have to base your decisions on probabilities in an
`atmosphere of uncertainty.
`Most people cannot accept uncertainty. The