Getting Started in Technical Analysis PDF
Preview Getting Started in Technical Analysis
Page i Getting Started in Technical Analysis Page ii The Getting Started in Series Getting Started in Asset Allocation by Bill Bresnan and Eric P. Gelb Getting Started in Online Investing by David L. Brown and Kassandra Bentley Getting Started in Stocks by Alvin D. Hall Getting Started in Security Analysis by Peter J. Klein Getting Started in Futures by Todd Lofton Getting Started in Technical Analysis by Jack D. Schwager Getting Started in Options by Michael C. Thomsett Getting Started in Real Estate Investing by Michael C. Thomsett and Jean Freestone Thomsett Getting Started in Annuities by Gordon M. Williamson Getting Started in Bonds by Sharon Saltzgiver Wright Coming Soon . . . Getting Started in Mutual Funds by Alvin D. Hall Getting Started in 401(k) Investing by Paul Katzeff Getting Started in Financial Information by Daniel Moreau Page iii Getting Started in Technical Analysis Jack D. Schwager Page iv This book is printed on acidfree paper. Copyright © 1999 by Jack D. Schwager. All rights reserved. Published by John Wiley & Sons, Inc. Published simultaneously in Canada. TradeStation® is a registered trademark of Omega Research, Inc. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate percopy fee to the Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA 01923, (978) 7508400, fax (978) 7504744. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 605 Third Avenue, New York, NY 101580012, (212) 8506011, fax (212) 8506008, EMail: [email protected]. 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 publisher is not engaged in rendering professional services. If professional advice or other expert assistance is required, the services of a competent professional person should be sought. Library of Congress CataloginginPublication Data: Schwager, Jack D., 1948— Getting started in technical analysis / Jack D. Schwager p. cm.—(Getting started in) Includes index. ISBN 0471295426 (pbk.:alk. paper) 1. Stock price forecasting. 2. Investment analysis. 3. Stocks— Charts, diagrams, etc. I. Title. II. Series. HG4637.S37 1998 332.63'222—dc21 9823565 Printed in the United States of America. 10 9 8 7 6 5 4 3 2 Page v CONTENTS Preface vii Introduction: The Great Fundamental Versus Technical Analysis 1 Debate Part One: Basic Analysis Tools 5 Chapter 1 7 Charts: Forecasting Tool or Folklore? Chapter 2 17 Types of Charts Chapter 3 33 Trends Chapter 4 51 Trading Ranges and Support and Resistance Chapter 5 73 Chart Patterns Chapter 6 110 Oscillators Chapter 7 120 Is Chart Analysis Still Valid? Part Two: Trading Issues 127 Chapter 8 129 Midtrend Entry and Pyramiding Page vi Chapter 9 136 Choosing StopLoss Points Chapter 10 143 Setting Objectives and Other Position Exit Criteria Chapter 11 152 The Most Important Rule in Chart Analysis Chapter 12 178 RealWorld Chart Analysis Part Three: Trading Systems 219 Chapter 13 221 Charting and Analysis Software Chapter 14 226 Technical Trading Systems: Structure and Design Chapter 15 253 Testing and Optimizing Trading Systems Part Four: Practical Trading Guidelines 275 Chapter 16 277 The Planned Trading Approach Chapter 17 288 EightyTwo Trading Rules and Market Observations Chapter 18 299 Market Wiz(ar)dom Appendix 315 Additional Concepts and Formulas Glossary 325 Index 333 Page vii PREFACE Trading success cannot be capsulized in a simple indicator, formula, or system—the pronouncements of countless books, advertisements, and brochures notwithstanding. This book is written by a trader, from a trader's perspective, rather than being yet another compendium of analytical techniques, indicators, or systems, using idealized illustrations. In explaining various analytical techniques and methods, I have tried to keep in the forefront key questions that are often ignored by writers of books on technical analysis: How can the methods described be applied in actual trading? What works and doesn't work in the real world? What are the implications of a method's failure? How can trading systems be designed and tested to maximize their future performance rather than their past performance? This is a practical book. I have used many of the methods described in this volume to construct a very profitable trading approach—yes, with real money. Why then am I willing to share this information? Because, to use a building metaphor, I am supplying the tools, but not the architectural design—that is left to the individual reader. I believe that readers who are serious about using technical analysis to become more successful traders and who understand that this goal requires individual work will find much here that is useful. JACK D. SCHWAGER Unless otherwise indicated, the charts in this book are reproduced courtesy of Prudential Securities, Inc. Page 1 INTRODUCTION— THE GREAT FUNDAMENTAL VERSUS TECHNICAL ANALYSIS DEBATE Curiously, however, the broken technician is never apologetic about his method. If anything, he is more enthusiastic than ever. If you commit the social error of asking him why he is broke, he will tell you quite ingeniously that he made the alltoohuman error of not believing his own charts. To my great embarrassment, I once choked conspicuously at the dinner table of a chartist friend of mine when he made such a comment. I have since made it a rule never to eat with a chartist. It's bad for digestion. —Burton G. Malkiel, A Random Walk Down Wall Street One evening, while having dinner with a fundamentalist, I accidentally knocked a sharp knife off the edge of the table. He watched the knife twirl through the air, as it came to rest with the pointed end sticking into his shoe. "Why didn't you move your foot?" I exclaimed. "I was waiting for it to come back up," he replied. —Ed Seykota (an avowed technician) Most speculators, especially those active primarily in stocks, are accustomed to trading from a fundamental perspective. Fundamental analysis involves the use of economic data—for example, P/E ratios or book values in the case of stocks, or crop reports or import/export figures in the case of commodity futures—to forecast prices, or equivalently, to gauge whether a market is overvalued or undervalued. Technical analysis, by comparison, is the study of price activity—more specifically, price patterns—to identify favorable trade opportuni Page 2 ties. The logical basis for this approach has two major elements. First, that the price of a particular stock, commodity, or financial future reflects all the knowable information about that asset at any given time and the opinions of all market participants regarding that information. Second, that the fundamental information and market opinions reflected by price will result in recurring price patterns that provide clues to potential future price movement. Hence, by analyzing historical price patterns, the technical analyst looks for price behavior that suggests the possible initiation, conclusion, or continuation of a trend. Which method—fundamental analysis or technical analysis—is better? This question is the subject of great debate. Interestingly, the experts are no less divided on this issue than the novices are. In a pair of books in which I interviewed some of the world's best traders (Market Wizards, New York Institute of Finance, 1988, and The New Market Wizards, HarperBusiness, 1992), I was struck by the sharply divergent views on this issue. Jim Rogers was characteristic of one extreme of the spectrum. During the 1970s, Jim Rogers and George Soros were the two principals of the Quantum Fund, perhaps the most successful Wall Street fund of its day. In 1980, Rogers left the fund to escape managerial responsibilities and to devote himself fulltime to managing his own investments—an endeavor at which he again proved spectacularly successful. (The Quantum Fund continued to maintain its excellent performance under George Soros's directorship.) Over the years, Rogers has been on record with a high percentage of accurate market forecasts. As but one example, in my 1988 interview with him, Rogers correctly predicted both the massive collapse in the Japanese stock market and the continued multiyear downtrend in gold prices. Clearly, Jim Rogers is a man whose opinion merits serious attention. When I queried Rogers about his opinion on chart reading (the classical method of technical analysis), he replied: "I haven't met a rich technician. Excluding, of course, technicians who sell their services and make a lot of money." That cynical response succinctly summarized Rogers's view about technical analysis. Marty Schwartz is a trader whose opinion lies at the other extreme. At the time of our interview, Schwartz, an independent stock index futures trader, was considering managing outside money. In conjunction with this undertaking, he had just had his personal track record audited, and he allowed me to view the results. During the prior 10year period, he had achieved an average return of 25%—monthly! Equally impressive, during this 120month period, he witnessed only two losing months— minuscule declines of 2% and 3%. Again, here was an individual whose opinion on the market demanded serious respect. Although I did not mention Rogers's comments to Schwartz, when I asked Schwartz whether he had made a complete transition from funda
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