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Technical Analysis Explained This page intentionally left blank Technical Analysis Explained The SucceSSful InveSTor’S GuIde To SpoTTInG InveSTmenT TrendS and TurnInG poInTS FiFth Edition Martin J. Pring New York Chicago San Francisco Athens London Madrid Mexico City Milan New Delhi Singapore Sydney Toronto Copyright © 2014 by McGraw-Hill Education. All rights reserved. Except as permited under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher. ISBN: 978-0-07-182655-6 MHID: 0-07-182655-6 The material in this eBook also appears in the print version of this title: ISBN: 978-0-07-182517-7, MHID: 0-07-182517-7. eBook conversion by codeMantra Version 2.0 All trademarks are trademarks of their respective owners. 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THE WORK IS PROVIDED “AS IS.” McGRAW-HILL EDUCATION AND ITS LICENSORS MAKE NO GUARANTEES OR WARRANTIES AS TO THE ACCURACY, ADEQUACY OR COMPLETENESS OF OR RESULTS TO BE OBTAINED FROM USING THE WORK, INCLUDING ANY INFORMATION THAT CAN BE ACCESSED THROUGH THE WORK VIA HYPERLINK OR OTHERWISE, AND EXPRESSLY DISCLAIM ANY WARRANTY, EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITED TO IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. McGraw-Hill Education and its licensors do not warrant or guarantee that the functions contained in the work will meet your requirements or that its operation will be uninterrupted or error free. Neither McGraw-Hill Education nor its licensors shall be liable to you or anyone else for any inaccuracy, error or omission, regardless of cause, in the work or for any damages resulting therefrom. McGraw-Hill Education has no responsibility for the content of any information accessed through the work. Under no circumstances shall McGraw-Hill Education and/or its licensors be liable for any indirect, incidental, special, punitive, consequential or similar damages that result from the use of or inability to use the work, even if any of them has been advised of the possibility of such damages. This limitation of liability shall apply to any claim or cause whatsoever whether such claim or cause arises in contract, tort or otherwise. To my son, Thomas William Pring This page intentionally left blank vii Contents Preface ix Part I: Trend-Determining Techniques 1. The Definition and Interaction of Trends 3 2. Financial Markets and the Business Cycle 17 3. Dow Theory 29 4. Typical Parameters for Intermediate Trends 41 5. How to Identify Support and Resistance Zones 55 6. Trendlines 70 7. Basic Characteristics of Volume 97 8. Classic Price Patterns 115 9. Smaller Price Patterns and Gaps 166 10. One- and Two-Bar Price Patterns 186 11. Moving Averages 209 12. Envelopes and Bollinger Bands 233 13. Momentum I: Basic Principles 246 14. Momentum II: Individual Indicators 279 15. Momentum III: Individual Indicators 311 16. Candlestick Charting 340 17. Point and Figure Charting 373 18. Miscellaneous Techniques for Determining Trends 383 19. The Concept of Relative Strength 401 20. Putting the Indicators Together: The DJ Transports 1990–2001 423 viii • Contents Part II: Market Structure 21. Price: The Major Averages 431 22. Price: Sector Rotation 455 23. Time: Analyzing Secular Trends for Stocks, Bonds, and Commodities 471 24. Time: Cycles and Seasonal Patterns 499 25. Practical Identification of Cycles 525 26. Volume II: Volume Indicators 531 27. Market Breadth 560 Part III: Other Aspects of Market Analysis 28. Indicators and Relationships That Measure Confidence 593 29. The Importance of Sentiment 610 30. Integrating Contrary Opinion and Technical Analysis 635 31. Why Interest Rates Affect the Stock Market 653 32. Using Technical Analysis to Select Individual Stocks 673 33. Technical Analysis of International Stock Markets 694 34. Automated Trading Systems 713 35. Checkpoints for Identifying Primary Stock Market Peaks and Troughs 739 Epilogue 753 Appendix: The Elliott Wave 755 Glossary 761 Bibliography 767 Index 773 ix PReFACe There is no reason why anyone cannot make a substantial amount of money in the financial markets, but there are many reasons why many people will not. As with most endeavors in life, the key to success is knowledge and action. This book has been written in an attempt to shed some light on the internal workings of the markets and to help expand the knowledge component, leaving the action to the patience, discipline, and objectivity of the individual investor. The mid- to late-1980s saw the expansion of investment and trading opportunities to a global scale in terms of both the cash and the futures markets. In the 1990s, innovations in the communications industry enabled anyone to plot data on an intraday basis for relatively little cost. Today, numerous charting sites have sprung up on the Internet, so now virtually anyone has the ability to practice technical analysis. Indeed, the technology of teaching technical analysis has progressed since the first edition of this book in 1979. We pioneered the teaching of the subject in video format in the mid-1980s, but I’ll venture to guess that technological progress and the acceptance of new media formats will mean that e-book sales of this edition will outstrip traditional sales of the physical book before it runs its course. Already, the written word is in competition with audiovisual presentations, such as my recently introduced online interactive technical analysis video course at pring.com; others are sure to follow! As a consequence of the technological revolution, time horizons have been greatly shortened. I am not sure that this is a good thing because short- term trends experience more random noise than longer-term ones. This means that the technical indicators, while still the most effective tool, are not generally as successful when applied to longer-term trends. The fifth edition of Technical Analysis Explained has been expanded and totally revised to keep abreast of many of these changes, and to include some technical innovations and evolvement in my own thinking since the publication of the fourth edition. Nearly every chapter has been thoroughly reworked and expanded. In the interest of efficiency, some have been dropped and others substituted. Considerable attention continues to be focused on the U.S. equity market, but many of the marketplace examples feature international stock indexes, currencies, commodities, and precious metals. Special chapters also feature technical analysis of the credit markets and global equities. Our focus has also been expanded to include analysis of the secular, or very long-term, trends of stocks, bonds, and commodities. In most cases, the marketplace examples have been updated, but some older ones from previous editions have been left in deliberately to give the book some historical perspective. These historical examples also underscore the point that nothing has really changed in the last 100 years. The same tried-and-true principles are as relevant today as they always were. I have no doubt whatsoever that this will continue to be so in the future. Thus, technical analysis could be applied in New York in 1850, in Tokyo in 1950, and in Moscow in 2150. This is true because price action in financial markets is a reflection of human nature, and human nature remains more or less constant. Technical principles can also be applied to any freely traded entity in any time frame. A trend-reversal signal on a 5-minute bar chart is based on the same indicators as one on a monthly chart; only the significance is different. Shorter time frames reflect shorter trends and are, therefore, less significant. The chronological sequence of some of the opening chapters differs from previous editions. In Martin Pring on Price Patterns (McGraw-Hill, 2005), I approached the subject by first describing the building blocks of price formations, peak-and-trough analysis, support and resistance, trendlines, and volume characteristics. This same logical sequence has been applied here, so when anyone proceeds to the explanation of price patterns they will be in a far stronger position to understand how these formations are constructed and interpreted. Two new chapters have been added in this edition. One on secular trends has already been referred to. The secular, or very long-term, trend is the granddaddy of them all and exists for each of the three primary asset classes: bonds, stocks, and commodities. The more I study markets, the more I become impressed with the fact that the direction of the secular trend influences the characteristics of the trends that fall directly below it. In secular uptrends, primary bull (business cycle–associated) trends generally have greater magnitude and duration than do bear markets and vice x • Preface Preface • xi versa. Understanding the characteristics of secular trends and how their reversal might be identified is therefore a key objective of Chapter 23. Our second new chapter discusses indicators and relationships that measure confidence in the U.S. equity market. The discussion points out that market reversals are often signaled ahead of time in a subtle way by changes in relationships that monitor investor confidence. Other impor- tant items that have been inserted in existing chapters include my Special K indicator. This momentum series is calculated from the summed cyclicality of the short-term, intermediate-term, and long-term Know Sure Thing (KST) and offers a series that on most occasions peaks and troughs simul- taneously with the price series it is monitoring. Another feature of the fifth edition is the inclusion of many exchange-traded funds (ETFs) as illustra- tive examples. These innovative products now allow investors and traders to purchase a basket of stocks or bonds reflecting popular indexes, sectors, or countries—and this is just the beginning. Indeed, active ETFs, such as the Pring Turner Business Cycle ETF (symbol DBIZ), allow investors to par- ticipate in various strategies, such as the approach discussed in Chapter 2. The introduction and widespread acceptance of ETFs make it so much easier for investors to gain exposure to individual country equity markets, credit market instruments, practice sector rotation, purchase inverse funds if they believe prices are headed lower, etc. In addition, recent years have seen the launch of exchange-traded notes, which allow the purchase of selected commodities. However, investors need to be careful to check tax implications and to make sure that swings in carrying costs in the futures markets truly reflect the ups and downs of the commodities in question. Since the 1970s, the time horizon of virtually all market participants has shrunk considerably. As a result, technical analysis has become very popular for implementing short-term timing strategies. This use may lead to great disappointment: In my experience, there is a rough correlation between the reliability of the technical indicators and the time span being monitored. This is why most of the discussion here has been oriented toward intermediate-term and long-term trends. Even short-term traders with a 1- to 3-week time horizon need to have some understanding of the direction and maturity of the main or primary trend. This is because mis- takes are usually made by taking on positions that go against the direction of the main trend. If a whipsaw (false signal) is going to develop, it will usually arise from a contratrend signal. Think of it as paddling upstream against the current. It can be done, but with great difficulty. Far better to have the current behind you. xii • Preface To be successful, technical analysis should be regarded as the art of assessing the technical position of a particular security with the aid of sev- eral scientifically researched indicators. Although many of the mechanistic techniques described in this book offer reliable indications of changing market conditions, all suffer from the common characteristic that they can, and occasionally do, fail to operate satisfactorily. This attribute presents no problem to the consciously disciplined investor or trader, since a good working knowledge of the principles underlying major price move- ments in financial markets and a balanced view of the overall technical position offer a superior framework within which to operate. There is, after all, no substitute for independent thought. The action of the technical indicators illustrates the underlying characteristics of any market, and it is up to the analyst to put the pieces of the jigsaw puzzle together and develop a working hypothesis. The task is by no means easy, as initial success can lead to overcon- fidence and arrogance. Charles H. Dow, the father of technical analysis, once wrote words to the effect that “pride of opinion caused the down- fall of more men on Wall Street than all the other opinions put together.” This is true because markets are essentially a reflection of people in action. Normally, such activity develops on a reasonably predictable path. Since people can—and do—change their minds, price trends in the market can deviate unexpectedly from their anticipated course. To avoid serious trou- ble, investors, and especially traders, must adjust their attitudes as changes in the technical position emerge. That does not mean that one should turn negative because prices are falling. Rather, one should take a bearish tack because the evidence has also done so. In addition to pecuniary rewards, a study of the market can reveal much about human nature, both from observing other people in action and from the aspect of self-development. As investors react to the constant struggle through which the market will undoubtedly put them, they will also learn a little about their own makeup. Washington Irving might well have been referring to this challenge of the markets when he wrote, “Little minds are taxed and subdued by misfortune but great minds rise above it.” Martin J. Pring October 2013 Part I TREND-DETERMINING TECHNIQUES This page intentionally left blank