Chart Reading for Professional Traders by Michael S. Jenkins ct nC, 1. TRADERS PRESS, INC. ENC O Rin @ WATT EO PO Bi 1206 GREENVIL 29606Mictaret 9, tenkinsBiographical Sketch of Michael S. Jenkins Michael S. Jenkins was bom in Schenectady, New York on March 12, 1949. From earliest, childhood, he was fascinated with the stock market and studied every book and publication he ‘could find reganding the subject. He studied Economics and Business Administration at Washington & Lee University and graduated with a BS in Commerce in 1971. In 1975, he received an MBA from George Mason University. He passed te Uniform CPA Examination the same yea Mr. Jenkins held positions at various bank trust departments from 1971 appointed portfolio managerfor three munval furdsin Washington, DC, 5. and in 1976, he was, Tn 1984, Mr. Jenkins maved to New York City to became a professional trader for a number of specialist firms on the NYSE. In 1985, he founded the investment newsletter “Stock Cycles Forecast.” Because of the widespread notoriety this letter received in precisely predicting the final stock market high in August 1987 and specifically calling for a 500 point Arup in the Dow that would end by October I9th of ¢hat year, Mr. Jenkins has become a frequent commentator on television and radio and is often the subject of numerous popular financial magazine and newspaper articles, Nearly every major high and low of significance in the past several years has been successfully forecasted in the “Stock Cycles Forecast” newsletter — many down to the exact day and ina few cases, the exact hour on those dates! Mr. Jenkins is considered an authority on cycles in the financial markets and often lectures on this subject, as well as providing investment seminars where bis proprictary trading methods are taught. He is the author of The Geomeiry of Stock Market Profits, A Guide To Professional Trading For A Living. This new book, Chart Reading For Professional Traders, is an attempt to provide the investing public with abasic reference work for reading charts to forecast and trade the speculative markets, using his proprietary discoveries in the area of technical analysis.Acknowledgments 1} wish to thank the following chart services for use of their charts in the various illustrations: Daily Graphs MetaStock PO Box 66919 EQUAS International, Inc. Los Angles, CA 90066-0919 3950 South 700 East Salt Lake City, UT 84107 Securities Research Company DollarLink Software 101 Prescott Street 1407 Dougine Street Wellesley Hills, MA 02181-3319 San Francisco, CA 94131 M.C. Horsey & Company, Ine. 120 South Blvd. Salisbury, MD 21801 Special thanks and appreciation are also extended to the following individuals from ‘Traders Press, who have spent countless hours in revising the original edition of this book: Alfan McGill Dobson Margaret Ros Hudson Theresa PutyerTRADERS PRESS, INC” INCORPORATED P.O. BOX 6206 GREENVILLE, S.C. 29606 Books and Gifis for Investors and Traders Publishers of: Commodity Spreads: A Historical Chart Perspective (Dobson) ‘The Trading Rule That Can Make You Rich* Dobson} Viewpoints of a Commodity Trader (Longstreet! Commodities: A Chart Anthology (Dobson) Profitable Grain ‘Trading (Ainsworth) A Complete Guide fo Trading Profits (Paris) ‘Traders Guide to ‘Technical Anatysla (Hardy) ‘The Professional Commodity Trader (Kroll) Jesse Livermore: Speculator-King (Sarnoff) Understanding Fibonacci Numbers (Dobsor} ‘Wall Street Ventures & Adventures through Ferty Years (Wyckoll) ‘Winning Market Systems (Appel) Tlow to Trade In Stoctes (Livermore) Stock Market Trading Systems (Appel & Hitschles) Study Helps in Polut and Figure Technique (Wheclan) Commodity Spreads: Analysts, Selection and Trading Techniques (Smith Comparison of Twelve Technical Trading Systems (Tukac, Brorsen, & Irvin) Day Trading with Short Term Price Patterns and Opening Range Breakout (Crabs!) Understanding Bollinger Bands (Dobsor) Chart Reading for Profecetonal Traders (Jenkins) Geometry of Stock Market Profits (lenkins! Please write ot call for our current catalog describing these and many other books and gifts of interest investors and traders. 1-800-927-8222 FAX 864-208-0221 ‘[email protected]TRADERS PRESS, INC? tNcoRroRATED P.O. BOX 6206 GREENVILLE, S.C. 29606 BOOKS AND GIFTS FOR TRADERS ANDINVESTORS. TRADERS PRESS, INC. stocks hundreds of titles of interest to investors and traders in stocks, options, and fotures. inaddition, wecarry a fall line of gift tems for investors. Please contact us, and we will gladly forward you our current "/RADER'S CATALOG" by relura ail. 800.927.8222 Fax 864.298.0721 ‘[email protected]Table of Contents Introduction .. Basic Concepts ... ‘Trend .. Circular Arcs Support & Resistance . Waves Angles ‘The Hourly Chart... onal Charts Common Fatterns .. Long Term Charts . Mirror Images ‘Volume... Strategy Intra Day Patterns Step By Step ... S&PEutures Trading ... Trading Stocks Advanced Techniques Appendix A Rxamples ..Introduction There has always been a debate about whether one should invest as a fundamentalist or as a technician. The fundamentalist, of course, does not look at charts but concentrates on analyzing hard economic figures in the belief that an improving fundamental situation will lead to higher prices. Although this sounds quite logical and perhaps 98% of all investors invest this way, itis nevertheless wrong. Only in a general sense do the fundamentals concer traders or investors who are looking for capital gains on an annual basis, and certainly day traders can easily go bankrupt from short term corrections against the fundamental bias. Unless major accumulation of an issue takes place, no matter how good the fundamentals, the price is likely to move very little, and itis this price movement that makes money for us. Charts and technical analysis, on the other hand, are mostly concemed with price movement. When securities or commodities are fluctuating, we can trade them and make money. Any truly fundamental development of importance will first show up in the price and volume data long before outsiders will learn about the fundamental development causing it. One does not need illegal information to see illegal accumulation or major developments within a corporation or commodity supply demand factors that may be changing. Money moves the markets, and big money isalways. right no matter what the reason. The skilled chart reader will always see this price movement and be alerted long before others. This is the fundamental argument for chart reading, but more important is the fact that cyclesexist and recur over and over again, showing up in the historical record of the price data and can be analyzed from such data to make future predictions. Wall Street would like to deny the existence of cycles because no oneneeds a highly paid analyst ora full service broker if cycles indicate that a stock or commodity is going up or down the next year, regardless of perceived fundamentals, Only by having a price history can we truly say we know what to expect from our investment, the nature of its personality, the extremes it has traded. to over the years, and where it is deviating from its past patterns, which could indicate anew significant development in the life cycle of the company. For years I have heard the arguments about long term investing and the many people who have made fortunes in the market using a buy and hold strategy. What is not said very often, however, is the tens of millions of investors who bought and held the wrong stock and after thirty years have only broken even or worse saw their company go bankrupt. Books are not written about these unfortunate multitudes. In 1965, General Motors was the most popular stock, and “what wasgood for GM was good for the country.” But,did you know that it took until January 1994 forGM tofinally exceed the price it sold at in 1965!!! It took nearly 30 years for those 1965 buyers to break even! The idea of buy and holdis a fundamental strategy. It assumes the issue you hold is going up every year. Inthese cases, you could get rich over time. But, the modern version of buy and hold has been perverted by the big brokerage firms and mutual funds to lock the customer into their particular investment program without emphasis on whether the issue is actually making money. The person who buys and holds a declining issue is not an investor buta fool. Believing the fundamental argument that improving eamings will eventually mean arising stock price has been the death knell for many an investor. Only technical analysis and chart reading can save these sorts of individuals. The chart clearly shows us the objective trend whether up or down, and we can then develop some sort of strategy to limit losses at a reasonable level if the fundamentals do not kick in. Ithas been rightfully said that chartists sell too soon out of fear of heights and miss the big move that often makes millionaires of fundamentalists. The corollary, of course, is that the chartists do not go down with the ship when they see a sinking chart pattem, Iam sure the number of rich buy and hold fundamentalists is a lot smaller than the number who held on and lost everything. The obvious solution, of course, isa marriage of the two concepts. Ihave no problem with the person who strongly believes in his investment and wants to hold it forever, using a common sense strategy tosell it when he gets a technical sell signal, but immediately takes steps to repurchase it ifit again reverses witha buy signal. This kind of long term strategy will be infinitely more rewarding in those cases where a stock goes up for years and truly does make millionaires out of its owners. This Book ‘The purpose of this book is to demonstrate the principles of chart reading and technical analysis as applied to general chart reading for trading purposes. Advanced techniques to find cycles, project price targets, and time periods for reversals will be examined at length. Many of my original discoveries in this field will now, for the first time, be published in an effort to help the investing public makea success of trading and allow the average person the ability to consistently make profits in the speculative markets. I will not cover all areas of technical analysis, nor will I teach the basics of stocks, options, or futures. assume you can learn these things from a thousand other books at your local library. What I will show you. however, is a comprehensive method to make money each and every month. Making money each month, of course, means that with areasonable amount of capital you can become independent and live the kind of life you choose not fettered with the burdens of everyday work drudgery. These principles always work. That is why they are called principles. 1 have no time to spend lengthy chapters explaining to you the reasons behind these principles or the fundamental cause and effect behind price movements. My purpose here is to simply reveal these methods for making money. I have been a professional trader for over twenty-three years now and canassure you that these principles are well worth learning! For those of you who must know the reasons, 1 direct you to my book The Geometry of Stock Market Profits, A Guide To Professional Trading For A Living. ‘There are many esoteric truths handed down to us from ancient times, and many of these are applicable to the speculative markets. The professional trader knows that the objective is to make money, not espouse a particular philosophy or do it “the right way.” Keeping an open mind isthe key. From the earliest days, great spiritual leaders have spent lifetimes trying to conquer the subconscious mind and the body. Often rigid disciplines of starvation, flagellation, meditation, or deprivation were used to teach the body and subconscious to respond without question. If you propose to enter the largest arena in the world that exhibits fear and greed (the speculative markets), and you are brought there motivated by the emotion of greed to make money, you will surely fail. This is why there are few rich stock analysts on Wall Street. They are deluded into thinking they are intellectual and rational in their behavior, but the reality is still emotional greed. The solution, and this may be the greatest lesson in this book, is that in anemotional market you must use your brains not to make money, but to control your emotions. Your logical reasoning should be put to use developing strategies apart from the emotions of the trade. Chart reading with this in mind will yield infinite results. Principles can be applied in a cold, hard, non-emotional fashion, and a stop loss. ipline is then rigidly applied when the strategy goes awry. Of course, this makes trading a business and not an emotional thrill, but it will be a consistently profitable business!Basic Concepts ay ‘The theory behind technical analysis is that all relevant information that concerns the appreciation or decline of stock prices is reflected in the chart of the price and volume. All information, no matter how secretive, must first surface in the buying and selling of the stock and thereby moves the price of the issue if it is of significance to the capital gains’ investor. Fundamental analysis, although possibly relevant to long term trends, may or may not generate current buying enthusiasm. and, in that case, has no effect on the price of the security. The idea of stock price movements as a process of accumulation and distribution is the backbone of chart analysis. Major insiders accumulating large positions prior to significant upward price movements readily show their characteristic footprints in the chart patterns prior tothe big moves, and these pattems have been shown to have high forecasting reliability. Simitarly, distribution periods where insiders slowly sell out major positions prior to big market breakdowns also have telltale characteristics that are of extreme value to the knowledgeable chart reader. Since these trends are usually long term in nature, at least the significant price movement ones, their characteristic patterns can be broken down into subtle waves or fractal patterns for each movement, and many of even the slightest counter-trend movements can be captured by the astute chart reader. A stock or commodity that has an annual range of 20% between the yearly low extreme to the high extreme often has three or four minor movements of 10 to 15% within that larger yearly range. ‘The active trader can therefore often achieve rates of retum several times the annual range ifa comprehensive trading discipline is utilized to exploit the known facts. Recent advances in technical analysis have opened the way to the possibilities of spectacular returns, and the purpose of this book is to acquaint you with many of my own proprietary discoveries in this area, along with the traditional methods that I have found to be most reliable in my professional trading career. Knowledge is only the beginning. Strategy and patience are equally important. In the end, only a few will truly succeed in a spectacular fashion. However, I would say that the vast majority will immensely improve their trading with just a casual reading of this book. Eliminating easy mistakes can often double annual rates of return, and I am sure that this book will point out many principles that you will find can easily change your bad habits into profitable careers.The Basic Accumulation, Distribution Pattern Most traders want to trade every day. In reality, you can only take what the market will give, and each day isnot an equal probability for success. Professional traders can readily size up amarket in the first hour and tell if the day is worth bothering with or whether the daily strategy is for small scalping trades with frequent reversals or for more leveraged major moves lasting several days. If you find yourself buying or selling every day in the first twenty minutes, youhavea problem. Many good trades come mid-day or at the close when most traders have already committed. Make sure you are not so emotional that you cannot keep from the action past the first hour. Knowing that each market movement has a reliable shape and time durationcan help. ‘The basic accumulation, distribution pattern looks like the statistical bell shaped curve, The _basehas an extended period of “backing and filling” in a sideways fashion, then comes the upside hit, traders should move to the sidelines and wait. Typical Accumulation / Distribution Pattern: —ft™ Tepoianbwon ASSESS Breakdown Run Base/Accumulation [cover short] Eqter rade here ing In the baseAUGAT, INC. E maautecturer Hectrocneatcsl Components Accumulation Distribution Phase Phase ‘Splle } for & li[srate > tor 2 1974 1958 [wre] ¥e97 | tome nr [oaea| sess | woes ies | sone | wer | sows | any [soso [ns [soe2 | ose] vcAR Long Term Bull and Bear Market, Accumulation / Distribution ‘The typical pattem is the same, regardless of the time period. In other words, the above pattem could be seen on an hourly, daily, or weekly chart. Obviously, differing trading strategies are employed for longer term movements, lasting days to months, rather than on an hourly chart. Leveraged traders using options and futures will work with hourly charts, and this pattern will often rise and fall over asingle day's duration. The “run” phase, where one owns put or call options or futures, will ideally be limited to8 to 13 HOURS. Holding positions longer than that is not trading but investing. Longer term traders using daily and weekly charts will find their horizon 3- 6 days to extremes of three weeks. These are stock trades and options, and futures would not be appropriate. It is one of the more difficult aspects of trading to “stay out” of the base or top and wait for the real move to get started. Most traders hunger for the cheapest entry point and usually waste days and several stops before the real move begins, when ,if they concentrated on the “easy” 70% of the move during the run phase, they would never get stopped out and would makc quick safe profits in the shortest time possible. Most techniques in this book are used for identifying this most rewarding part of the pattern (run or breakout).Remember that the “flat” areas of the base or top that we want to avoid trading in can be spotted by loss of momentum. Momentum is simply the amount of price movement per time period. Large momentum is nothing more than big price fluctuations in a short time period. When the momentum dies down, we exit our Positions until activity picks up again. If you keej eep in mind the bars ona bar chart, the : and these big bars are the payoff. Failure to trade out of fearis a mortal sin for a professional trader. The Bar Chart ‘There are many types of charts one can use in trading, but the primary basic oneis the simple bar chart. Throughout this book, I will refer to these kinds of charts and use them in the examples. A ‘good chart reader after some practice can easily visualize the other kinds in his head without having to keep up numerous chart papers. Even Japanese Candlesticks, which seem to be the current rage, give no information not found on a regular bar chart but are marketed as being easier to interpret. This is not the case if you know the principlesbehind chart reading, and the simplest bar chart will yield infinite amounts of information if you know where to look. In its basic form, a bar chart is simply a line drawn from the high of the time period to the low represented by a straight vertical line. More information can be obtained by addinga mark on the, Tepresent the opening and closing levels. These opening and closing levels can tellus. current day's probabilities. For instance, aclose at the extreme high or low of the day will usually carry well into the next. Similarly, several bars or: daysin sequence that close strong Tepresent accumulation going on. I could probably write several chaptersalone on the meanings of opening and closing ranges, but for the vast majority of traders the trend is more important than the projection, and I will leave the study of those ranges to you if you want to master intra-day trading. Many of the charts I will use in this book will omit the opening and closing marks on the vertical bars soas to cut out all but the simple trend information that is contained within the range on each bar. For most trading purposes, knowing the trend and the momentum shown by the size of the individual bar’s range is enough. The typical bar chart looks as follows: Three Time Periods Opening Level In Decline Closing Level | | | | Five Time Periods With A Rising TrendTypical Daily Bar Chart Personalities When you look at a chart, one of the first considerations is the type of personality the chart has. By this, I mean its trading characteristics. Some stocks are glamorous and big movers, while others are slow moving snails. Tops and bottoms usually form individual characteristics with some stocks “spiking” into a solitary high bar and rapidly declining, while others gradually “roll over” and go down. You must adapt your trading strategy to these individual characteristics to be successful. Quickly buying into a gradually rounding base is a w: of time, but a buy at a spike bottom on a signal bar reversal is a good practice. Only a Took at the most recent history will alert you to these trading characteristics. Learn to scan all the markets to find ones with personalities that fit your trading style and profit objectives rather than just taking any trade that shows up. A corollary to this is to only trade the most active markets and only when they are moving. Trading wheat, corn, bonds or stocks simply because you have a big account is a mistake. You should concentrate on the active ones to maximize your return over the shortest time period. Identifying the personality characteristics is one of the first things you should do. Only after you note the type of character and see if it will satisfy your particular objectives should you then spend time on a more detailed look at the trend, cycles, and projection targets. Examining the past is always a good first exercise, so you will have an idea ahead of time as to what is possible or likely and what is based on factual past trading patterns. Looking for a huge up or down movement that is out of character will tie up your capital needlessly. 18Trend jy Basic Trend Determination The fundamental reason we look at charts is to determine the trend. We can see at a glance whether the market is rising or falling, but few casual observers realize that the real trend is actually a patternof advances and declines. Once that pattern is discerned, it usually persists for quite some time. This is the basis for all investing —determining the primary trend and tradingwith that trend and not against it. On a basic bar chart, the bars consist of a range from the low to the high foreach period. These periods can be of any length, such as five minutes, fifteen minutes, hourly, daily, weekly, monthly, etc. The following are the critical telltale trend pattems for which we are looking: ows. In its simplest form, cach individual bar would havea higher botiom onevery bar, and, over several days, each swing correction would end at a higher swing low than the previous one. When Tuse the word “swing,” | am talking about a short term movement toa high and back toa low, then back to a high. Each minor high and low in such a pattern, no matter how small the scale, is referred to as a “swing.” It is extremely important to emphasize thatwe are only concerned with lows or bottoms when determining a bull trend. Highs have no relevance. The vast majority of. traders buy breakouts at the high of the day, and, when the market declines the next day, they are stopped out for a losseven though that next day's low was higher than the day before! If you lean emotionally but tohave a strategy to buy into dips that end ata slightly higher price than the prior low, you can enter your trades with low risk and a very easily identifiable sel! out poi at prior low if violated subsequently. Perhaps the real reason behind considering only’ the lows of the move as the critical level is that the big money which moves the markets cannot just jump in and chase stocks or commodities, but must patiently wait and accumulate their holdings atlimit price levels. This gives the market major “support levels,” and, when the markets are really moving and the institutionsstill do not fill their orders, they slowly ratchet up their limits, giving us the classic “stair step” pattern of rising support level bottoms.‘The Bear Pattern consists oftwe critical elements: lower highs and lower lows! This simply ‘means that in acyclical downtrend each highon every individual bar will be lower than the preceding bar, and each low will likewise be lower than the preceding low. Ona ‘swing’ basis, each little rally will fail at a slightly lower level than the prior rally, and eachnew swing low will hit anew low for the entire move. The reasoning here is that the big money is selling at limit levels and lowers them as they do not finish ateach level. In addition, since the market is weak, there are few buyers around, and each decline will usually have to gotoa slight new low to attract bargain hunters or shorts to cover at profitable levels, creating temporary buying. Basic Trends | | lj Simple Downtrend \! || ' iH MH) lI | a Simple Uptrend | | higher bottoms, 1, 2, 3, 4 1 2 3 i) | | 1 | | ‘Swing Dowmtrend with lower tops 1, 2,3 end lower lows A, B, eet B c technical analysis. | find that, over the years, I have tried to make this point over and over, an seems that only a fraction ofa percet x int rket gra nple but_ powerful conce ep Asa resitacvely me the market, plunges 50 points oreven 100 Dow points, werally, | ‘then short on every rally. Plunges per se are not particular ly bearish. Only the lower lowsand lower fopspattern. ‘The same holds true on intra-day charts. S&P futures traders continually get shaken_ out of a bullish trend ona fifteen minute plunge that turns out to. bea single bar decline and not a a 20Remember that at the heart of the theory is the idea of accumulation or distribution, and these are ongoing processesthat do not culminate ona single day. Large trends are cyclic in nature and cannot change overnight. The single day movement would have to be so extreme as to change everyone's long term opinion in order to change from an accumulation to distribution process and vice versa. Also, remember that Bull and Bear Markets, in general, are psychological processes by the masses as a whole and cannot be changed overnight. If it takes institutions a three year_ ike period of day after day buying to get thei them to sell everything and end anew Bear Market in only six weeks. After years ofa continuing 3g for yestenay' leader to go rallies will stop ata higher level as support increases, ing make you a fortune, if you going : against that bar when does not forma pattem. The following two exhibits demonstrate the bull and bear patterns: Basi Uptrend withhigher bottoms le | int a i Mh wif if wifi » [Nata wo are only concerned with bottoms 211 Basie Downtrend with numerous lower highs and lower lows. What Can We Deduce From This Trend Information? ‘The primary use of tren bullish, we wait to buy is todevelop strategies to enter and exit trades. Ifwe are above the most recent low. If we are bearish, we _ ch should be slightly lower than the prior one. In general, the basic rule about higher bottoms. or lower highs and lower lows is that you will eventually break one of the prior swing I Inother words, when buying i intodips, adip may golowerthan the immediate past di level but will usually not ‘carry down to the second one back. When shorting a bear rally, know that the rally could exceed the recent past high but not likely the second one ‘back. This idea also gives rise to.a a swing level prior and move it up or down only as w way we can the trend. allel channels. These are simple trendlines connecting a series of low points and then drawing an upper angle parallel to the lower but through one of the upperlevel swing points, Parallel channels are especially good for analyzing 22Jong term trends, such as over five to ten years. They give you good perspective in that, for both upper and lower trendline to hold parallel over long periods, the trend would have to be extremely strong, and one would have to think twice before assuming the existing trend was about to tun. ‘Multi-year parallel channels for differing industrial groups isone way to determine an overall market’s Parallel Channels Note that these are only approximations used to get a rough idea of the trend Reversal of Trend ‘We know that a bullish trend has a series of higher bottoms and that the bearish trend has a series of both lower tops and lower lows. Since our basic goal is to invest with the primary trend, how do we determine just when one trend tums into another? There are sr of techniques, butthe_ Most basic isthe signal reversal bar. This is defined as follows In an uptrend, when you havea series of higher bottoms each day or for that matter any time period and each few days you see a new high bar for the move, the reversal comes when you find the highest high bar for the move. Weare individual bar. ‘The bar after that must have alowerhighto toset upa ee signi »§ that next day or a subsequent one when the low of th day is by example, you might have a high bar and the next day you have alower high but the low is hier rat the same price as the low on the high bar peri if that bar breaks below the low, of that highbar. When that tlw is fin aly