Table of Contents

Title Page

Dedication

Copyright Page

Introduction

SOME HISTORY

HOW TO REACH ME

About the Author

CHAPTER 1 - Technical Analysis

THE BULLS VERSUS THE BEARS

WHY IS A PREDICTION VALUABLE?

A WORD ON SHORTING

SUPPORT AND RESISTANCE

WHAT HAPPENS WHEN PRICES PUNCH THROUGH?

HISTORY REPEATS ITSELF

HEAD AND SHOULDERS

A BREAKOUT AND A FAILURE

A CHANGE IN DIRECTION

WHEN PATTERNS WORK TOGETHER

MORE BREAKOUTS

MORE BREAKDOWNS

CHARTING FOR YOURSELF

CHAPTER 2 - Fundamentals of Chart Creation

ARITHMETIC VERSUS LOGARITHMIC

DIFFERENT INSTRUMENTS, DIFFERENT CHARTS

LET’S START CHARTING

ZOOMING FOR A BETTER VIEW

DATA DETAILS

SEARCHING FOR SYMBOLS

OPTIONS SEARCH

FUTURES SEARCH

STREAMING CHARTS

CHARTING DIFFERENT TIME PERIODS

CLONING CHARTS

NEXT UP

CHAPTER 3 - Modules and Preferences

BASIC MODULE BEHAVIOR

THE DETAILS OF EACH MODULE

PREFERENCES IN PROPHETCHARTS

DRAGGING AND DROPPING

RIGHT-CLICKING FOR MORE ACTIONS

CHAPTER 4 - Watch Lists and Chart Styles

WATCH LIST BASICS

MY WATCH LISTS

DRAGGING-AND-DROPPING

RIGHT-CLICKING ON SYMBOLS

CHART STYLES

CREATING AND SAVING A STYLE

TRADING STYLE

ON TO TECHNICAL STUDIES

CHAPTER 5 - Market and Data Types

INDEXES

EQUITIES

MUTUAL FUNDS

FOREX

E-MINI FUTURES

FUTURES AND COMMODITIES

OPTIONS

OPTION CONTROLS

CHAPTER 6 - Indicators in Action

SINGLE VERSUS MULTIPLE INDICATORS

MOVING AVERAGES

BOLLINGER BANDS

THE RIBBON STUDY

LINEAR REGRESSION CHANNEL

PARABOLIC STOP AND REVERSAL (PSAR)

MACD INDICATOR

RELATIVE STRENGTH INDEX (RSI)

CHAPTER 7 - Multiple Studies and Comparisons

THE TECHNICAL STUDIES EDITOR

EDITING A STUDY

WORKING WITH PANES

DELETING STUDIES AND PANES

CROSSOVERS AND MULTIPLE STUDIES

SAVING STUDY SETS

COMPARING CHARTS

THE LEFT-SCALE AXIS

SUMMARY

CHAPTER 8 - Trendlines and Reversals

USING THE TOOL

CHANGING COLOR AND STYLE

HISTORICAL CHART EXAMPLES

RESISTANCE

BREAKS TO THE DOWNSIDE

SUPPORT BECOMES RESISTANCE

PARALLEL TRENDLINES

FALSE BREAKOUTS

MULTIPLE TRENDLINES OVER THE LONG HAUL

INTERPRETING AMBIGUITY

SUMMARY

CHAPTER 9 - Expansion and Channels

RESIZING AND EXPANSION

WHY RESIZE?

PARALLEL LINES

BREAKDOWNS AND BREAKOUTS

SUMMARY

CHAPTER 10 - Rounded Tops and Saucers

PRICE PULLBACKS

PRICE FAILURE

SAUCER BOTTOMS

ROUNDED TOP PATTERNS

PATTERN FAILURES AND BREAKDOWNS

SUMMARY

CHAPTER 11 - Cup with Handle

USING THE HORIZONTAL LINE TOOL

MORE CUP WITH HANDLE EXAMPLES

PATTERN FAILURES

DIAMONDS AND DEAD-CAT BOUNCES

CHAPTER 12 - Multiple Tops and Bottoms

HIGHLIGHTING CHARTS

ADDING TEXT NOTES

HIGHER HIGHS AND HIGHER LOWS

MULTIPLE TOPS

MULTIPLE BOTTOMS

SUMMARY

CHAPTER 13 - Head and Shoulders

THE HEAD AND SHOULDERS PATTERN

A CLOSE-UP VIEW OF BRCM’s H&S PATTERN

THE IMPORTANCE OF THE NECKLINE

USING RETRACEMENTS

MORE ON THE HEAD AND SHOULDERS PATTERN

TRADING ON THE H&S PATTERN

THE INVERTED HEAD AND SHOULDERS PATTERN

SUMMARY

CHAPTER 14 - Pattern Recognition

HOW TO FIND PATTERNS

WORKING WITH THE RESULTS

PATTERN FAILURES

GRIDS AND EXPORTING

CANDLESTICK PATTERNS

CHAPTER 15 - Fibonacci Drawings

A BRIEF HISTORY LESSON

THE FIBONACCI RETRACEMENT

FIBONACCI FANS

FIBONACCI ARCS

FIBONACCI TIME ZONES

COMBINING OBJECTS

SUMMARY

CHAPTER 16 - Power Features

LABELS

GRID CHARTS

RATIO CHARTS

HIDING ELEMENTS

UPSIDE-DOWN CHARTS

MORE TO COME

CHAPTER 17 - For Bears Only

THE PHILOSOPHY OF SHORTING

PRACTICAL GUIDE TO SHORT-SELLING

EXCHANGE-TRADED FUNDS

PUTS FOR LEVERAGED PROFITS

GOOD AND EVIL

THE SLOPE OF HOPE

CHAPTER 18 - A Practical Guide to Trading

TRADING RULES

HOW TO OPEN A POSITION

HOW TO HOLD A POSITION

HOW TO CLOSE A POSITION

TIME AND MONEY

THERE IS NO HOLY GRAIL

CHARTING YOUR WAY TO PROFITS

APPENDIX A - The Kirk Report Interview

Q&A WITH TIM KNIGHT

APPENDIX B - MarketMatrix

Index

To Alexander Dobrovolski, who made it all possible

Copyright © 2010 by Tim Knight. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.

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 per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.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 per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions. (201) 748-6008, or online at http://www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002. (317) 572-4002.

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Library of Congress Cataloging-in-Publication Data:

Knight, Tim, 1966-

Includes bibliographical references and index.

ISBN 978-0-470-62002-1 (cloth)

1. Stocks-Charts, diagrams, etc. 2. Investment analysis. 3. Electronic trading of securities. I. Title.

HG4638.K55 2010

332.63′2042-dc22

2010005946

Introduction

One of my favorite photographs was taken by my wife on our honeymoon. We were on the second leg of our trip, the first of which was in Dubrovnik, Croatia (part of the former Yugoslavia), and the second in central Italy. The photo shows me in bed, apparently asleep. The title of the book I am holding across my chest is clearly legible: Technical Analysis of Stock Trends, by Edwards and Magee.

Charting the financial markets has been my passion for over 20 years. The very first trade I ever placed in my life was on Black Monday, the crash of 1987—hardly a propitious start. But the markets and their vagaries have fascinated me ever since.

In 1992, I took my three main areas of interest—computers, trading, and business—and combined them to create Prophet Financial Systems. That was before the commercial Internet even existed (we used dial-up modems in those days for daily data updates). Over the years, we built a wide array of tools, all with the purpose of trying to help people make better trading decisions.

To be honest, I personally find books about technical analysis kind of boring. They are full of indicators, formulas, tables, and numbers. By and large, they put me to sleep (witness the honeymoon photo). I set out to make this book different. I wanted you to enjoy learning from this book, and I wanted to use as many real-life examples as possible. Hypothetical charts mean little, in my opinion. So you will find this book packed with hundreds of examples drawn from real trading in U.S. equity markets. This should give you a practical way to see how to apply the ideas presented in these pages.

SOME HISTORY

In 1998, we at Prophet took the first small steps toward creating a charting applet, which we called JavaCharts. My philosophy in product development has always been the same: have my engineers create a product that I love to use. This had the happy side effect of attracting a lot of traders, because they liked what they saw, too.

JavaCharts became the foundation of the business in many ways. It was very popular on our own web site, Prophet.net, and we licensed it to a wide variety of brokerages and other businesses. The quality and reputation of the product was an important reason behind our securing the “Best of the Web” awards from both Barron’s and Forbes, beginning in 1999 and continuing for years.

Over a nearly four-year period—from the beginning of 2003 to the end of 2006—we focused on our next generation of charting. Originally referring to this as simply JavaCharts 2, we later christened it ProphetCharts. Although this book will prove helpful to anyone interested in technical analysis, it will be especially instructive to ProphetCharts users.

HOW TO REACH ME

I would love to hear from you! I enjoy being in touch with other people interested in charting, so feel free to drop me a line with your questions and comments. My e-mail address is trader.tim.knight@gmail.com.

You also might enjoy my widely read blog, The Slope of Hope, which can be accessed via your browser at www.slopeofhope.com.

Whether you use any charting product, you should benefit from this book. I’ve tried to make it accessible, understandable, and practical for anyone interested in making better trading decisions. Let me know what you think, and good luck with your trading!

About the Author

Tim Knight was the founder of Prophet Financial Systems, an online software company that was acquired by INVESTools in January 2005, which in turn was acquired by Ameritrade in the summer of 2009. He currently is an active trader and professional money manager.

Tim founded Prophet in 1992 to provide market data to self-directed investors using stand-alone technical analysis software. With the advent of the World Wide Web, he envisioned combining the power of these expensive software packages with browser-based convenience—enabling traders to focus on their analysis, instead of worrying about software upgrades and database issues. His online technical analysis suite at Prophet.Net delivered on this vision.

In his trading today, Tim relies on technical analysis as the primary basis for his investment decisions. He is the managing partner for the Tim Knight Organization, a money management firm, and writes the popular Slope of Hope blog.

Before starting Prophet, Tim was Vice President of Technology Products at Montgomery Securities in San Francisco, where he led the development of an institutional online-trading platform. Additionally, he held various positions in marketing management at Apple Computer and is the author of 20 computer books. Tim is a graduate of Santa Clara University’s honors program and holds a bachelor’s degree in business management.

He lives in Palo Alto, California, with his wife, children, dog, and three pampered chickens.

CHAPTER 1

Technical Analysis

What It Is and Why It Works

Technical analysis is the study of past price movement for the purpose of predicting future price movement, which, if done correctly, can lead to substantial trading profits. The prices studied are typically those of financial instruments such as stocks, commodities, and foreign currencies. But no matter what market is being studied, the underlying principles are the same. Specifically:

• A price chart is the most perfect representation of the balance of buyers and sellers for any given entity.

• Prices tend to move in trends and patterns, which, based on historical analysis, can lead to statistically meaningful probabilities of future price movement.

• The close and skilled examination of a price chart can guide traders as to how long they should remain in a trade and when they should exit.

No matter what you trade, technical analysis can make you a better and more profitable trader. Price charts will consistently provide the most truthful picture that can be had of a tradable object, because everything that can be publicly known or speculated is already built into the graph. You will never get the same pure representation of a stock (or anything else) from a broker, a newsletter writer, or an analyst. A chart is as good as it gets.

THE BULLS VERSUS THE BEARS

Before we get into price charts—and there will be hundreds of them in this book—let’s examine the basics about what forms a price chart in the first place: sellers (the supply) and buyers (the demand).

When buyers are more powerful than sellers, prices move up. When sellers are more powerful than buyers, prices move down. This tug-of-war, in these simple terms, is behind the trillions of dollars that get traded every week of the year.

What many people tend to forget is that every time a trade is placed, each side believes that they are right and the other side of the transaction is wrong. When person A buys stock from person B, person A believes the stock is going to go up in price (meaning B is selling too cheap), and person B believes he would rather have the cash than the stock (meaning A is buying an overvalued, or at least fully valued, stock).

As a group, the individuals who believe a given instrument is going to move higher in price are the bulls, whereas the opposing camp, believing prices for the same instrument will drop, are the bears. And the war between the bulls and the bears, fought over many thousands of different stocks, options, and commodities every day, is what creates price movement. Analyzing that movement well is what will give you a substantial edge in the markets you trade.

WHY IS A PREDICTION VALUABLE?

The astonishing thing about technical analysis is not only how far out its predictive power goes but also how, even with a future full of unknowns, it still seems able to see its way clear to make a meaningful prediction. A staggering number of great forces can wreak havoc with financial markets—scandals, war, governmental chaos, interest rates, terrorist attacks, earnings surprises, the social climate, and so forth. Through it all, the knowledgeable chartist can see what others cannot see and know what seems unknowable.

Let’s take a real-life example with a very long time span: the Dow Jones Industrial Average over a period of more than 100 years. Figure 1.1 has two Fibonacci fans drawn on it. (Don’t worry if you are not familiar with that term; it will be explained in Chapter 15.) These fans are drawn from an extreme low to an extreme high. The first is drawn from the low in 1903 (the “Rich Man’s Panic,” it was called) to the peak of the roaring twenties bull market in 1929. The second is drawn from the depths of the depression in 1932 to the peak of the Internet bubble in January 2000.

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!

Lesen Sie weiter in der vollständigen Ausgabe!