Chapter Objectives

By the end of this chapter, you should

• Know why identifying trends is paramount to profits in securities
• Be able to recognize an uptrend, a downtrend, and a trading range
• Understand the concept of support and resistance
• Be familiar with the major methods of determining trends
• Be familiar with the major signals that a trend is reversing

We are now entering into the more controversial aspects of technical analysis: the analysis of trends, and in Part IV, “Chart Pattern Analysis,” the analysis of patterns. This is the “fuzzy” aspect of technical analysis. Because the observations or rules are not specific, they discourage most students very quickly. Rules in technical analysis come from many observations by many traders and investors. In general, the rules have remained unchanged since Dow’s time, and in reading some of the old masters back in the 1930s, one sees the same observations today. The advent of the computer has sped the process and has often eliminated rules that are quantifiable but turn out to be unprofitable. However, the basics remain essentially the same. The markets have near, intermediate, and long-term trends. Patterns still form in much the same manner as 50 or 100 years ago, and analysts interpret them in the same manner as in the past. The details may be different, and perhaps the methods of profiting depend on various trade-offs between risk and reward, but still the analyst must use the rules and decide on the entry and exit points. The difficulty of profiting from technical analysis is not with the rules themselves but with their application.

In all the following chapters in this book, it is important to remember that the observations and statements we make derive from our observations and those of other practitioners of technical analysis. Most trends and patterns are not mechanical methods that can be easily programmed and tested on computers. Generally, they take long periods of practice to be fully utilized. One of the major criticisms of technical analysis is that it has yet to be thoroughly computerized and tested. As we saw in Part II, “Markets and Market Indicators,” numerous relationships have been tested in the past but then break down as the future unfolds. The only constants, it seems, are that trends occur and that they are the source of profit when recognized and properly used.

All analysts occasionally make statements that appear to be fact, but in many cases, they are statements based on subjective observations and should never be blindly relied upon without a thorough investigation. Our discussion of trend, support and resistance, and pattern nuances will show where they can be in error or where interpretation can be particularly difficult. Rules have developed over the years that will help with interpretation. Nevertheless, the student, when he can, should test and experiment. Nothing in technical analysis, or any other investment analysis approach, is foolproof. Indeed, it is surprising how much money is invested using fundamental and technical theories that have not been tested or, when they have, have proven to be unprofitable. Most professionals, who have spent their lifetime in the study and practice of technical analysis, will assert, “There is no easy, magic formula for wealth!” Do not, therefore, expect the following observations and rules to be an easy means to profit. Study, have patience, and study some more. We suggest that the student trade on paper, and finally with small amounts of money. There is no need to rush. The markets are always there.

Source: Kirkpatrick II Charles D., Dahlquist Julie R. (2015), Technical Analysis: The Complete Resource for Financial Market Technicians, FT Press; 3rd edition.