001

Table of Contents
 
ESSENTIALS SERIES
Title Page
Copyright Page
Dedication
Preface
Acknowledgements
 
CHAPTER 1 - Introduction to Technical Analysis
 
What Is Technical Analysis?
Technical versus Fundamental
Methods
What to Expect
Summary
 
CHAPTER 2 - The Story of Technical Analysis
 
The Beginning: Japanese Rice Markets
Dow Theory
Charting
Elliott Wave
W. D. Gann
Indicators
Trend Followers
Market Technicians Association
Technical Analysis Today
Summary
 
CHAPTER 3 - The Power of Technical Analysis
 
Introduction to Price Action Concepts
Components of Price Action
Summary
 
CHAPTER 4 - The Basics of Technical Analysis
 
Bars and Candlesticks
Line Charts
Point-and-Figure Charts
Summary
 
CHAPTER 5 - The Heart of Technical Analysis
 
Introduction to Trend
Effect of Time Frames on Trend Determination
Parallel Trend Channels
Trend Lines
Summary
 
CHAPTER 6 - The Soul of Technical Analysis
 
Introduction to Support and Resistance
Support Becomes Resistance Becomes Support
Summary
 
CHAPTER 7 - Primary Drawing Tools
 
Introduction to Drawing Tools
Static Support and Resistance
Dynamic Support and Resistance
Horizontal Support and Resistance Lines
Trend Lines
Parallel Trend Channels
Summary
 
CHAPTER 8 - Chart Patterns
 
Introduction to Chart Patterns
Continuation Bar Patterns
Reversal Bar Patterns
Gaps
Candlestick Patterns
Single-Candle Patterns
Multiple-Candle Patterns
Summary
 
CHAPTER 9 - The World of Moving Averages
 
Introduction to Moving Averages
Moving Average Crossovers
Moving Averages as Support and Resistance
Summary
 
CHAPTER 10 - Key Technical Indicators and Oscillators
 
Introduction to Indicators and Oscillators
Key Indicators
Key Oscillators
Summary
 
CHAPTER 11 - Fibonacci and Elliott Wave
 
Fibonacci Theory and Methods
Elliott Wave Theory
Summary
 
CHAPTER 12 - Point-and-Figure Charting
 
Introduction to Point and Figure
Point-and-Figure Patterns
Point-and-Figure Price Targets
Summary
 
CHAPTER 13 - Volume
 
Introduction to Volume
On-Balance Volume
Tick Volume
Summary
 
CHAPTER 14 - Technical Trading Strategies
 
Introduction to Technical Trading Strategies
Moving Average Crossovers
Breakout Trading
Trend Trading
Range Trading
Price-Oscillator Divergences
Oscillator Trading
Fibonacci Trading
Positive Expectancy
Summary
 
CHAPTER 15 - Risk Control and Money Management
 
Introduction to Risk Control and Money Management
Stop-Losses
Reward:Risk Ratio
Maximum Allowable Loss
Multiple Fractional Positions
Diversification
Summary
 
Index
Wiley End User License Agreement

ESSENTIALS SERIES
The Essentials Series was created for busy business advisory and corporate professionals. The books in this series were designed so that these busy professionals can quickly acquire knowledge and skills in core business areas.
Each book provides need-to-have fundamentals for those professionals who must:
• Get up to speed quickly, because they have been promoted to a new position or have broadened their responsibility scope
• Manage a new functional area
• Brush up on new developments in their area of responsibility
• Add more value to their company or clients
Other books in this series include:
 
Essentials of Accounts Payable, Mary S. Schaeffer
Essentials of Balanced Scorecard, Mohan Nair
Essentials of Business Ethics, Denis Collins
Essentials of Business Process Outsourcing, Thomas N. Duening and Rick L. Click
Essentials of Capacity Management, Reginald Tomas Yu-Lee
Essentials of Cash Flow, H.A. Schaeffer, Jr.
Essentials of Corporate Fraud, Tracy L. Coenen
Essentials of Corporate Governance, Sanjay Anand
Essentials of Corporate Performance Measurement, George T. Friedlob, Lydia L.F. Schleifer, and Franklin J. Plewa, Jr.
Essentials of Cost Management, Joe and Catherine Stenzel
Essentials of Credit, Collections, and Accounts Receivable, Mary S. Schaeffer
Essentials of CRM: A Guide to Customer Relationship Management, Bryan Bergeron
Essentials of Enterprise Compliance, Susan D. Conway and Mara E. Conway
Essentials of Financial Analysis, George T. Friedlob and Lydia L. F. Schleifer
Essentials of Financial Risk Management, Karen A. Horcher
Essentials of Foreign Exchange Trading, James Chen
Essentials of Licensing Intellectual Property, Paul J. Lerner and Alexander I. Poltorak
Essentials of Knowledge Management, Bryan Bergeron
Essentials of Managing Corporate Cash, Michele Allman-Ward and James Sagner
Essentials of Managing Treasury, Karen A. Horcher
Essentials of Patents, Andy Gibbs and Bob DeMatteis
Essentials of Payroll Management and Accounting, Steven M. Bragg
Essentials of Sarbanes-Oxley, Sanjay Anand
Essentials of Shared Services, Bryan Bergeron
Essentials of Supply Chain Management, Michael Hugos
Essentials of Trademarks and Unfair Competition, Dana Shilling
Essentials of XBRL, Bryan Bergeron
 
For more information on any of the above titles, please visit www.wiley.com.

001

To my parents, my wife, my children, and technical analysts everywhere

Preface
The practice of technical analysis has grown at a remarkably rapid pace in the last few decades. Traders, investors, and analysts involved in all of the various financial markets have increasingly turned to the principles of technical analysis both to interpret as well as to act on market price behavior. These practitioners recognize that technical analysis provides a concrete, logical, and effective approach to tackling any major financial market.
In addition, the development of new methods and techniques within the realm of technical analysis has been equally rapid. Whether it is the latest and greatest technical indicator or a fresh and innovative way to denote support and resistance, technical analysis has generally progressed in a swift, continuous manner since its inception. Many of these new developments have contributed substantially to the further evolution of the field.
Consequently, innumerable specialties and subspecialties have developed within the discipline of technical analysis. In my years as an analyst and trader, however, I have deliberately refrained from having my primary focus “progress” onto excessively complex or esoteric concepts within the field. As a result, many have asked me why I keep my analysis and trading so simple. My answer is always the same: Simple, at least in the arenas of technical analysis and technical trading, works quite well. Therefore, I have consistently preferred to focus all concentration on the essentials, as opposed to diluting attention on the countless areas of technical analysis that can possibly be focused on.
A quick look at any one of my daily or intraday analysis charts will illustrate my general approach. I like to draw lines, and lots of them—short lines, long lines, horizontal lines, angled lines, line shapes, and everything in between. I tend to keep the mechanical indicators on my charts to a minimum, although anything that helps me better identify the trend (like moving averages) and the key support /resistance levels within a given market is a welcomed element in my trading arsenal.
In light of the simplicity of this approach, if I was asked to summarize the essence of technical analysis and technical trading in a concise, working description, it would probably be this: the study of how mass market behavior affects the manner in which market prices move in relation to the trend and support/resistance.
When all of the layers are peeled away, these are essentially the elements that remain. In fact, the majority of mainstream technical analysis tools and studies ultimately just help define or act on the trend, support/resistance, or a combination of both.
To clarify further, the concept of trend can refer to a directional price move, a reversal of the prior directional price move, or a lack of direction in the market altogether. The concept of support/resistance can refer to static price levels (unchanging levels at which a market may react in a significant manner) or to dynamically changing price levels (as in an ascending or descending trend line).
Staying on the theme of keeping it simple, although different technical analysts gravitate toward different techniques and methods, I would strongly stress the fact that the most successful practitioners tend to concentrate primarily on only one or a few aspects of the discipline. If one is able to know a particular method inside and out—whether it is drawing trend lines, using the relative strength index, counting Elliott Waves, trading Fibonacci retracements, identifying reversal patterns, or any one of the countless other technical approaches to the financial markets—the path to trading success will likely be much smoother than if one attempts to dabble in a little bit of everything. Again, keeping it simple by mastering one or a few essential aspects of technical analysis is much preferred over diluting attention in all different directions.
With that having been said, this book should act as your straightforward guide to the wealth of essential methods and approaches that are available within the field of financial technical analysis. There is much to choose from within these pages, but once a focus is established, the rest is simply a matter of exhaustive further study, experimentation, and experience.
Good luck and good trading.
 
James Chen

Acknowledgments
For their tremendous support and understanding during the time I was writing this book, as well as in all other aspects of life, I would like to thank my parents, Shou Lien and Hsiaowen; my brother and sister, Jack and Julie; my wife, Dongping; my sons, Tommy and Kevin; and my newborn daughter, Emily.
Additionally, I would like to acknowledge all of the tireless hard work and support from the wonderful editors at John Wiley & Sons, including Tim Burgard and Stacey Rivera, who also published my previous book, Essentials of Foreign Exchange Trading (2009).
Sincere gratitude also goes out to these trading industry luminaries for generously contributing their knowledge and expertise in the form of insightful book passages: Robert Prechter, Jr.; Steve Nison; Alexander Elder; and Michael Covel.
Finally, I would like to give a big thanks to my many colleagues at FX Solutions who have consistently shown a great deal of interest and encouragement during the course of my writing this book.

CHAPTER 1
Introduction to Technical Analysis
Pursuing Profit in the Financial Markets
002
After reading this chapter, you will be able to:
• Understand the general concept of technical analysis.
• Discern the basic differences between technical analysis and fundamental analysis.
• Recognize some of the key tools and methods of technical analysis.
• Know what concepts will be discussed throughout the rest of this book.

What Is Technical Analysis?

Technical analysis is the study of how past and present price action in a given financial market may help determine its future direction. At the same time, however, technical analysis should not be considered a crystal ball. Rather, the skills of a technical analyst are used primarily to help determine the highest-probability reactions to past and current price movement, as well as likely future price movement. Therefore, technical analysis is less about actually predicting the future and more about finding high-probability potential opportunities to trade in the financial markets.
The primary tool used by technical analysts is the ubiquitous price chart, which generally plots prices over a given period of time. The various major chart types are discussed in detail in Chapter 4, which covers the basics of technical analysis. Different analysts/ traders may choose to use different types of charts at different times, whether it is a line chart, a bar chart, a candlestick chart, a point-and-figure chart, or any of a number of other chart types.

Technical versus Fundamental

When many people in the financial world refer to technical analysis, it is often in direct contrast to the other major school of market analysis, fundamental analysis. The contrast between the two is clear and distinct.
Fundamental analysis focuses on what the underlying reasons may be for market movement. In the stock market, this would consist of news and financial information (e.g., earnings) that are directly associated with a particular publicly traded company. In the futures market, it would consist of substantive market information regarding a specific commodity (e.g., wheat or oil) or financial market/index (e.g., S&P 500). In the foreign exchange, or currency, market, fundamental analysis would be primarily concerned with international economies, central bank policy, interest rates, and inflation.
Fundamental analysis stands in stark contrast to the world of technical analysis. Instead of concerning itself with the underlying reasons for price movement, technical analysis focuses on the price movement itself and how mass human behavior is manifested in price action. Technical analysts believe that all fundamental information and economic factors that can cause price movement are already reflected in price action. Therefore, technical analysis purists generally avoid looking at earnings or crop reports or international economic conditions. Instead, the two primary tools of price and volume as depicted on a financial chart are sufficient for most analysts of the technical persuasion. Of these two tools, price is universally more important.
Here is another way to describe the distinction between fundamental analysis and technical analysis: While fundamental analysis may concern itself with the myriad reasons “why” price moves, technical analysis is single-mindedly focused on “how” price moves and the way in which that might affect future price movement. Technical analysis consists of a broad methodology through which traders can identify trading opportunities and make all of their most important trading decisions. This includes trade entries, trade exits, stop-loss placement, profit target placement, trade sizing, risk management, and more.
While some traders and investors are strict adherents to either fundamental analysis or technical analysis, and completely exclude consideration of the other, many use a combination of both.
003
EXECUTIVE INSIGHT
Robert Prechter, Jr., CMT
In a written interview with the author, Robert Prechter, Jr., publisher of The Elliott Wave Theorist since 1979 and founder/president of Elliott Wave International (elliottwave.com), discusses being a pure technician. Legendary for his market timing and trading acumen utilizing Elliott Wave principles, Prechter has won numerous major accolades from the media and financial community over an illustrious, decades-long career. He has authored many books, several of which were instrumental in bringing Ralph Nelson Elliott’s groundbreaking Elliott Wave Principle into the forefront of financial market analysis. More about Robert Prechter, Jr., and his considerable contributions to the development of technical analysis can be found in Chapter 2.
Prechter states:
Most analysts are not technicians. But it is also true that most self-described technicians are not pure technicians. They talk about Federal Reserve policy, political action, economic news and other such events as causal to the market’s movement. If such events are causal, then technical indicators would not be potent, because randomly occurring outside events would be creating the supposed patterns, making them spurious. Any new event could make the market go contrary to what a pattern or indicator suggested. To be a hybrid analyst is to be theoretically inconsistent. Either outside events move the market or market behavior is patterned. One cannot have it both ways.
A pure technician is someone who believes that the stock market’s causality derives from unchanging aspects of human behavior. Only if this is true can a head-and-shoulders pattern, a trend line, or a wave form be reliable. Otherwise such things are simply artifacts of random movement. True technicians are those who rely solely on technical indicators and models such as price trends, cycles, volume patterns, momentum readings, sentiment indicators, Elliott Waves, Edwards and Magee patterns, and Dow theory. Fundamentalists look for outside causes and try to predict them, reasoning from those predictions to market predictions. Technicians study patterns relating to market behavior and make decisions on that basis alone. Fundamentalists study everything but the behavior of the market. Technicians study only the behavior of the market.

Methods

The methods of utilizing technical analysis are many and varied. They include such ubiquitous concepts as head and shoulders, support and resistance, trends, moving averages, and double-tops. But they also include concepts that are less popularly known, such as linear regression, bullish engulfing patterns, Elliott Wave, and point-and-figure charts. All of these elements of technical analysis, and much more, are discussed in the pages of this book.
The main focus of this book is to provide the essential knowledge about technical analysis that is necessary to begin serious analysis of any major financial market. With that goal, this book outlines and describes the primary tools used by technical analysts and traders. Of course, technical analysis is a huge subject that is growing every day, and no book could ever hope to cover all of the information within the field adequately. Therefore, this book provides substantial coverage of the essentials, as the title suggests, while necessarily omitting some of the more esoteric concepts in the field.

What to Expect

After this introduction, Chapter 2 begins with a concise history of the most pivotal events in the development of technical analysis— from the Japanese rice markets in Osaka; to the revolutionary tenets of Dow theory; to the development and mainstream adoption of charting; to the advent of Elliott Wave theory; to the emergence of trend following; and finally to the automated, systematic trading of today.
Then the most important aspect of technical analysis, price action, is described in detail in Chapter 3. Price action, or the patterned behavior of price that can give clues as to potential future direction, is truly the basis for the study of technical analysis as we know it today.
The book then jumps straight into the primary basics of technical analysis—charts. These are the primary tools of technical analysts and traders, whether the chart of choice is a line chart, a bar chart, a candlestick chart, a point-and-figure chart, or some other manner of graphically depicting price action. All of these chart types are presented and discussed in Chapter 4, including their structures and methods of interpretation.
After these basics are covered, Chapter 5 is devoted entirely to what is arguably the single most important concept within technical analysis and the heart of the discipline: trend. The definitions and characteristics of uptrends, downtrends, and no trend are covered, as well as methods to identify trend conditions.
After the heart of technical analysis is discussed, Chapter 6 talks about another vital aspect of the field that can be considered the soul of technical analysis: support and resistance. These twin concepts are the basis for much of the technical analysis that is published in the media as well as for many technical trading methods and strategies.
The chapter on support and resistance is followed by a discussion of the practical drawing tools necessary for depicting both trends and support/resistance levels. These important drawing tools include trend lines, trend channels, and horizontal support and resistance lines. Chapter 7 covers how these lines are customarily drawn and interpreted by technical analysts and traders.
Moving on to Chapter 8, the discussion then turns to the key topic of chart patterns. This includes the most prevalent and important bar chart shapes, such as triangles, wedges, flags, pennants, head and shoulders, and the like. The chapter also includes descriptions of the most common Japanese candlestick formations, such as hammers, shooting stars, doji, engulfing patterns, and the like.
Chapter 9 covers the world of moving averages, those wavy lines that can reveal so much about a market’s trending conditions and support /resistance areas. Moving averages also play a pivotal role in many technical trading strategies, as well as in market analysts’ commentaries.
Besides moving averages, many other important technical indicators are mathematically derived from price. The most common and important of these indicators, which include a special subcategory called oscillators, are presented and described in Chapter 10.
From there, this book moves into the more advanced concepts of Fibonacci and Elliott Wave theories in Chapter 11. These unique perspectives on market price action are often used by more sophisticated technical traders, and they can provide extremely valuable insight into the structure of price and how to reap potential benefit from it.
Chapter 12 covers yet another unique perspective on price action: point-and-figure charting. Significantly different from its line, bar, and candlestick cousins, point-and-figure analysis concentrates exclusively on the market’s price action, excluding all other factors, including time and volume. Because of this fact, many consider point-and-figure trading to be the purest form of price action trading.
Although volume is customarily excluded on point and figure charts, it is the star of Chapter 13. Used primarily by stock market traders, volume is considered both a leading indicator as well as a confirming indicator. When trading equities, volume can be a vital tool for providing important confirmation of price action. Confirmation is a key concept within technical analysis.
Chapter 14 brings together all of the tools, methods, and concepts of technical analysis discussed up to that point and describes specific trading methods and strategies used by professional technical traders. This discussion includes information on both manual and automated trading and on how each strategy covered is suited to either mode of trading. The strategies and methods described in Chapter 14 comprise the culmination of all the building blocks of information found throughout the rest of the book.
Finally, Chapter 15 discusses one of the most important aspects of any trading plan: risk control and money management. Although it is not nearly as enthusiastically embraced a topic as trade entry strategies, at least with many novice traders, most successful and professional traders/investors would likely agree that risk control and money management are the keys to consistent success in the financial markets. Without these vital components of a sound trading plan, failure can almost be assured. Chapter 15 covers some of the most important aspects of a good risk and money management plan.
By the end of this book, the goal is for the reader to be well on his or her way to becoming well rounded and knowledgeable on the art and science of technical analysis. To truly master any of the concepts discussed in this book will require further study and a lot of practical, hands-on experience. But once that mastery occurs, one invariably finds that it is always well worth the effort to get there. This book is meant to serve as an essential guide pointing the way to eventual mastery of technical analysis concepts and applications.

Summary

This chapter delved into the basic concepts of technical analysis, including a core definition and the differences between technical analysis and the other main school of financial market study, fundamental analysis.
The sharp contrast between technical analysis and fundamental analysis is useful in helping those who are new to the financial markets understand how each discipline may fit into one’s overall market outlook. Fundamental analysis is more concerned with “why” price may move, while technical analysis focuses on “how” price moves. Technical analysis helps traders and investors to identify trading opportunities, which include trade entries, exits, risk management, and more.
This introductory chapter then went on to describe what is covered in each subsequent chapter. All of the essentials of technical analysis for financial markets are covered in these chapters.

CHAPTER 2
The Story of Technical Analysis
From the Japanese Rice Markets to Dow Theory to Automated Trading
004
After reading this chapter, you will be able to:
• Appreciate the key developments within the history of technical analysis.
• Identify some of the most important historical contributors to the technical analysis body of knowledge.
• Understand some of the most vital components of Dow theory.

The Beginning: Japanese Rice Markets

Technical analysis has had a long and colorful history marked by the emergence of many different characters who have had a significant combined influence on the course of the major financial markets.
From what is known about the earliest use of technical analysis, traders in the Japanese rice markets of the early eighteenth century employed technical methods in their trading that were developed by a rice merchant named Honma Munehisa. These methods were eventually to become what we know today as candlestick chart trading. Much later, these techniques were introduced to the Western financial world by a pioneering trader and technical analyst named Steve Nison.
005
EXECUTIVE INSIGHT
Steve Nison, CMT
In a written interview with the author, Steve Nison, who is currently president of CandleCharts.com and author of the definitive book on the subject of candlesticks, Japanese Candlestick Charting Techniques, discusses “why technical analysis.”
Nison states:
I frequently give on-site and Web-based custom seminars to some of the top financial firms. Interestingly, some of these, up until they “saw the light” with Nison candlesticks, had used only fundamental analysis. Since this book focuses on technical analysis, I want to relate to those of you new to this field what I related to these institutional clients about the importance of technical analysis:
1. Technical analysis incorporates all information, whether known by insiders or the general public.
2. There are two factors that influence price—our rational side (what fundamentals gauge like p/e [price/ earnings] ratios) and our emotional side (“I have to get out NOW!”). And the only way to gauge the emotional component of the market is through charts.
3. As the Japanese proverb states, “Like the right hand helping the left,” so it is with technical and fundamental analysis. Both of these help round the circle of analysis. Companies I have worked with may have 10 stocks on their fundamental buy list. So they would use technical analysis and our candlestick insights to determine which are technically best to buy. After all, would it make sense to buy a stock that is under support? So fundamentals, in this case, give them what to buy. And technicals help with the timing.
4. Technical analysis helps foster a risk and money management approach to the market. This is because the most powerful aspect of charts is that there is always a price that says we are wrong. By the time the fundamentals change, it may be too late.
5. By unemotionally analyzing a chart, it helps foster an objective view of the market. So if the market is rallying and making higher closes, but if each of these sessions are shooting stars or candle lines with longer upper shadows, it is a warning that the market is, as the Japanese would say, “rising in agony.” This means, in spite of the higher closes, if you looked at the market objectively with these bearish upper shadows on the chart, it should be a cause for concern.
6. Since so many traders and analysts use technical analysis, it often has a major impact on the market. As such, it is important to be alerted to technical signals others may be using.
In the rice markets of Osaka during the early eighteenth century, Honma Munehisa found great trading success using techniques based on the psychology of the market. This was an almost revolutionary way of viewing financial markets at the time. Besides authoring several books on the principles that were later to fall under the umbrella of candlestick analysis, Honma eventually became one of the most profitable financial traders in history.

Dow Theory

Fast-forward to the late nineteenth century in America. Charles Dow (born 1851) is considered the father of technical analysis in the West. He originated a theory, later named Dow theory, which outlined his views on price action in the stock market. Dow was one of the founders of Dow Jones and Company as well as the first editor of the Wall Street Journal. After Charles Dow’s death in 1902, Dow theory was further refined by others, primarily William Hamilton, Robert Rhea, E. George Shaefer, and Richard Russell.
Although there is significant controversy in modern times regarding the original concepts behind Dow theory, this group of principles forms the general underlying basis for Western technical analysis as practiced today by millions of market participants.
It should be kept in mind when evaluating Dow theory that the principles were originally based primarily on two stock market average indexes: industrial (manufacturing) and rail (now transportation). In the present day, however, concepts of Dow theory can be applied to all market indexes and can be extended to all major financial markets. According to Dow theory, there are several primary principles of market price action. They can be summarized in this way.
The market discounts everything. All news and fundamental market information is always priced into the market or reflected in market prices. Since these market prices are based on human knowledge and expectations, they are constantly adjusting to accommodate and reflect all relevant information, including all actual news as well as any potential future events that may be expected, feared, or hoped for. In other words, all events and speculation on events are always already reflected in the current market price.
Three trends. Financial markets (or, according to Dow, the stock market average indexes) are comprised of three trends: primary, secondary, and minor. A primary trend is a major directional price move, whether up or down, that usually lasts between one and three years. A secondary trend can be characterized as a medium-term swing, often a countertrend reaction, which usually retraces between one-third and two-thirds of the primary trend and lasts from around three weeks to three months. Finally, a minor trend is a short-term price move that can last anywhere from a few hours to several weeks. Minor trends exist within the context of secondary trends, which in turn are often reactions to primary trends.
Three phases. According to Dow theory, the most important trend, by far, is the primary trend. There are generally three phases within a primary trend. In an uptrend, these three phases are accumulation, public participation, and then excess. Accumulation in a new uptrend occurs at the tail end of a downtrend, when the smart investors are beginning to buy once again. The public participation phase, which is usually the longest phase, then commences when the investing public begins to recognize the new uptrend and to enter into it. Finally, the excess phase begins when the smart investors start to sell off their positions to late market entrants that are getting in at exactly the wrong time. At the tail end of the excess phase, signs begin to point to a possible start of a new, opposite primary trend, in this case a downtrend. Similar to uptrends, downtrends also have three phases: distribution, public participation, and excess.
Confirmation. This concept was originally meant to apply to two stock market average indexes: industrial (or manufacturing stocks) and rail (now transportation stocks). Dow asserted that these two indexes have to confirm each other by moving in the same direction before a trend determination can be made. In other words, a stock market uptrend is an uptrend only if the two indexes are both in clear uptrends. In the present day, confirmation within the field of technical analysis has gone in a completely different direction, but it remains as vitally important today as it was in Dow’s time.
Volume confirms trends. Although price is always of utmost importance, volume is used as an important confirmation of price action. Price movement in the direction of the trend should be accompanied by high volume, while countertrend corrections should be accompanied by significantly decreased volume. If volume confirms the trend in this manner, it is an indication that the trend is strong and should continue.
Trends are valid until reversed. Trends continue until there is clear evidence that a bona fide reversal has occurred. This means that while countertrend corrections and consolidative price action may occur, only a clear reversal indication can signal the end of a trend. While one of the goals of technical analysis is to differentiate clear reversals from corrective price action within a continuing trend, this is one of the key challenges for any trader or investor.
While much has changed since Dow’s time, the core principles of Dow theory continue to provide a foundational basis for modern technical analysis. Although it would be difficult to adhere closely to Dow theory in today’s trading environment, the practical tools and techniques that stem from Charles Dow’s original ideas comprise a powerful approach to trading present-day financial markets.

Charting

Perhaps the most important development in the history of technical analysis was the genesis of modern-day price charts. These graphic representations of price action are the primary tools for countless technical analysts, traders, and investors involved in all of the financial markets.
As discussed in Chapter 4, there are several different types of charts available for analyzing market prices. First to develop in the United States was the point-and-figure chart, which began to come into use in the late nineteenth century, around the time that Charles Dow originated his market theories. From crude, handwritten records of market prices, point-and-figure charts gradually evolved over the years in the early twentieth century into the form that we see today, with columns of Xs for uptrends and Os for downtrends.
Also in the early twentieth century, the currently ubiquitous bar chart first came into use. Over decades of widespread adoption of this charting method, bar charts eventually became the most widely used charts in all financial markets.
The dominance of bar charts continued unchallenged until candlestick charting was formally introduced to the Western world in the late 1980s. Brought over from Japan by Steve Nison, an American technical analyst and trader, candlesticks quickly flourished to pose a serious challenge to the long-held dominance of bar charts. Although the origins of candlesticks were rooted centuries earlier in the rice markets of Japan, as mentioned previously, it was not until they had been introduced to the United States that they began to gain widespread international popularity.
From their early origins, point-and-figure charts, bar charts, and candlestick charts have all withstood the test of time and have flourished in their own ways, with different analysts and traders, and in all financial markets.

Elliott Wave

Many important industry figures after Charles Dow have contributed a great deal to the field of modern technical analysis. One of these key innovators is the originator of one of the best-known and most widely adopted models in the field of technical analysis, Elliott Wave. His name was Ralph Nelson Elliott.