The 1948 book Technical Analysis of Stock Trends, written by Robert D. Edwards and John Magee, is often referred to as “the bible of technical analysis.” It is considered by many to be the definitive reference source for information on classical chart patterns. However, Edwards and Magee attributed the credit for their ideas to the original research and theories of both Charles Henry Dow and Richard W. Schabacker.

Dow was a co-founder of the Dow-Jones & Co. financial news service and the first editor of The Wall Street Journal. He created the original Dow Jones stock averages in the late 1800s and wrote a series of editorials in the Journal that analyzed the price movements of these averages. After his death in 1902, William Hamilton and Robert Rhea refined Dow’s ideas into what became known as “Dow Theory.”

Loosely defined Dow Theory is a method of analysis that utilizes specific price patterns to infer the direction of the market’s primary trend. If prices are making a succession of new highs, interrupted by shorter-term reactions which terminate above previous reaction lows, the trend is considered to be up. Conversely, a succession of new lows in price accompanied by lower highs on intervening rallies indicates a downtrend. Dow recognized that on all levels, from major swings down to day-to-day fluctuations, prices do not move in a straight line along their trend but rather in a pattern of “zigzags” or “waves.”

This observation by Dow is significant to chart pattern analysis as it form the basis of all classical chart patterns; combinations of “zigzag” or “wave” patterns make up the core of all classical chart pattern definitions. Other Dow Theory principles also underlie classical chart pattern analysis. These include Dow Theory “lines” which appear as a narrow range of price fluctuations, and indicate a period of stagnation in price where buying and selling forces are roughly equal.

As Edwards and Magee noted, a degree of coincidence appears to exist between Dow Theory lines and what might otherwise be viewed as classical chart formations. Finally, the idea that volume tends to expand on price movements in the direction of the dominant trend is also a tenet of both Dow Theory and classical chart pattern analysis. While Dow focused on the longer-term trends of business activity as reflected in the relationship between the closing prices of his averages, it was Schabacker who adapted these principles to bar charts of individual securities on a short to intermediate time frame.

In 1930, while employed as the financial editor of Forbes magazine, Schabacker authored Stock Market Theory and Practice, a reference work on the subject of the stock market and trading. He also published a manual in 1932, Technical Analysis and Stock Market Profits, which expanded upon the principles introduced in his first book. It was primarily through these two texts that Schabacker pointed out the various bar chart patterns that were later discussed and popularized by Edwards and Magee. Thus Schabacker was the chief architect of the “classical” chart patterns we know today such as triangles, head-and-shoulders, et al.

To reiterate, these patterns belong primarily to the area of technical theory related to the trading of individual securities. There have been other significant contributors to the body of charting knowledge, notably Richard D. Wyckoff and Ralph Nelson Elliott. Though it would be inaccurate to label the work of either Wyckoff or Elliott as “classical charting” per se, some overlap does exist.

For instance, like Charles Dow, both Wyckoff and Elliott sought to identify repeatable price patterns of a cyclical or rhythmic nature. Wyckoff and Elliott also viewed the relationship between price and volume similarly to Dow. More recently formal research has been made into the area of classical chart patterns. While no definite conclusions regarding the efficacy of classical chart patterns have been reached, there have been some encouraging results.

For example, a 1995 study by the New York Reserve Bank found that the head-and-shoulders chart pattern yielded “significant excess profits” in select currency markets. Research by Alex Saitta, a technician at Salomon, has shown profitable trading results using standardized classical chart patterns in the Treasury Bond market.

By Daniel L. Chesler, CMT, CTA

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