StairStops Using John Magee’s Basing Points to Ratchet Stops in Trends: Using John Magee’s Basing Points to Ratchet Stops in Trends

StairStops Using John Magee’s Basing Points to Ratchet Stops in Trends describes a robust and powerful method for setting rising (or falling) stops in trends. Using wave analysis similar to Dow Theory it is a virtual algorithmic, but natural, method for trend following.

Introduction:

Tucked quietly away in the shell of Chapter 28 of Technical Analysis of Stock Trends is a trend following procedure that is the pearl of John Magee’s work: The Basing Points Procedure. As with Fermat’s Last Theorem Magee left some anomalies in the Basing Points Procedure, but his work is sufficiently clear to summarize as follows:

In an orderly market (bull market assumed, bear market mirror image) prices ascend in waves. An up wave, then a down wave. Students of Dow Theory will immediately recognize Dow’s observation. Sink a stake on the beach at the highest reach of a wave; then sink a new stake at the height of the next wave. Solong as higher highs are achieved the tide is rising. When the highs begin to fall short of previous stakes the tide has turned and is running out.

In an uptrend the price rises, then recedes, making a higher low, then rises, making a higher high, then recedes, making a higher low, then rises – and the pattern comprises a bull trend: higher highs and higher lows. Basing Points are wave lows upon which we base the calculation of stops.

Magee (among others) observed that “they” (or the market, or the specialists, or the market makers or … whoever…) probe for stops during a down wave. So a stock (or commodity, or bond, or currency) rises to 10 and then falls to 5, rises to 11 and falls to 6 where market forces (whoever or whatever they are) will attempt to take out the low at 5.

Exacerbating volatility, or creating it in the first place, is not a new game. In Charles MacKay’s classic, Extraordinary Popular Delusions and the Madness of Crowds, the trading of tulip bulbs replaced sober commerce and business as the occupation of Holland, and enormous fortunes were made trading the tubers. Blocks of real estate, breweries, assets of real and large value were traded for one tulip bulb. And MacKay produced my favorite paragraphs in the literature of finance:

“A golden bait hung temptingly out before the people, and one after the other, they rushed to the tulip-marts, like flies around a honey pot. Every one imagined that the passion for tulips would last forever, and that the wealthy from every part of the world would send to Holland, and pay whatever prices were asked for them.”

“The demand for tulips of a rare species increased so much in the year 1636 that regular marts for their sale were established on the Stock Exchanges of Amsterdam, in Rotterdam, Harlaem, Leyden, Alkmar, Hoorn, and other towns. Symptoms of gambling now became, for the first time, apparent. The stock jobbers, ever on the alert for a new speculation, dealt largely in tulips, making use of all the means they so well knew how to employ to cause fluctuations in prices.”