Based on Richard W. Schabacker, Technical Analysis and Stock Market Profits (1932)
Richard W. Schabacker was the financial editor of Forbes magazine and wrote the first comprehensive, systematic treatise on technical analysis in the early 1930s. His work predates Edwards and Magee's Technical Analysis of Stock Trends (1948) by sixteen years. Edwards was in fact Schabacker's brother-in-law and directly inherited his charts, notes, and methodology. Everything in the Edwards & Magee canon traces back to Schabacker's original observations.
Where Edwards and Magee refined, systematized, and expanded the catalog of patterns, Schabacker was the original field naturalist. He was the first to name, classify, and assign predictive significance to the chart formations that every technical analyst now takes for granted. He did this not from academic theory but from direct observation of market behavior during the most volatile era in American financial history — the roaring 1920s boom and the devastating 1929 crash and its aftermath.
| Aspect | Schabacker (1932) | Edwards & Magee (1948) |
|---|---|---|
| Emphasis | Psychological origins of patterns | Mechanical classification of patterns |
| Gap theory | Detailed, original, four-type system | Inherited and condensed from Schabacker |
| Pattern catalog | First formulation, fewer strict rules | Expanded catalog with precise rules |
| Market context | Written amid the 1929 crash aftermath | Written in post-war bull market |
| Philosophy | Charts as windows into crowd psychology | Charts as self-contained analytical tools |
| Trading rules | Practical, flexible, judgment-based | More systematic and rule-based |
| Moving averages | Early, experimental application | More developed treatment |
| Tone | Exploratory, pioneering | Encyclopedic, definitive |
Schabacker's essential insight — and the one that separates his work from everything that came before — is that chart patterns are not random. They are the visible traces of human psychological processes repeated across time. Every head-and-shoulders top is a record of hope rising, confidence peaking, doubt creeping in, and finally capitulation spreading. The chart does not cause the future; it records the psychological conditions that make certain futures more probable.
Schabacker argued that the chart is fundamentally a psychological document. Every price bar records the net result of thousands of individual decisions driven by fear, greed, hope, and despair. These emotions do not change from generation to generation. Therefore the patterns they produce do not change either.
This is a deeper claim than simply saying "history repeats." Schabacker's argument is causal: patterns repeat because their cause (human psychology) is constant. A triangle forms because uncertainty causes buyers and sellers to narrow their range of disagreement until one side capitulates. A head and shoulders forms because confidence reaches a peak, tries to reassert itself, fails, and collapses. These are not arbitrary shapes — they are emotional narratives rendered in price.
The market price at any moment is the consensus of all participants. That consensus incorporates fundamental data, insider knowledge, institutional positioning, and emotional bias. The fundamental analyst tries to gather all this information independently and arrive at "fair value." The technical analyst observes the market's own verdict and acts on the assumption that the market is a more efficient information processor than any individual.
Schabacker did not dismiss fundamental analysis. He argued that technical analysis is faster. By the time a fundamental analyst can gather and process all relevant data, the chart has already moved. The chart leads the news because informed participants act before information becomes public.
The chart records everything. All knowledge, all expectation, all emotion is embedded in price. There is no information that matters which is not already in the chart — or will not appear there before it appears anywhere else.
Prices trend. Markets do not move randomly. They move in trends of various durations. The primary task is to identify the trend and align with it. Fighting the trend is the most common and most expensive mistake a trader can make.
Patterns recur because people do not change. The same emotional sequences produce the same chart formations. This is not mysticism — it is applied psychology. The crowd in 1932 reacts to fear and greed in the same way the crowd in 1907 did, and in the same way crowds will react a century hence.
Schabacker acknowledged his debt to Charles Dow's foundational work but moved beyond it in critical ways. Dow Theory deals with the broad market (averages). Schabacker applied the same principles to individual stocks, arguing that each stock has its own "personality" — its own patterns of behavior that recur because its shareholder base and institutional following create consistent psychological dynamics.
Schabacker adopted Dow's three-tier trend framework but applied it to individual securities with greater nuance:
Primary Trend (The Tide)
Secondary Trend (The Wave)
Minor Trend (The Ripple)
UPTREND in force when:
- Most recent significant high > prior significant high
- Most recent significant low > prior significant low
- Volume expands on advances, contracts on declines
DOWNTREND in force when:
- Most recent significant high < prior significant high
- Most recent significant low < prior significant low
- Volume expands on declines, contracts on rallies
TREND REVERSAL suspected when:
- Price fails to make a new high (uptrend) or new low (downtrend)
- Price breaks below the prior significant low (uptrend) or above the prior significant high (downtrend)
- Volume pattern diverges from trend direction
Unlike Dow, who dealt only with market averages, Schabacker observed that individual stocks develop characteristic trend behaviors. Some stocks trend smoothly with shallow corrections. Others move in violent swings. Some form congestion areas before advancing; others break out cleanly. He urged traders to study the historical behavior of each stock they intend to trade, learning its "personality" before committing capital.
This is an early formulation of what modern traders call "reading the character of a stock" or understanding its volatility signature.
Schabacker identified the head-and-shoulders pattern as the single most reliable reversal formation. His original formulation emphasizes the psychological narrative:
The Psychological Story:
Schabacker's Original Rules:
Inverse Head and Shoulders: The mirror image at bottoms, with one critical difference Schabacker emphasized: volume confirmation on the upside breakout is absolutely essential. Stocks can fall under their own weight, but they require active buying power to rise. An inverse H&S that breaks the neckline on light volume is suspect and unreliable.
Schabacker's Caution: Schabacker warned that the double top is one of the most over-identified and most misidentified patterns. Traders see two peaks at similar levels and immediately declare a double top, when in fact many such formations are merely normal fluctuations within a continuing trend.
Valid Double Top Requirements (Schabacker's Formulation):
Valid Double Bottom Requirements: Mirror of the double top, with volume confirmation essential on the upside breakout.
Schabacker noted these are rarer but more powerful than double formations. Three distinct tests of a resistance (or support) level without breakthrough create immense psychological significance. Each test weakens the defending side, and when the formation finally resolves, the move tends to be violent and sustained.
Key distinction from Schabacker: The triple top or bottom is often confused with the rectangle (trading range). The difference is intent. A triple formation is a reversal pattern — it occurs at the end of a trend. A rectangle is a consolidation — it occurs within a trend and usually resolves in the direction of the prior trend.
Schabacker identified three types of triangles and was the first to articulate their psychological meaning:
Symmetrical Triangle (The Coil):
Ascending Triangle (Bullish):
Descending Triangle (Bearish):
Schabacker's Triangle Trading Rules:
Schabacker's Formulation: A rectangle forms when price oscillates between a well-defined horizontal support and resistance level. It represents an even battle between buyers and sellers.
Rules:
Schabacker identified these as short-duration continuation patterns:
Flags: Small parallelograms that slope against the prior trend. In an uptrend, the flag slopes downward. In a downtrend, the flag slopes upward. Volume contracts during the flag and expands on the breakout.
Pennants: Small symmetrical triangles that form after a sharp advance or decline. Same volume characteristics as flags.
Both patterns are "rest periods" — the market pauses to digest a rapid move before continuing. Schabacker observed that the preceding move (the "flagpole") tends to be approximately replicated after the pattern completes.
Gap analysis is one of the areas where Schabacker's original contribution is most visible and most distinct from Edwards & Magee. Schabacker developed the first comprehensive classification system for gaps, and his four-type taxonomy remains the foundation of all gap analysis to this day.
A gap is a price range where no trading occurs — a void on the chart. On a bar chart, it appears as a space between one day's range and the next. Schabacker argued that gaps are among the most significant chart phenomena because they represent an extreme imbalance between supply and demand.
Type 1: Common Gap (Area Gap)
Type 2: Breakaway Gap
Type 3: Continuation Gap (Runaway Gap, Measuring Gap)
Type 4: Exhaustion Gap
GAP CLASSIFICATION PROCEDURE:
1. Identify market context: is the gap inside or outside a pattern?
2. If inside a congestion zone -> COMMON GAP (ignore)
3. If at pattern boundary with volume surge -> BREAKAWAY GAP (trade with gap direction)
4. If mid-trend with strong volume -> CONTINUATION GAP (use as measuring tool, stay with trend)
5. If near end of extended move -> watch for EXHAUSTION GAP:
- If gap fills within 3-5 days -> exhaustion confirmed, prepare for reversal
- If gap holds -> reclassify as continuation
ISLAND REVERSAL:
- Exhaustion gap + reversal + breakaway gap in opposite direction
- The price area between the two gaps is "isolated" like an island
- Extremely powerful reversal signal
- Trade aggressively in the direction of the breakaway gap
Schabacker treated volume as the essential companion to price — price shows what happened, volume shows how much conviction was behind it. His volume analysis is less formalized than later treatments but more psychologically grounded.
Rule 1: Volume should expand in the direction of the trend. In a healthy uptrend, volume increases on advancing days and decreases on declining days. In a healthy downtrend, volume increases on declining days and decreases on rallying days. When this relationship holds, the trend is confirmed and likely to continue.
Rule 2: Volume divergence is an early warning. When price makes a new high but volume is lower than on the previous high, buying enthusiasm is waning. When price makes a new low but volume is lower than on the previous low, selling pressure is exhausting itself. Schabacker considered volume divergence the single most reliable advance warning of trend change.
Rule 3: Climactic volume marks turning points. An enormous spike in volume after an extended trend often signals the end of that trend. In a bull market, this is the "blow-off" — a final surge of buying that exhausts demand. In a bear market, this is the "selling climax" — a final wave of panic selling that exhausts supply.
Rule 4: Volume confirms pattern breakouts. Any breakout from a chart pattern that occurs on low volume is suspect. Schabacker was particularly insistent on this point for upside breakouts. Stocks can decline on light volume (gravity works in the market), but they cannot sustain advances without active buying. An upside breakout on light volume should be treated as a potential false breakout until volume confirms.
Rule 5: Shrinking volume within a pattern signals impending breakout. As a triangle, rectangle, or other consolidation pattern develops, volume should contract. This contraction reflects declining interest and narrowing disagreement. The breakout, when it comes, should be accompanied by a sharp expansion in volume. If volume does not contract during the pattern, the eventual breakout is less reliable.
Schabacker made an important observation that is often overlooked: tops and bottoms have fundamentally different volume characteristics.
Tops: Often form quickly and dramatically. Volume tends to spike at the peak (the blow-off) and then decline rapidly. The emotional shift from greed to fear is abrupt.
Bottoms: Tend to form slowly and quietly. Volume dries up as selling exhausts itself. The base-building process involves a gradual accumulation phase where informed buyers absorb supply from discouraged sellers. The breakout from a bottom requires a visible surge in volume to confirm that demand has finally overcome supply.
This asymmetry reflects a deep psychological truth: fear is a more powerful and more sudden emotion than hope. Markets fall faster than they rise.
Schabacker was the first to articulate why support and resistance levels work in psychological terms. His explanation:
Support exists because of memory and regret. When a stock declines to a level where it previously found buying interest, three groups of participants are affected:
Resistance exists for the mirror reasons. Previous buyers at that level who are now underwater want to "get out even." Previous sellers who profited want to sell again. Previous buyers who missed selling want another chance.
Role reversal. When support is broken, it becomes resistance. When resistance is broken, it becomes support. Schabacker was among the first to document this phenomenon. The psychological explanation: those who bought at support and are now underwater become sellers when price returns to their purchase level — they want to "get out even."
Significance increases with volume. The more shares traded at a particular price level, the more participants have a psychological anchor at that level. High-volume support is more significant than low-volume support.
Significance increases with recency. Recent support/resistance is more significant than old support/resistance because the emotional impact is fresher.
Significance increases with number of tests. Each test of a level that holds reinforces its psychological importance. However — and this is a critical subtlety — each test also weakens the level because it absorbs some of the buying/selling pressure. A level tested too many times eventually breaks.
Round numbers are natural support and resistance. Schabacker observed that prices tend to stall at round numbers (10, 20, 50, 100). This is purely psychological — people think in round numbers and place orders accordingly.
Schabacker's approach to trendlines is less rigid than later systematizations but more attuned to practical application:
Uptrend Line:
Downtrend Line:
Schabacker recognized that minor penetrations of a trendline are common and not meaningful. His criteria for a valid break:
Schabacker was among the first to formalize the channel concept:
Schabacker introduced the concept of fan lines: when a trendline is broken, a new, less steep trendline is drawn from the same origin point to the most recent significant low. If this second line is broken, a third line is drawn. Schabacker observed that the breaking of the third fan line typically confirms a trend reversal.
The fan line principle captures the gradual degradation of a trend: the first break slows it, the second break weakens it further, and the third break kills it.
Schabacker's treatment of moving averages was early and experimental, far less developed than what came after. But he grasped the essential concept: a moving average smooths out short-term fluctuations and reveals the underlying trend.
Basic Signals:
Schabacker's Caution: He recognized that moving averages are lagging indicators — they confirm trends after the fact and signal reversals late. He never advocated using moving averages in isolation. They were one tool in a toolkit, useful primarily for confirming what pattern analysis and trendline analysis had already suggested.
Schabacker did not develop crossover systems (short-term average crossing long-term average) in any formal way. He used the moving average as a trend filter and a reference line, not as a signal generator. This is actually closer to how many sophisticated modern traders use moving averages — as context, not as triggers.
Principle 1: Trade with the primary trend. Never take a position against the primary trend unless you are an experienced short-term trader. The primary trend is the most powerful force in the market. Fighting it is like swimming against the current — you may make progress for a while, but you will eventually exhaust yourself.
Principle 2: Buy on secondary reactions within bull markets. The ideal entry is when a stock has corrected within a primary uptrend and shows signs of resuming the upward movement. This combines trend alignment with favorable pricing.
Principle 3: Sell on secondary rallies within bear markets. The mirror of Principle 2. In a bear market, rallies are selling opportunities, not buying opportunities.
Principle 4: Wait for pattern completion. Do not anticipate breakouts. A triangle is not a buy signal — a breakout from a triangle is a buy signal. A head and shoulders is not a sell signal — a neckline break is a sell signal. Patience is the trader's most valuable asset.
Principle 5: Confirm with volume. Never trust a breakout that is not accompanied by expanding volume. Volume is the conviction indicator. Without conviction, breakouts fail.
Principle 6: Use gaps as confirmation. A breakaway gap adds powerful confirmation to a breakout. If a stock breaks out of a pattern with a gap and heavy volume, the signal is exceptionally strong.
ENTRY TIMING:
1. Primary trend identified (bullish or bearish)
2. Secondary reaction has occurred (pullback in uptrend, rally in downtrend)
3. Chart pattern has formed and is nearing completion
4. Breakout occurs with:
- Price closing decisively beyond pattern boundary
- Volume expanding
- Optionally: gap confirming
5. Enter position in direction of breakout
ALTERNATIVE ENTRY (Conservative):
1. Wait for breakout as above
2. Wait for pullback/throwback to the broken boundary
3. Enter when price bounces off the broken boundary (support becomes resistance, or vice versa)
4. This sacrifices some profit for higher probability
EXIT TIMING:
1. Pattern measuring target reached
2. Opposite pattern forming (reversal pattern in direction against your position)
3. Trendline break against your position
4. Volume divergence warning
5. Stop-loss hit
Schabacker repeatedly emphasized that the great majority of trading losses come not from incorrect analysis but from incorrect timing. Traders who identify the right stock and the right direction but enter too early or too late turn good analysis into losing trades. His advice: let the market confirm your analysis before you act. "Be right and sit tight" was not just Livermore's mantra — it was Schabacker's operational philosophy.
Writing in the aftermath of the 1929 crash, Schabacker had witnessed the complete destruction of fortunes. His risk management principles carry the weight of that experience.
Rule 1: Never risk more than you can afford to lose. This is not a platitude — Schabacker meant it literally. Capital devoted to speculative trading should be money that, if entirely lost, would not affect your standard of living or your ability to earn a living. The emotional distortion caused by trading with "scared money" virtually guarantees poor decision-making.
Rule 2: Use stop-loss orders. Schabacker was an early and persistent advocate of stop-loss discipline. Every position must have a predetermined point at which it will be closed if the analysis proves wrong. This point should be determined before the position is entered, based on the chart structure — not on a dollar amount or percentage.
Rule 3: Place stops at technically significant levels. A stop should be placed just beyond a level that, if reached, would invalidate the analysis. For a long position entered on a pattern breakout, the stop belongs just below the pattern boundary. For a long position entered on a trendline bounce, the stop belongs just below the trendline.
Rule 4: Never move a stop in the direction of greater risk. Once a stop is set, it may be moved in the direction of profits (a trailing stop) but never moved backward to "give the trade more room." Moving stops backward is the most common form of self-destruction in trading.
Rule 5: Diversify — but not excessively. Schabacker recommended holding positions in multiple stocks to reduce the impact of any single failure. But he warned against over-diversification, which dilutes attention and makes it impossible to monitor positions properly. He suggested a maximum of 5-10 active positions for most traders.
Rule 6: Scale into positions. Rather than committing full capital at once, buy in stages. Take an initial position on the first signal. Add to the position as the market confirms the analysis. This limits risk on the initial entry while allowing full participation if the trade works.
Rule 7: Cut losses short, let profits run. The asymmetry of gains and losses means that one large winner can offset several small losers. The key is to exit losers quickly (stops) while giving winners room to develop. Most traders do the opposite — they take small profits (satisfying) and hold large losses (hoping for recovery). This pattern guarantees long-term failure.
Mistake 1: Trading against the primary trend. The most expensive mistake. A trader who shorts a stock in a bull market or buys a stock in a bear market may occasionally succeed, but the odds are relentlessly against him. Secondary reactions tempt traders into counter-trend positions, but most of these reactions are shorter, shallower, and harder to time than they appear.
Mistake 2: Seeing patterns that are not there. Schabacker warned extensively about the human tendency toward pattern recognition — we see faces in clouds and head-and-shoulders patterns in random noise. Discipline requires that every pattern meet strict criteria before it is acted upon. A vague resemblance to a pattern is not a pattern.
Mistake 3: Acting on incomplete patterns. Entering before a pattern is confirmed is anticipation, not analysis. The head and shoulders pattern is not complete until the neckline breaks. The triangle is not complete until the breakout occurs. Acting on incomplete patterns is gambling disguised as analysis.
Mistake 4: Ignoring volume. A breakout without volume is not a breakout — it is a trap. Schabacker considered this rule inviolable. Many of the "false breakouts" that frustrate traders would be avoided if they simply checked volume.
Mistake 5: Refusing to take losses. The hope that a losing position will "come back" has ruined more traders than any other single factor. Schabacker was blunt: the market does not care about your cost basis, and hope is not a strategy. When the analysis is wrong, exit. Immediately. Without negotiation.
Mistake 6: Over-trading. Not every day presents a trading opportunity. Not every chart has a clear pattern. The compulsion to always be in the market, always be doing something, leads to forced trades in ambiguous situations. Schabacker advised: when in doubt, stay out.
Mistake 7: Trading too many stocks simultaneously. The human mind cannot effectively monitor more than a handful of positions. Over-extension leads to missed signals, late reactions, and general confusion. Better to trade five stocks well than twenty stocks poorly.
Mistake 8: Relying on tips, rumors, and opinions. The chart is the only honest advisor. Tips from brokers, friends, newsletters, and "insiders" are noise at best and manipulation at worst. Schabacker was emphatic: trade what you see on the chart, not what someone tells you.
Phase 1 — Market Context Assessment The primary trend of the broad market is assessed. The major averages have been in a downtrend but show signs of stabilization. A selling climax occurred with record volume followed by a rally and a successful test of the low on lighter volume. The primary trend is potentially shifting from bearish to bullish.
Phase 2 — Stock Selection Scan for stocks showing relative strength — those that held up better than the market during the decline. One candidate has formed a clear inverse head-and-shoulders pattern over the past three months. The right shoulder is higher than the left, suggesting aggressive accumulation. Volume has been contracting through the pattern development.
Phase 3 — Pattern Analysis
Stock: ABC Industrial
Pattern: Inverse Head and Shoulders
Left Shoulder Low: $35 (August)
Head Low: $30 (October)
Right Shoulder Low: $37 (December) — higher than left, bullish
Neckline: connects the rally highs at $42 and $44 — upward-sloping neckline (bullish)
Volume: contracted through pattern, light on right shoulder decline
Phase 4 — Entry Planning
Phase 5 — Execution Day 1: Stock breaks above $44 on a gap, opening at $45.50 on triple-average volume. This is a breakaway gap from an inverse H&S with heavy volume — an exceptionally strong signal. Enter initial position at $45.50. Stop set at $36.
Day 5: Stock pulls back to $44.50, testing the broken neckline from above on light volume. Neckline holds as support. Add to position on the bounce. Raise stop to $43 (just below the neckline — if it breaks back below, the pattern has failed).
Phase 6 — Management Week 3: Stock at $50. Uptrend line can now be drawn from the right shoulder low through the neckline test low. Trail stop to just below this trendline at $46.
Week 6: Stock at $54. A continuation gap occurs on heavy volume — this suggests the move is approximately halfway done, confirming the $58+ target. Tighten stop to below the gap at $51 (the gap should act as support).
Phase 7 — Exit Week 9: Stock reaches $59, slightly exceeding the measuring target. Volume begins to diverge — the rally to $59 occurs on lighter volume than the rally to $54. A small double top forms at $58-59. Exit full position at $57 on the decline from the second peak.
Result:
"The chart of a stock is a graphic picture of its market history. It records the net result of all buying and all selling, of all hopes and fears, of all knowledge and ignorance, of all greed and caution."
"The patterns which form on the chart of any actively traded stock are the footprints of human psychology. They recur with remarkable fidelity because the emotions that create them do not change."
"The gap on a chart is among the most significant phenomena available to the technical analyst. It represents a price area at which no one was willing to trade — a void that speaks volumes about the urgency of buyers or sellers."
"There is nothing more deceptive and more dangerous than the uncompleted pattern. The trader who acts before the signal is confirmed is not analyzing — he is gambling."
"Volume is the steam that makes the engine run. Price tells you what; volume tells you whether the market means it."
"The greatest enemy of the speculator is not the market but himself — his impatience, his refusal to accept small losses, and his compulsion to act when the proper course is to wait."
"The stop-loss order is the speculator's best friend and his most ignored ally. To enter a position without a predetermined exit point for a loss is to invite the market to take everything you have."
"A trend remains in force until it has given unmistakable evidence of having reversed. The burden of proof always lies on the reversal, never on the continuation. This single principle, thoroughly understood and consistently applied, is worth more than all the chart patterns ever catalogued."
"Each stock has its own personality — its own habits of movement, its own patterns of congestion and breakout, its own relationship to volume. The wise trader studies this personality before committing his capital."
"The man who must be in the market every day, who cannot stand to sit idle with his capital in cash, will surely lose. The market rewards patience above all other virtues and punishes impatience above all other vices."
Richard W. Schabacker's work is the root from which all modern technical analysis grew. Edwards and Magee formalized his observations. Subsequent generations added indicators, oscillators, and computerized tools. But the foundation — that charts are psychological documents, that patterns recur because human nature is constant, and that the disciplined trader must combine patient analysis with strict risk management — belongs to Schabacker. To read him is to return to the source.