Measuring Principle: What It is, How It Works, Example

What Is Measuring Principle?

The measuring principle is a method for targeting the minimum price of securities to determine entry and exit points for traders.

Key Takeaways

• The measuring principle is an informal method for finding the minimum security price target for traders.
• The measuring principle allows traders to determine a stock’s price target by weighing movements on chart patterns.
• The measuring principle method works best with clearly defined and widely recognizable chart patterns.

Understanding Measuring Principle

The measuring principle uses technical analysis of historical stock patterns to detect price movements. Traders hope to find an indication that a stock is ready to move down in price to a level where it could be seen as a buying opportunity. Likewise, they will use the measuring principle to pinpoint upward movements and selling opportunities.

No hard and fast mathematical proof exists for the measuring principle as an accurate indicator of direction. While historically reliable, it is more of a heuristic measure.

The measuring principle is a type of analysis that looks to historical price movements to identify future trends. In contrast, fundamental analysis uses economic and market indicators to recognize directions. Analysts who use the measuring principle method compare and contrast stock chart patterns of different time frames and formats against one another.

The technique works best with well-defined chart patterns, such as a head-and-shoulders formation, a rectangle or triangle pattern, and other widely-recognized price formations. If the stock price diverges from the expected direction indicated by the measuring principle, the trader must be ready to take quick action.

Trading Using Measuring Principle

Setting a specific minimum price target for trading stocks is the basis of the measuring principle. Traders may accomplish this by analyzing technical charts. Charts show the movement of a stock over time, and patterns come in two primary types: continuation and reversal.

The measuring principle can guide trading behavior. Principles are instructive and may not always be explained or verifiable mathematically. Many traders use fundamental and technical analysis together to verify their beliefs in price movements.

Both technical and fundamental analysis are methods of forecasting movements in the stock market. Technical analysis also studies indicators other than chart patterns to help with decision making. Other tools include moving averages, oscillators, Bollinger bands, and support or resistance levels.

Measuring Principle Example

The measuring principle is used to find the minimum target for a stock price move. As a hypothetical example, Company XYZ’s stock demonstrates a topping pattern with a peak of $100 and support at $90.

To calculate the measuring principle, an analyst would subtract the peak of the pattern from the support level and then subtract the resulting figure from the support. If they were looking for a breakout to the top, they would add that result to the resistance level.

Thus, in the example above, the measuring principle would be: ($100 – $90 = $10) and ($90 – $10 = $80).

Investors should ensure the calculated figure makes sense in the context of the overall technical analysis picture of the stock. Further validation can come from the lower Bollinger band around $75.