What Is Measuring Principle?

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

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 against each other.
  • The measuring principle method works best with clearly defined and widely recognizable chart patterns.

Understanding Measuring Principle

Measuring principle uses technical analysis of historical stock patterns to detect the direction of 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 measuring principle as an accurate indicator of direction is valid. While it is a heuristic measure, historically, it has tended to be relatively reliable. 

Essentially, the measuring principle is a type of analysis which 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 will compare and contrast stock chart patterns of different timeframes (e.g., daily vs. weekly) and formats (e.g., candlestick vs. bar chart) 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. Should the stock price diverge from the expected direction that the measuring principle indicated, then the trader must be ready to take quick action in buying or selling their holdings. 

Trading Using Measuring Principle

Setting a specific minimum price target for trading stocks is the basis of the measuring principle. As mentioned, traders may accomplish this with the analysis of several technical charts. Charts show the movement of a stock over time and patterns come in two primary types, continuation and reversal

The key is that the measuring principle can guide trading behavior. A principle, by definition, will guide behavior. Further, principles are instructive and may or may not be explained or verifiable, in a mathematical sense of the term. Many traders will use fundamental and technical analysis hand-in-hand as a way to verify their belief in the price movement of the targeted securities.

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 them in their decision making processes. Other tools include analyzing moving averages, oscillators, Bollinger bands, and support or resistance levels – to name a few. Another primary technical analysis principle is the idea that prices have directional movement and that the current price will reflect all available information.

Measuring Principle Example

The measuring principle is used to find the minimum target for a stock price move, which requires figuring out where the height of the movement will be. 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).

Since the measuring principle is not a logical calculation or mathematically proven, investors should ensure the calculated figure makes sense in the context of the overall technical analysis picture of the stock. If the trend line is at $85, then the measuring principle makes sense in this case. Further validation of the $80 price can come if the lower Bollinger band were around $75.