The ideas of Charles Dow, the first editor of the
Wall Street Journal, form the basis of technical analysis today.
Dow created the Industrial Average, of top blue chip stocks, and a
second average of top railroad stocks (now the Transport Average). He
believed that the behavior of the averages reflected the hopes and fears
of the entire market. The behavior patterns that he observed apply to
markets throughout the world.
Markets fluctuate in more
than one time frame at the same time:
Nothing is more certain than that the market has three well defined
movements which fit into each other.
- The first is the daily
variation due to local causes and the balance of buying and selling
at that particular time (Ripple).
- The secondary movement covers
a period ranging from days to weeks, averaging probably between six
to eight weeks (Wave).
The third move is the great swing covering anything
from months to years, averaging between 6 to 48 months. (Tide).
- Bull markets are broad upward
movements of the market that may last several years, interrupted by
secondary reactions. Bear markets are long declines interrupted by
secondary rallies. These movements are referred to as the primary
- Secondary movements normally
retrace from one third to two thirds of the primary trend since the
previous secondary movement.
- Daily fluctuations are
important for short-term trading, but are unimportant in analysis of
broad market movements.
Various cycles have
subsequently been identified within these broad categories.
Primary Movements have
Look out for these general
conditions in the market:
- Bull markets commence with
reviving confidence as business conditions improve.
Prices rise as the market responds to improved
- Rampant speculation dominates
the market and price advances are based on hopes and expectations
rather than actual results.
- Bear markets start with
abandonment of the hopes and expectations that sustained inflated
- Prices decline in response to
- Distress selling follows as
speculators attempt to close out their positions and securities are
sold without regard to their true value.
- A secondary reaction may take
the form of a ‘line’ which may endure for several weeks.
- Price fluctuates within a
narrow range of about five per cent.
Breakouts from a range
can occur in either direction.
- Advances above the upper limit
of the line signal accumulation and higher prices;
- Declines below the lower limit
indicate distribution and lower prices;
Volume is used to confirm price breakouts.
A bull trend is identified by a series of rallies where each rally
exceeds the highest point of the previous rally. The decline, between
rallies, ends above the lowest point of the previous decline.
Successive higher highs and higher lows.
The start of an up trend is signaled when price makes a higher low
(trough), followed by a rally above the previous high (peak):
= higher Low + break above previous High.
The end is signaled by a
lower high (peak), followed by a decline below the previous low
End = lower High + break below previous
What if the series of higher
Highs and higher Lows is first broken by a lower Low? There are two
possible interpretations - see Large Corrections.
Each successive rally fails
to penetrate the high point of the previous rally. Each decline
terminates at a lower point than the preceding decline.
Successive lower highs and lower lows.
A bear trend starts at the
end of a bull trend: when a rally ends with a lower peak and then
retreats below the previous low. The end of a bear trend is identical to
the start of a bull trend.
What if the series of lower Highs and lower Lows is first broken by a
higher High? This is a gray area - see Large Corrections.
A large correction occurs when price falls below
the previous low (during a bull trend) or where price rises above the
previous high (in a bear trend).
Some purists argue that a
trend ends if the sequence of higher highs and higher lows is broken.
Others argue that a bear trend has not started until there is a lower
High and Low nor has a bull trend started until there is a higher Low
For practical purposes: Only accept large corrections as trend
changes in the primary trend:
- A bull trend starts when price
rallies above the previous high,
- A bull trend ends when price
declines below the previous low,
A bear trend starts at the end of a bull trend (and