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Nadeem
Veteran Investor
Joined: 11 Jul 2004
Posts: 639
Cash Points ££ 13955.74
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 Posted: Mon Jan 22, 2007 4:41 pm Post subject: Dow Theory and Cycles Analysis |
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Recently I have received e-mails asking about cycles and Dow theory. I have addressed this before, but it seems that it's now time to look at this topic again. I have virtually every scrap of material written by Charles H. Dow, William Peter Hamilton and Robert Rhea and I want to confirm that cycles are definitely not a part of the Dow theory. I'll also add that head and shoulder formations, rising wedges, symmetric triangles and other technical patterns are not a part of the Dow theory. The McClellan oscillator, stochastics, RSI nor any other oscillator for that matter is a part of the Dow theory. Gold, the dollar, bonds or individual stock analysis is not a part of the Dow theory.
In a purist sense, Dow theory is a study of price action only as related to the Dow Jones Industrial Average and the Dow Jones Transportation Average. The Dow theory looks at such things as confirmation and non-confirmation, Dow's three movements, which is a means to separate and understand the short, intermediate and long-term movements, market phasing and value, to mention a few. Many think that the Utilities are a part of Dow theory, but they are not. As a matter of fact, the Utility average didn't even come to be until after Charles Dow's death. The Dow theory only looks at the Industrials and the Transports.
My use of cycles simply allows me to quantify the moves within the broad context or framework of Dow theory. On page 42 of The Stock Market Barometer, William Peter Hamilton gives the dates and directions of the "Primary Trend." These dates correspond exactly with the price action of the "4-year cycle." In The Story of the Averages, Robert Rhea quantifies each "Primary Swing" and "Secondary Reaction" throughout this entire 200 page document. These dates also correspond with 4-year, seasonal and 22-week cycle highs and lows. So, regardless of the label we pin on these movements, these price movements are one in the same. The cycles work is simply another completely separate discipline that allows me to quantify the movements regardless of their names. Cycles allow for the development of expectations based on the quantification of prior moves of the same degree. Cycles allow one to look at the market in several dimensions, just as Charles Dow did with his three movement concept. The cycles work allows me to apply the historical quantifications in order to develop future expectations.
For the record, Dow, Hamilton and Rhea also spoke of the market having "three well defined movements" or dimensions. Hamilton said, "There are three movements of the averages, all of which may be in progress at one and the same time. The first, and most important, is the primary trend: the broad upward or downward movements known as bull or bear markets, which may be of several years' duration. The second, and most deceptive movement, is the secondary reaction: an important decline in a primary bull market or a rally in a primary bear market. These reactions usually last from three weeks to as many months. The third, and usually unimportant, movement is the daily fluctuation." Cycles are simply another way of looking at these movements.
As an example, the diagram below was taken from The Story of the Averages by Robert Rhea. Notice that Mr. Rhea labels the move from Point A to Point J as the Primary Bull Market and the move from Point J down to Point Q as a Primary Bear Market. From a cyclical perspective, the move from Point A to Point J was the move from the 4-year cycle low to the 4-year cycle top. The move from Point J down to Point Q was the move from the 4-year cycle top into the 4-year cycle low and the complete move from Point A to Point Q was one complete 4-year cycle. From a cyclical perspective the moves from Points A to C and from C to E were the movements of the short term trading cycle. Movement G to I was a 22-week cycle while the movement from Point E to Point I constituted one complete seasonal cycle.
Rhea labels the movement H to I as a "Secondary Reaction" in the Bull market. If I put my cycles hat on, that same movement becomes the downside piece of both a 22-week and a seasonal cycle. Movements from Point K to Point L and M to N were both "Secondary Reactions" in the Bear market. I might add that this advance from K to L topped out in only 3 months and there was a slight Dow theory non-confirmation at this top. From a Dow theory perspective, this non-confirmation was a warning and when the movement from Point L to M violated the Point K lows, the bear market was confirmed. Through my eyes as a cycles analyst, the upside piece of this move from Point K to L was both a 22-week and a seasonal cycle advance that topped in only 3 months. My work with cycles tells me that any seasonal cycle that tops out in 6 months or less has a 73% probability of moving below the previous seasonal cycle low, which was Point K. The same is also true for the advance between Point M and N in that M was expected to have been violated based on the cyclical quantifications. This same cycles work tells me that the average decline for all seasonal cycles topping in 6 months or less and that failed to move above their previous seasonal cycle high (in this case Point J) is 26.59%. In this case the decline that followed into the 4-year and seasonal cycle low, Point Q, was 45.22%. Dow theory does not tell us these things. Statistics such as these only come from cyclical or trend quantifications.
Full article - http://www.marketoracle.co.uk/Article244.html |
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