The Dow Report: The 50% Principle
By Tim W Wood CPA, September 12, 2003
The 50% principle was developed by the great Dow theorist E. George Schaefer. I feel that this is once again an appropriate time to take a look at this principle. Mr. Schaefer stated in his 1963 book How I Helped More Than 10,000 Investors To Profit In Stocks,
"In my endless search for clues to the stock market's behavior, I have developed a concept which at times has proved extremely useful. This is my 50% Retracement Concept. While it is primarily helpful in reinforcing conclusions I have drawn from my other technical studies, it has given me great comfort and reassurance during the trying times when the market has fallen to low ground- in 1949, in 1953, in 1957, in 1960 and in 1962."
I would indeed consider the current times with the market as "trying times."
Applying The Principle to Today's Dow Industrials
Mr. Schaefer applied this principle to secondary movements that served to correct the longer-term primary movements. These primary movements were periods of several years. Mr. Schaefer used closing prices, so in the application of his principle, I will do the same. Let's now apply Schaefer's principle to our present situation.
The bull market top occurred on January 14, 2000 at 11,723.00. So far, the bear market bottom has been 7,286.27 which occurred on October 9, 2002. The half-way point is 9,504.64. This level is marked with a red horizontal line on the weekly DJIA chart below. This line is also labeled "50% Line." Mr. Schaefer states,
"Whenever a primary movement of several years duration is corrected by a secondary movement in the opposite direction which fails to retrace more than 50% of the preceding move, then we may conclude that the original primary trend movement will resume in due time."
Note that the rally off the October 2002 low has exceeded this level, which was bullish as long as the market held above 9,504.64. However, we have now moved back below this level. The market's inability to hold above 9,504.64 has now turned this principle bearish.
Chart courtesy www.stockcharts.com
Applying The 50% Principle to Seasonal Cycles
Not to dilute or misapply Mr. Schaefer's 50% principle, but I also use this concept with the seasonal cycles in the market. First, let me explain that the seasonal cycle is an annual cycle that averages about 12 months. In my studies of Robert Rhea's The Story of the Averages, it became obvious that what I have been calling seasonal cycles from a cyclical perspective is nothing more than a primary swing and secondary reaction from a Dow theory perspective.
Rhea actually gives dates of these primary swings and secondary reactions and they match perfectly with my dates for the seasonal cycles. So, I am comfortable that I am on the same page with Rhea in regard to this issue. It's just that we are putting different labels on the same price movements. Also, Mr. Schaefer was actually applying his principle to a series of primary swings and secondary reactions that made up a larger primary move.
Now that the explanations are out of the way, let's apply the 50% principle to the current seasonal cycle. The previous seasonal cycle topped out on March 19, 2002 at 10,635.20 and bottomed on October 9, 2002 at 7,286.27. The half-way point of this decline was 8,960.74. Please note on the weekly DJIA chart below that I have marked the 50% level for the current seasonal cycle. So far, the current seasonal cycle has carried the DJIA up well above this level to a closing high of 9,587.90. So far, the actual retracement has been 68.72%. The question obviously is, can the current seasonal cycle hold above 8,960.74 as we move into the coming seasonal cycle low? If not this could indeed prove to be troublesome for the market. So, as we move into the coming seasonal cycle low watch both 9,587.90 as applied to the larger picture as well as 8,960.74 as applied to the current seasonal cycle.
Chart courtesy www.stockcharts.com
The Dow Jones Industrial Average closed the week at 9,471.55, down 31.79 points for a weekly loss of 0.34%. The Dow Jones Transportation Average was also down 9.46 points closing the week at 2735.60, a loss of 0.34% for the week. The S&P 500 closed at 1,017.94, down 3.45 points for weekly loss of 0.34%, and the NASDAQ composite was down 3.20 points closing the week at 1,855.04 for a weekly loss of 0.17%.
Tim W. Wood
© 2003 Tim Wood