The Dow Report: Confirmations, Quantifications and Complements
By Tim W Wood CPA, July 9, 2004
I have been asked about the use of cycles and the Dow theory. This issue was recently addressed in my newsletter. Because of the fact that the question seems to keep coming up, I want to also address it in this Observation as well.
I have virtually every scrap of material written by Charles H. Dow, William Peter Hamilton and Robert Rhea. 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 most 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, dollar, bond or individual stock analysis is also not a part of the Dow theory.
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, there is a relationship and I could actually argue that they are one in the same. The cycles work is simply another, completely separate, discipline that helps 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.
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 on 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. 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%.
Cycles Work Confirms and Complements Dow Theory
I could go on and on with each of these points, but there is really no need as my point should be clear. Cycles are not a part of the Dow theory. Cycles simply offer us another way of looking at the same movement, but through different eyes. If we have a working knowledge of both disciplines, we can use them together to confirm each other. Once the move failed in only 3 months, the cycles work was warning us based on the quantifications of previous cycles. At the same time the Dow theory was warning with its non-confirmation. A Dow theory "Sell Spot" then developed as the Industrials formed a "line" into early January 1907. The trigger to sell was then hit with the downside break of this "line." The cycles work confirmed the break and offered a price target, which in this case proved to be conservative. Then, with the violation of Point K, Dow theory confirmed the bear market. As you should be able to see in this simple example, both disciplines have their place and can be used as separate tools to confirm and complement each other.
This is sort of like a Boxer deciding to also get his Black Belt in Karate. This would not minimize the knowledge or ability of the fighter. It would only enhance his skills by giving him more tools. What about someone who speaks English, French and German? Does this person also not have more tools? Does knowing more than one language corrupt or minimize the value of the other languages? What about the medical doctor who is also a naturopathic doctor? Is it not advantageous to have a doctor who could address an issue from both angles? Even while they are different approaches, both have their place. What about the mason who also learns carpentry skills? Has he not also increased his skill set and knowledge?
Separate, But Complementary Tools
The use of Cycles, Dow theory and the many other technical disciplines is really no different. Again, they are just separate tools. It was cycle theory that allowed me in the summer of 2001 to forecast a decline below 7,400 in the DJIA in 2002. It was cycle theory that allowed me to forecast the bottom in gold in 2001. It was cycle theory that allowed me to call the 2002 bottom in the CRB. It was cycle theory that allowed me to call the dollar top in 2002. It was cycle theory that warned me of the April 2004 high in gold. It was cycle theory that allowed me to call the February 2004 low in the dollar. It is cycle theory and my work with the George Lindsay material, which currently confirms my Dow theory work, which is all warning me of the seriousness of the stock market today.
It is the Dow theory that provides the backdrop of the overall Big Picture. It is the Dow theory that provides the understanding of bull and bear market phasing and where we are in this Big Picture. It is the Dow theory that provides important non-confirmations at most major cyclical turn points. It is the Dow theory that provides us with the setups at "Buy and Sell Spots."
It is the use of the two theories that complement each other, which in turn aids in the overall market analysis. Having knowledge in another discipline simply gives one yet another tool that can be used to help him better evaluate the task at hand. Again to clarify, cycle theory is not a part of the Dow theory. These are indeed two completely different theories that can be used to confirm and complement one another. Rhea warned about the "Bastardization" of the Dow theory. I have to say that I could not agree more. The Dow theory has proven itself well for over 100 years and I believe that it should indeed remain pure. However, this is not to say that we can’tuse other tools in conjunction with the Dow theory as long as we keep them separate. These other tools may be in the form of oscillators, point and figure charts, Elliott wave, Gann or even cycles.
If you are looking for a source that can provide you with a very detailed technical approach to the market then please consider Cycles News & Views. I incorporate the use of the Dow theory, Cycle theory, the work of George Lindsay and other master technicians of the past. These theories as applied to the current market are all covered on an ongoing basis in current issues of the newsletter. The July issue is now out covering the specifics of the current setup in much much more detail. With a subscription you will also be receiving the Gold Report, e-mail updates, weekly commentary, and periodic exclusive interviews. To contact me, please visit my website at www.cyclesman.com or call 318-342-9038.
Tim W. Wood
© 2004 Tim Wood