As I stated yesterday, “The theory also addresses the three issues influencing the forecasting of market movement – the primary, long-term trend, the reaction to the primary trend, and the daily fluctuations.” I also stated that within this statement is a series of articles. Although I don’t intend, necessarily, to write a series on this, I do feel it important enough to write a bit about the phases today because I believe that understanding Dow Theory will help us become better traders overall, and better traders in this market.
The primary trend (long term bull or bear market), the reaction to the primary trend (secondary reaction), and the daily fluctuations are integral to Dow Theory, so understanding these goes a long way toward understanding the theory itself. Today, though, I just want to generally explain the phases of the primary trend because I believe we are in the latter stages of the first phase of a bull market, just about to enter the second phase. So, understanding this will go a long way to understanding the markets today and understanding how we should position our trading selves.
There are three phases to a primary trend, bull market, according to Dow theorists. The first is the “crying the blues” phase where the news is gloomy day after day, yet the markets stop retreating and begin to rise to new highs. We are now past that phase to a large degree, although this past week or so, the doomsayers are back. Nevertheless, in this phase, the market averages refuse to retreat to new lows. We are seeing this today, for sure.
The second phase of the primary trend bull market, which we are close to entering, is often the longest phase. In this phase, prices adjust and readjust according to improving business conditions (corporate earnings and an improving economy). The DIJA and the DJTA both move to higher highs in the past year, but based on this past week, we are not quite completely in the second phase, as we have seen a retreat from the highs, We are close, however. Prices are adjusting and readjusting. Pundits and analysts are calling this adjustment phase a “correction.” Here is one thing we can learn from this – accept that prices are adjusting (correcting) and adapt. Either pull out and sit on the sidelines until the markets smooth out, or get aggressive and trade the volatility, the daily ups and downs. Either way, the important point is to recognize where we are in the cycle, so we can adapt.
The second of the three issues influencing broad-market movement (after primary trend) is the secondary reaction to the primary trend. This is any movement that runs counter to the primary trend. These “reactions” are often, mistakenly, considered changes in the primary trend. We are seeing some of this now. More than few, but less than a majority, of pundits and analysts are calling this correction a change in the primary trend. In my opinion, this is simply not the case. Prices are adjusting to the long bull rally we have had since March of last year.
The third issue is the daily fluctuations, which we are seeing in spades the last week or so. The Dow has been up and down like a yo-yo. Dow theorists would tell you not to consider the daily fluctuations in your long-term forecasting because they skew the picture. They are misleading in when looking at the big picture. Keep your eye on the primary trend.
Keep in mind, Dow Theory assumes normal business cycles. We are, in no way, shape, or form, in a normal business cycle. The economic collapse of last year has exacerbated this cyclical recession, but it is still worth looking at Dow Theory because we can infer much about “how” the market should behave, according to the theory. It is a tool, then, to help us adapt.
Trade in the day; invest in your life …
