2-10 (p.13-6) The five week patterns are in Fig. l3D. The interesting configurations are marked "Bullish" and "Bearish" in the left margin. There are two especially significant patterns. Number 25 (DOWN-DOWN- UP- UP- UP) is especially bullish. This pattern appeared 73 times in the last 40 years. In the week following the pattern the market rose 52 times and declined only 21 times. Parte rn number 12 (UP-DOWN- UP-DaWN-DOWN) is especially bearish. This pattern appeared 46 times in the 40 year period. The expectation for the following week is UP: 26. DOWN: 20. The historical record is UP: 20. DOWN: 26. This is a significant difference from expectation.
(p.14-l) Chapter 14: WHAT IS THE DOW THEORY? IS IT PROFITABLE? The Dow Theory began with Charles Dow (1850-1902) founder of the Dow Jones News Service. and founder and first editor of the Wall Street Journal. In his capacity, he wrote many editorials on the subject of the market. These editorials are the foundations of the Dow Theory. His work has endured. Today the interpretation of his ideas is providing a livelihood for many men. S. A. Nelson, a writer and publisher. tried to persuade Dow to write a book summarizing his ideas. but he didn't succeed. Nelson had determination, however, and collected all of the important editorials from the files of the Wall Street Journal. He published these in a small book "The ABC of Stock Speculation". In this book he labelled the Dow chapters "Dow's Theory" -- and the name was established. Nelson laid the cornerstone. A few years after Dow's death, William Peter Hamilton became editor of the Wall Street Journal. He proceeded to develop Dow's ideas from the status of general statements into a workable method. In 1922 he wrote a book "The Stock Market Barometer", which erected a structure on Dow's foundation. A short time before his death he supported his thesis by a famous editorial "The Turn of the Tide". This editorial. in the October 23, 1929 Wall Street Journal (one week before Black Tuesday) definitely called the end of the long bull market and the beginning of the great bear market. Robert Rhea (1887-11/6/39), because of an airplane accident in the first world war, was bedridden from 1918 to his death. In Colorado Springs. he began a study of the Dow ideas - first as a hobby. and later as a profitable vocation. His own wealth accelerated from the practice of his ideas. He was long of stocks through most of the twenties; he had no stocks at the time of the 1929 crash; he thereafter sold short for two years. Perhaps I am prejudiced, but I believe that he contribu-
2-8 (p.14-2) ted more to the development of the Dow Theory than Dow or Hamilton. You will understand my prejudice when you learn that Rhea liked to count and to measure. (This is the underlying thesis of the book you are reading.) Rhea's writings are a goldmine of statistics for the serious student. Some very capable students of the Dow Theory are active today. One of the best is Richard Russell of San Diego. Russell has written a book "The Dow Theory Today." He supplements his analyses of the market with other market barometers. Another capable interpreter is E. George Schaefer, author of "How I Helped More Than 10, 000 Investors to Profit in Stocks." In this book, he develops his ideas of a "New Dow Theory. " Another acute interpreter is Perry Greiner, who was associated with Robert Rhea in the last years of RheaI s work. Many books have been written on the Theory (See Appendix All),but the fundamentals are not complicated. Hamilton wrote "The essence of Dowis Theory can be summed up in three sentences. In an editorial December 19,1900, he says 'The market is always to be considered as having three movements, all going on at the same time. The first is the narrow movement from day to day. The second is the short swing running from two weeks to a month or more; the third is the main movement, covering at least four years in its duration. I" Hamilton's quotation was an oversimplification, of course. Actually, it is an example of the beginnings of the "Theory". The work of Hamilton and Rhea, and others, has expanded the beginnings into a fair-sized book shelf. The outline which follows is a condensation of these writings.
DOW THIOILY (p.14-3) BASIC I (I) J B r e Ollit hr OU9h - [stoblishes(Al end of Bull Market and beginning of Bear Market at point (9) 01 preceding Bear Market a beginning of Bull Market Of point (I). (A) - Both Industrials and Roils must breokthrough Li.e. confirm) for (l valid siQnal. PRIMARY These Primol'V Markets lost trom one yeor to several years. PRIMARY SWINGS: (1)-(2). (3)-15), (61-(7),18)-(9), (9)-110),1111"(131,(141115) IAlso collod "logs'.) SECONDARY REACTIONS: (2)-(3), (5)-(6), (7)-(81, (101-(11),113-'4) These lost from three 'Meeks to three months and retrace u.e. "correct") 1/3 to 2/3 of the p receding Primary Swing. Fig.14A
2-6 (p. 14-4) THE DOW THEORY -- A SEVEN POINT SUMMARY: Point (1) The fluctuations of the Dow Jones rail and industrial averages are a composite index of all the hopes, fears, and knowledge of everyone who knows anything of financial matters. They therefore can serve as a barometer of the future. Hamilton wrote: "Consciously or unconsciously the movements of prices reflect not the past but the future. When coming events cast their shadows before, the shadows fall on the New York Stock Exchange. " Rhea believed that students should concentrate their studies on the averages - other statistics could be ignored! Point (2) The market consists of three movements, which are going on at the same time: (2A) The Primary Markets. These are the great bull and bear markets. They last from one year to several years. These great movements are fundamental in nature, and are beyond the reach of manipulation. (2B) Secondary Movements: (See Figure 14A). These are called Primary Swings (or legs) when in the direction of the Primary Market. When in the other direction (rallies in bear markets; declines in bull markets) they are called Secondary Reactions. The Secondary Reactions are distinguished from minor changes by their magnitude (usually sufficient to retrace one-third to twothirds of the preceding primary swing) and by their duration (three weeks to three months. ) (2C) The minor or day-to-day movements. If the Primary Movement is considered a tide, the secondary is similar to the waves that please the surfboard enthusiasts, and the minor movements are the small ripples. The minor movements are not considered important in the Dow Theory.
(p.14-5) Point (3) The great bull and bear markets each consist of three phases. These are not related to the secondary movements described above in (2), and should be considered separately: (3A) In a bull market, the First Phase represents the improvement in public confidence and a correction of the undervaluation developed in the last phase of the preceding bear market. The Second Phase is a response to improvement in corporate earnings. The Third Phase is one of rampant speculation, when stocks are advanced on "hopes and expectations. " (3B) In a bear market, the First Phase is a correction of the speculative excesses of the Third Phase of the preceding bull market. The Second Phase is a deterioration of prices in gear with a slide in the earnings of shares. The Third Phase is a final depression of prices caused in part by distress selling. Point (4) The trend can be determined by the action of the secondary swings. Refer to Figure 14A. The rise from point (1) to (2), at the time, might be considered a secondary reaction in the preceding bear market. But when prices turned upward at point (3), which is higher than (1), the picture begins to look bullish. Then, when prices broke through the level of (2) at point (4), the rise is known to be part of a bull market which began at point (1) • In a downward swing, the same type of analysis would be valid. If the drop from (9) to (10), the classification would be "s econdary reaction" until the drop at point (11), when the classification becomes dubious. Then, at the breakthrough at point (12), the classification is definitely changed to "Bear Market". This method of determining trends by "breakthrough" has been aptly compared to the determination of tides. by the extent of waves on a sandy beach. If the farthest sweep of a wave is marked on the beach with a stick, and the next wave carries past this point (a breakthrough), the tide is probably rising.
2-4 (p. 14-6) Point (5) In determining the trend in (4), both Industrial and Rail averages must be considered.----changes and break-throughs by one average are not considered signals until the moves are confirmed by the actions of the companion average. The confirming action, however, need not be on the same day. Point (6) The averages sometimes move horizontally, within a 50/0 band, for three weeks or longer. When both averages do this, it is called a "Line". When both averages break out of this "line", in the same direction, an important move in the same direction is probable. The breakout is usually made with an increase in volume. Hamilton noted that "lines" seldom occur at the beginning or ending of secondary swings, but usually in the center. Rhea's analysis recommends the consideration of "lines" of less than 5%. If both averages, for example. have been moving in a 2% band, a breakout from this would be significant. Rhea found that in a bull market, downside penetrations of "lines" are very speculative, while upside penetrations are more reliable. Point (7) Volume: A market which is "overbought" becomes dull on rallies and develops activity on declines. Conversely, in "oversold" markets, the tendency is to become dull on declines and active on rallies. Robert Rhea supplemented Hamilton's tabulations with a detailed listing of all of the bull and bear markets and secondary movements in the period from 1896 to the time of his death in 1939. These tabulations have been charted in Figures 14B and 14C. These charts trace the Primary Markets with heavy lines; the light lines are the Secondary Movements. In addition, the points of confirmation of the primary markets are marked with the letter "C". Profits and losses obtained by buying and selling at these points of confirmation are indicated by arrows. Since the confirmation always follows the top or the bottom of a primary market, the profits are always less than the total move. The data for these charts are in Appendix A9) You can profit from this theory. It doe sntt always give a correct forecast, and the forecast isnIt always clear. But the profits over the years, when cumulated, are the equivalent of compound interest at the rate of 11. 7% per year.
(p. 14-7) 1--------------------- ----------- 1896 = 1919 DOW THIORY BULL • BIAR IIAI.IIT8 .. .. : 1 • > ---- ~-----,----------M-II " . 00'11 Jones lP'\dustriols - Chart bCl8eo on data by Ro bar r Rhea -- .... .. @ c GONFIRNATION POINT ----- 100 s I , c V.ell .. V 0 '" 7 .. --- .. 6 . ~------------l50 _ c " .. - - - • "AI i - - Fig.14B ;; :: . .. .. e . E .. II' .." .. .. a z Itf-----;~------,;:--------.,_----------------- - 251-------------------------------
(p. 14-8) 400---------- FIGURE 14-C MA' DOW TBIOIY lULL • ••AI MAIKETS I I 1919 =1939 - - Dow Jones Indusl ria Is -- - IJ • 0 c..... --- ------ -------,. 'J -- Chari based on dolo by Robert Rhea. Hamilton's editorial 10/25/29 1~1 -The Tur n of the Tide," • C = CONFIRMATION POINT ------------------ --- ~---------- - - 0 ---- -- - ----_.,- ,,--- .__._-~ N .. - , 0 .. a --------------- ---- .. , ~--- .. .~ C ;:: - - - -- A - fj - ; - " e 11 0< t - ----- ~t-- ----- e '{ -~ .. .. !: !! 0 1 .. a _ 0 ~c1- t ~~ \~ - .. !V c : c ;;; \ ... -- -- -_._. ---- --_. -- - - .... - _.. --- - - - 50- 40-------------------------=~-------- 00 90 70 60 '00 250 200 '50 .00 z-z
3-1 (p.15-l) Chapter 15. WHAT IS THE ELLIOTT WAVE THEORY? Some refreshing ideas about the behavior of Wall Street were developed by Ralph Nelson Elliott (187l-Jan. 1948). We will outline these ideas in this chapter. Additional details are in App. 4, and an analysis is in App. 5) After many pleasant hours of study and analysis, my own conclusion is this: Elliott's ideas resist reduction to specific rules for profit. They require interpretation; i. e. two Elliott enthusiasts in the same situation will quite probably have two differing conclusions. If you are reading this book for specific suggestions. you can skip this chapter. Ralph Elliott spent many years in Latin America as an accountant. In 1927 he retired to Los Angeles where he developed his wave theories. These were published in a monograph "The Wave Principle" in 1938, in a series of articles in the Financial World in 1939, and in a book "Nature's Law" published in 1946. His ideas proved so interesting to investors that he came to New York and spent the last years of his life writing a financial report. Basically, he believed that prices tend to fluctuate in natural ways. The most important tendencies, he believed, were founded on the Fibonacci series of numbers: 1-1-2-3-5-8-13-21-34-... Each number in this series is equal to the sum of the two preceding numbers. and the ratios are found many places in nature. The count of seeds in the whorls of sunflowers and pineapples are examples. Elliott found the numbers existing in the timing of waves and in the ratios of stock market prices at various turning points.
IBAS He BULL MARKET ... WAVES OF MAJOR DEGREE INTERMEDIATE DEG REE """ r 5 II MINOR DEGREE """ (p. 15- 2.) I LLJGT T y Jl: 5 JZ: 5 BEA R MA RKET
3-3 (p.15-3) Elliott's most basic conclusions are illustrated by Figure 15A, a chart which is derived from one that he published in "Nature's Law". The tendency that he illustrates is simply that moves in the direction of trend tend to be in five waves; those in the contrary direction tend to be in three waves. The top chart illustrates the "major" or primary waves in a bull and a bear market. The bull market has five waves; the bear market has three. The center chart illustrates the tendency toward the breakdown of the primary waves into waves of the next smaller or "Intermediate" degree. Note that each major wave in the direction of trend (up in a bull market; down in a bear market) is made up of five waves of intermediate degree. These are marked I, 2, 3, 4, 5. Each wave counter to trend is made up of three waves. These are marked a, b. c. The lower chart is a continuation of the same basic tendency. The longer of the "Intermediate" waves is made up of five waves of minor degree; the shorter of the "intermediate" waves breaks down into three waves of minor degree. An exception is the wave marked "flat". (This is a variation which will be described in Appendix A6. )
(p. 15-4) Unfo r tunat ely, the simple pattern of Elliott's "basics" (Fig.15A) does not line up very well with the record. You can check this visually by a review of the bull and bear market charts in Appendix AlO. Elliott took care of this by designing a series of variations. (These are in Appendix A4) For example, consider Elliott's direction of trend: (five waves) The to the record: Less than 5 waves: Elliott's basic five: More than five: basic pattern for the score, when applied 58. 60/0 21. 4 20.0 100.0 65.4% 26.0 8.6 Elliott's basic pattern for corrections is three waves. The score: Less than 3 waves: Elliott's basic three: More than three: 100.0 In other words, the exceptions are rnor e prevalent than the basics. (Footnote for students: See variations in Appendix A4; a support for the conclusions above in Appendix A5)
3-5
(p.16-1) - DE'INITIONS BULL MARKET To qualify I must be at least 40% of (B), or more than one year in duration. PRI MARY SWINGS OR LEGS ---'-----(8) , , • •, SECON DARY REACTIONS To qualify, must be at least 5% of (Al and one week in duration. BEAR MARKET To qualify, must be , , at least 40°' of (81, , , or more than one , yaar in dura t Ion. SECONDARY REACTIONS To qualify, must be at least 5% of (Al and one week 10 duration. SWINGS LEGS , , , , , IB)- FIG. 16-A
3-7 (p.16-2) Chapter 16. HOW LONG SHOULD YOU EXPECT A BULL MARKET TO LAST? A BEAR MARKET? A PRIMARY SWING? A SECONDARY REACTION? Suppose that we are in a bull market - or a bear market. How long should we expect to continue? What is the life expectancy? Suppose that we are in a primary swing - or in a secondary reaction. How long? In this chapter, you will find some life expectancy tables, which are based on the experience of two-thirds of a century. But - what is a bear market? A secondary? The Dow definitions (Chapter 14) are too fuzzy for our purposes. Some "authorities" called the 1962 slide a Bear Market; others. using the same Dow definitions, called it a Secondary Reaction. Some say that we are in a Bull Market which began in 1949; others say 1937, or 1962. We must define our terms with more precision before we can proceed with analysis. There is no ultimate authority. To permit analysis, we have made our own definitions. (If you disagree, you can modify these definitions, and with the help of a computer, set up modified tables.) We believe that the definitions in Figure 16A are defensible, for they are designed to approximate the swings tabulated by Hamilton and Rhea. (The analysis is in Appendix A6) These definitions might be considered a sharpening of the Dow Theory, except that we have not included "Percent Retracement" or "Confirmation by the Rails" in the definitions. Instead, our definitions use amplitude and duration only. They provide a means for the definite classification of all waves into four classes. which approximate those delineated by Dow Theorists.
(p.16-3) With the solid foundation of specific definitions, we can erect a very i.nteresting and useful structure. We have summarized this in the "Life Expectancy" tables which follow. We are using the life insurance technique, but we will think positively, and shun the name "mortality table". These tables are based on all swings of the D-J Industrials from 1897 through 1963. Note that these life expectancy tables never say "move ended". Instead, as with human life expectancy, there is always an expectation for continuation. If we consider all men who are 95 years old, we know that they will all continue to live, but for varying periods. The average time is the additional life expectancy. These tables consider the life expectancy of a move in terms of amplitude of swing in %. duration of swing in days and in number of legs. Here is an example. Suppose that we are in a bull market. We have advanced 67.6%; the duration so far is 880 calendar days; we are in the fourth leg. What is the expectancy for continuation? This was the situation November 1. 1964. First, consider the size of the swing in Fig. 16B. The life expectancy in a bull market after a swing of 600/0, is 47 percentage points additional; after a swing of 70% it is 42%. Our swing is 67.6%; interpolating we estimate 43 additional percentage points. This means that. in the past, the average bull market carried on for an additional43 percentage points, or to a complete swing of lll%. (68% plus 43%)
3-9 (p.16-4) DEFINITIONS - Used in the following Life Expectancy Tables (See Fig. 16A and Appendix A6): (1) The great primary Bull and Bear Markets include all swings of the D-J Industrial Average with an amplitude of more than 40% 2!: a duration of one year or more. (Z) The Primary Swings or Legs are smaller swings in the direction of the primary market, which are terminated by Secondary Reactions. (3) Secondary Reactions are contrary swings within the bull and bear markets which exceed 5"/0 in amplitude and one week in duration. (4) Minor Swings are all swings smaller than (Z) or (3). LIFE EXPECTANCY - PERCENT SWINGS Percent Life expectancy, additional percentage points Achieved: Bull Markets: Bear Markets: 30 67 4l. 40 58 40 50 5Z 35 60 -f1.- Z8 70 4Z ZO 80 38 13 90 37 6 100 54 lZO 88 140 107 160 110 180 III ZOO 114 Median total % swing: -- 96% 66% Fig.16B
(p.16-5) Now consider duration. In Fig. 16C. the expectancy after 800 days is 590 more days; after 900 days it is 580 more days. If we interpolate our duration of 880 days. we estimate the duration to be 582 days. This means that the average bull market which, in the past. lasted for 880 days. carried on for an additional 582. more days. Finally. consider legs. In Figure 160. we note that after four legs. the expectancy. on the average. is for three more legs. You can use the same method for the expectancy in primary swings and in secondary reactions. The tables are in Figures 16E. 16F. 16G. and 16H. These tables should help you to make more profit by adding perspective to your decisions. Footnotes for students; (1) In order to make downward swings comparable to upward swings. we have made 1000/0 the lower point in all cases. A swing from 80 to 100 and back to 80 is called a 250/0 swing upward and a 250/0 swing downward. Our 400/0 swing requirement for a bear market is the equi valent of a 28.60/0 reduction; the 50/0 requirement for a secondary is equivalent to a 4.760/0 reduction. (2) The tables are based on smoothed data. The actual turning points are tabulated and charted in Appendix AIO. (3) The data for secondaries (0/0 swing and duration) includes the first primary swing of the following primary market. since the latter is not distinguishable from the previous secondaries until the primary market is definitely established. (4) The tables exhibit some strange changes. At times the figures decrease. then increase. then decrease. (See Fig. 160) The reason is not clear. Perhaps the samples are too small for regularity. (5) Duration is measured in calendar days. not trading days. See Appendix Al3.
(p.16-6) LIFE EXPECTANCY; DURATION IN DAYS: Days Life Expectancy - Addional Days: Achieved: Bull markets: Bear Marl<ets: 100 640 540 200 630 460 300 630 380 400 620 300 ""610- 230 600 600 200 700 600 190 800 590 170 900 580 160 1000 580 1200 560 1400 550 1600 540 Median total days duration: -- 794 629. Fig.16C LIFE EXPECTANCY - NUMBER OF LEGS - 1 3 2 2 1 o ---s.o Life expectancy - Additional Legs: Bear Markets: 4 3 2 1 Legs Achieved: 1 2 3 _4_ 5 6 7 8 -9- Bull Markets: 6 5 4 3 2 2 3 4 4 10 4 Median total legs: ""6."""7 Fig.I6D 3-11
(p.16-7) LIFE EXPECTANCY - PRIMARY SWINGS - PERCENT SWING Median Total "!o Percent Achieved 5 6 7 _8_ 9 10 12 14 16 18 20 25 30 35 40 45 50 Life Expectancy - additional percentage points: In Bull Markets: In Bear Markets: 11 12. 3 10 11. 3 9 11. 1 9.5 11.1 9.8 11.1 10 11.1 10.5 10.7 10.7 10.0 11 9.4 11 8.8 11 7.8 10.8 ..........;.9:...4~ __ 10. 1 14 9.1 19 8 24 7 27 5.1 27 16.0 Fig.16E LIFE EXPECTANCY - PRIMARY SWINGS - DURATION IN DAYS - Days Life Expectancy - Additional Days: Achieved: 7 10 15 20 30 40 50 -2L70 80 90 100 150 200 300 Median total duration: In Bull Market s: 70 67 64.5 64 61 56 50 44 45 46 48 48 50 47 33 77 In Bear Markets: 37 34 32.5 29 30 30 29 27 24 22 18 14 14 44 Fig.16F
(p.16-8) LIFE EXPECTANCY - SECONDARY REACTIONS - PERCENT SWING-- Percent Achieved: 5 6 7 8 9 10 12 14 16 18 20 25 30 Median Total Swing: Life Expectancy - Additional Percentage Points: In Bull Markets: In Bear Markets: 5.0 6.0 5.0 7.0 4.8 7.7 4.5 7.8 4.2 7.5 3.8 7.0 3.6 6.1 4.2 6.0 4.5 6.7 5.0 7.1 5.0 8.0 6.0 9.8 3.0 11.5 11.1 Fig.16G LIFE EXPECTANCY - SECONDAR) REACTIONS - DURATION IN DAYS - Days Achieved: 7 10 20 30 -1Q...... 60 80 100 150 200 250 300 Median Total Duration 3-13 Life Expectation - Additional Days: In Bull Markets: In Bear Markets: 18 31 19 29 __21__ 29 22 29 22 29 21 ---.l.L-. 40 36 61 41 87 45 80 53 40 57 60 55 3"8 Fig.16H
(100-;- %YIELO) '65 CAl DIVIDENO RATI ... 0 ... .. ... l!.~ .. e .. 17A -'l=' ..... I -
3-14 (p.17-2) Chapter 17 IS THE MARKET INFLUENCED BY EARNINGS? The value of an investment at any time is the price at which it can be sold. Earnings and dividends should be an important factor in this value. It is clear that, at any given moment, the di vidends and earnings of individual stocks are definitely important factors in the relative prices. But when we consider different times in history, investors have evaluated these factors through a wide range. Note Figure 17 A. This chart plots the cost of buying one dollar of dividends in the D-J averages. The cost swings through a wide range. There were times when you had to pay as much as $36.90 to get enough shares to pay one dollar a year; at another time you could have made the same purchase for $10. The points in the chart have been divided into three areas. The top one quarter of the points fall above $28. This has been labelled the "expensive range." The lowest one- quarter fall below $17. This has been labelled the "bargain area". The median price for the entire period is $22. When prices are in the expensive area (They are in this area at the time of writing), it appears that one should not hold out hope for much higher prices; when they are in the "bargain area" one should not expect to buy at much lower levels. There seem to be limits in the judgment of investors. Investors aren't willing to pay much over $28; they haven't been willingto sell for much less than $17.
(p. 18-1 l!_B_E IFHE PEIRCENT PENETRATION MIT80D_ SELL on a Downward Penetration Profit Profit Fig. 16-A Buy -)- - - - - - - - - - - - - - - ______ .; _"~~I~s_a~"_ _ _ _ _ _ _ Loss than 5 % (100% is Ignore all Turning with swings of less on an Upward Pe ne rr et ion at a Turning Poinl
3-12 (p.18-2) Chapter 18 - IS TREND FOLLOWING PROFITABLE? Is it practicable to follow the longer swings of the market? When does a short turn become a trend? The Dow Theory and the Elliott Wave Theories are investigations in this direction. In both of these investigations, a considerable amount of "interpretation" is required. The case is never specifically' defined. In this chapter, a simple and definite trend following method will be outlined and tested. It is described in Fig. 18A. It uses the "breakthrough" idea in the Dow Theory, but it rigidly defines the qualifications. A hundred men using the Dow Theory could have a good debate on the subject of a breakthrough; a hundred men using the Elliott Wave ideas would have a real donnybrook; a hundred men with Fig. 18A would come to identical conclusions. The results of this method over any span of time can be measured definitely • The figure "5%" is not essential. The important point is that it's specific. If you select a higher percent, there will be fewer errors in the selection of trend; there will be fewer losses. Balancing this advantage will be a lower profit; you will buy later and higher in a trend; you will sell at a lower figure. The results have been tested over two periods of time. The first is the 1897-1939 period for which Robert Rhea tabulated the Dow Theory signals. For this period, the result of the Dow Theory is quite excellent. (This was reported previously in Chapter 14) The profit, including short sales, averaged 12.9% per year. H 2% is deducted from each trade (one buy and one sell), the rate is reduced to 11. 7% per year. If the shortsale profits are excluded, the rate is reduced to 8.4% per year. These figures are a considerable improvement over buying and holding for the entire 42 year period, which is 3.5% per year.
(p.18-3) The score for the 1150/0 Penetration Method" is almost as good. before the deduction for expenses: 12. 340/0 per year. However. since there were 84 trades in the period (The Dow Theory had 2Z). the overall profit after expenses is reduced to 7.90/0 per year. If short sales are excluded. the rate for the period is 6.60;0 per year. Both of these figures. however, are substantially better than the buy-and-hold rate of 3.50/0 per year. One disadvantage in the "Five Percent Penetration" method is the number of whipsaw trades. In the 84. trades. no less than 37 were made at a loss. The losses, however. averaged much smaller than the profits. The method has been checked back over the entire period from January I, 1898 through November I, 1964. In this period there were 123 trades. Of these 63 were profitable and 60 were made at a loss. The median profit, however. was 10.30/0 while the median loss was only 6.30/0. The largest loss was 16.80/0. while there were eight profits larger than 500/0 and one of 1040/0. The average growth for the entire period. after deducting 20/0 for each trade. amounted to 4.920/0 per year, including short sale trades. If the short sales were excluded, the total rate of income was not as high. as expected. However. since there were half as many trades. the net income after expenses actually rose to 5.50/0 per year! Both of these figures are an improvement over the buy-and-hold figure of 4.850/0. The conclusion is that a definite policy of trend-following would have produced profits. However. the use of short selling with this method is dubious.
3-10
3-8 (p.19-2) Chapter 19: ARE SOME PRICES PREFERABLE TO OTHERS FOR PURCHASE? FOR SALE? Analysts have long noted "resistance points" and "support levels". In the former, resistance to a rise is created by the offering of stock at a certain level; in the latter, support arrests a decline by supplying purchase bids. These resistance and support points have been found, in individual stocks, to be located near previous turning points. We have checked this tendency to see if it appeared in the D-J average. The major turning points from 1914 to 1964 have been charted in Figure 19A. In this chart note any tendency toward clustering. This would indicate a point of persistant resistance or support. There aren't very many clear supports for the theory in this chart. There are a few interesting spots. Note 71. 8 72.8 76.1 90.2 96.2 136-138 142-146 176 186-187 570630 690
(p.19-3) =DUTI.IBUTRON' WITHllN THE POINT= -- All Common Slacks on N.Y.S.E -- I 1961 HI GH PO I N TS : I 1/8= 12.5% II 96 2 LOW POI NT S: I 1/8 = 12.5 % 7/8 3/4 5/6 3/6 1/4 1/8 o FIG. 19-8 26.4%
3-6 (p.19-4) There is a very definite tendency for support and resistance based on the number itself. Retail stores have found that a price of $1. 97 is more attractive than a price of $2.01 Note this tendency in Fig. 19B. All of the common stocks on the N. Y. Stock Exchange have been examined. (Preferred stocks have been excluded.) In the upper part of the chart the high points in 1961 have been tabulated. All of the price has been ignored except the fraction at the very end. For example: a stock with a high of 195 would be in the upper bar; one with a high of 6 7/8 would be in the next bar; one with a high of 26 3/4 would be in the third bar. Note that the even number is a strong resistance level. 19.6"/0 of the stocks topped out at the even price. The next most popular resistance is at the 1/2 with 18.8"/0. The quarter points follow; the eighths are least popular. Stock seems to be offered for sale more often at the even price; the half is almost as big a resistance level. If you plan to sell at the top, then, you should avoid offering at the eighth, since the price will probably move up to the next quarter. The reverse, of course, is true on a stop-loss sale. These should be placed on the eighth points, since prices will probably not stop at the eighth. but will move higher.
(p.19-5) Consider the lower half of Fig. 19B. The low points of all common stocks on the NYSE were tabulated for the 1962 decline. The even price, again, is the most important support. 28.4% of all stocks stopped their decline at an even price. A lot of purchase orders seem to be placed at this price. The next most important support point is the one-half, where 17. 5% of the stocks stopped their declines. The 114 price is close behind. For profit on purchase, then, one should not place purchase points at the 1I 8 level, since prices, when they hit that level, will probably continue to the next even quarter before reversing. For stop loss, the reverse should be true. This order should be placed on the 1/8 points, since a price will probably continue to the next 114. The 718 point (just below the major support) should be a good place for a stop-loss.
3-4 (p.20-l) Chapter 20: CONCLUSIONS: The major conclusion of this book is this: The market has definite upward tendencies at certain predictable times; it has leanings in the downward direction at other predictable times. Some observers have noticed a feed-back effect in market forecasts. When a barometer or a method is published, it tends to affect the behavior of readers; this behavior in turn tends to affect the market. It will be interesting in future years to note if the findings in this book become spread far enough to produce a feedback. If so, they may tend to advance the timing of changes. If the market has, in the past, shown a tendency to rise on a certain day, buying in anticipation of the rise on the preceding day may produce an upward bias on that day. The study of these inclinations should continue, therefore, and not be considered a static collection of knowledge. Readers should note new developments, and add these to the background reported in this book. The possibility of change, however, should not discourage the investor. The inclinations of the market reported in this book have a long and substantial foundation. The market is widespread; it has inertia. The inclinations and biases reported in this book should be useful both to speculators and to investors. If purchase is considered, and the market has an inclination downward, a prudent man should delay purchase. If a sale is contemplated, and the market has a downward inclination, a prudent man should sell immediately. The recognition of these inclinations, which are reviewed in the preceding chapters, should reduce l osse s and increase PROFITS.
(App. AI-p. I) Appendix A I: ARE THE DOW JONES INDUSTRIALS REPRESENTATIVE? In 1896, Charles Dow began to report the averages of a few selected industrial stocks. After 67 years of use, it is still the most widely-quoted measure, although a number of very sophisticated indexes have entered the field. Twelve industrial stocks were used until 1916, when the list was increased to 20, and the new average was worked back to December 1914. Only the closing averages were calculated. The method was simple. The stock prices were listed and divided by the number of stocks to get an average. If a stock split, a multiple was applied before adding with the others; if the split were two-for-one, for example, the stock price after the split was always multiplied by two before combining with the other prices. On October 1,1928, a number of changes were made. The number of industrial stocks was increased to 30 (the current number); the closing prices were supplemented by calculation of the highest and lowest averages for each day, and the method of coping with splits was altered. The multiples were eliminated, and the adjustment was made in the final divisor. The divisor was also adjusted when a new stock was substituted for another in the list, in order to gi ve continuity. To calculate the current average, list the stocks (you will find them occasionally in Barron's and the Wall Street Journal). Set down the prices; add them up; divide by the divisor (See Barron's or the Wall Street JournaL); the result is the index.
3-2 (App. Al-p. 2) There are four principle limitations: (1) A minor irritation is the high price. $800 is a number that many find misleading. An eight-point change sounds big - but it is actually 10/0. If this irritation disturbs you, simply divide the index and its changes by ten before interpreting. (2) A more serious objection is levelled at the highlow calculation. These are not highs and lows for the index; instead they are averages calculated from the individual stocks in the index. Srnc e these highs and lows occur at different times in the day, the average at any given moment is always lower than the daily "high" and higher than the "low for the day. " (3) Representation: The D-J reports the price change of 30 stocks. Are they representative of the entire market? The stocks have been selected because of their importance. If you total the market value of the 30 stocks (multiply price by number of shares listed), you will find that this small group of companies is more than onethird the value of all stocks listed on the N. Y.Stock Exchange. This is a very important list! But this selection represents only the "blue-chips". It is far from the random selection advocated for some purposes by statisticians. Two-thirds of the market is not represented. If the blue chips rise, the D-J rises; the remainder of the market may be declining. (4) Weighting: Statisticians wince when they learn the D-J weighting method. In a representative average, each stock should be weighted by some rational method, so that its importance in the index is properly reflected by the index. In the D-J, the weighting is the price. Owens Illinois Glass is more important in the index than Standard Oil of New Jersey, because its price is higher. (The total value of the stock of Jersey is more than 25 times that of Owens Illinois. )
700 600 50 4 300 (App. AI-p. 3) DOW-JONES INDUSTRIAL.S USE LEF HAND CALE.- 8 70 60 50 40 30 MAl 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 Fig. AlA
(App. Al-p. 4) The lack of logic in the weighting method is evident at the time of a stock split. If a D-J stock is split fourfor-one, the importance of the stock in the index (if this influence is measured by the effect of a 10% change in price) is reduced to one-quarter of its importance before the split. Has the split changed the true importance of the company? (It should be not e d that lower-priced stocks are usually more volatile - see Appendix A7. This characteristic helps the "Dow". The change of one dollar in the price of each stockin the index carries equal weight. It is easier for a hundred dollar stock to move one dollar than for a $20. However, it's easier for a $20. stock to change 5% than for a $100. stock. This characteristic off-balances some of the illogical weighting after a stock split. ) After we consider all of the limitations, the D-J still seem to represent the market quite well. We have compared it with the Standard and Poors 425 Industrials in Figure AlA. The latter index represents some 87.3% of the total value of all stocks on the NYSE, and is weighted in a rational manner. If the scales are adjusted it is found that both indexes move together in a remarkable fashion. 4-1 The conclusion, after a the Dow Jones Industrials well. study of Figure AlA, is that represent the market quite
(App. A2-p. 1) TIINDS : CONTINUATION or IUJNS (Ok of times that runs continued in the same direction, e. did not reversel I RUNS DOWNINARD"l 6,10 60'----r---.-------.- 50 Jan. 1962- ....... .... ... 0 •••••• .. ..... June 1964 40 1 2 3 4 5 - RU N - 60 gDAYS 50 Jan.1697- June 1964 40 I 2 3 4 5 - RUN - 60 l j 50 Jan.1697- June 1964 40 1 2 3 4 5 -RUNFIG. A2-A 5 5 4 5 4 4 3 - RU N3 - RUN - UPWARD I 3 - RUN - 2 2 2 RU NS <, ...., .. ....... .. .. .. .. ...... / r--.... )..:,..... ...., 0 40 I 6 401-----L-----1------L------JI 60,.----.-----,----,------,-- 50 0/0 60 5 40 1
4-3 (App. AZ-p. Z) Appendix AZ: IS THE MARKET RANDOM? This appendix deals with market~. A "run" is a continuation of moves in the same direction. If the market goes down. then up. then down: the run is one in the up direction. If the market goes up. then down four times, then up: the run is four in the down direction. Hourly runs have been examined from January 1962 through June 1964. Daily runs have been noted through every day from January 1897 through June 1964. Weekly runs have been studied for the same period from January 1897 through June 1964. Figure AZA charts the percent of the times a run continued. You will note the tendency toward continuation in the case of the shorter runs (hours. days). The runs in the weekly series don't have the same inertia. and make a good case for a "random walk". (Pure chance)
(App. AZ-p. 3) RUNS IN BOURLY DATA :'\ '\ ....'\. , \ ~ACTUAL ,..'.:,,- \,:,,~ ..... :" ,,:'.'':-'':\ \ ...: .... ".::.::,\ EXPECTED-"" J .., \:; , '\ .. t -DOWNWARDFIG. A2B I 134567891011 -Lenqth of Run10 8 6 4 3 2 20 500 400 300 200 150 100 80 60 40 30 -UPWARD- - Length of Run - Hours 0 0 ;~ K, o . 0' '\. 0 - "'-'I. 0 "\\. 0, ". 0 \" '\ 0 ".\.- 0 : (:\rACTUAL 10 ';:'\ e ':.\. 6 '.' .:~ 4 "::::'1 3 2 EXPECT ED-"'\ A 'V::, \ I I 2 3 4 5 6 7 8 1\ 13 ') 10 " 14 15 16r '0 8 6 4 3 20 15 50 40 30 I Ptriod - 3691. Hour. Jan. 1962 - June 1964; CoJ Indu.trials) RUNS IN DAR LY DAT A -UPWARD- -OOWNWAROFIG. A2e - Lengfh or Run" f\ - , " T \ \ '\. 0 '\ , ~ACTUAL EXPECTEO~\, \ ~.~ -V \, \1, , 1 2 3 4 5 6 7 8 8 10 II~ '2 13 I '00 80 80 &0 4 30 20 10 8 6 4 3 1000 800 600 400 300 200 2000 7 8 9 3000 ,'\. ,.\ ~'t-ACTUAL \ "'- A EXPECTEOJ;: 5 6 - Lenqth of Run - Cays - ...\. '\ " '\. 2 3 4 " 3000 2000 1000 800 \. 600 (Period - 19044 Cays Jan.IS97- June 1964; CoJ Industrial.)
(App. A2-p. 4) • RUNS IN WilILY DATA = UPWARD-- DOWNWARD-- FIG. A2-0 - Lenglh of Run- \. \. 0 \ 0 0 , \, \. 0 \. 0 EXPECTED~ACTUAL \~ [? \ :\ C%. 1 2 3 4 5 6 7 8 3 10 8 50 10 20 500 300 13 - Longlh of Run - Weeks - 0 0f\----=---------~~---- --- 0 -. - - 0 -lI.. 0 '~ACTUAL 10 \~.... 7 ._~ 51----_ '\:~ 3 EXPECTED --<\ 2 ___ L--l.--I ,\ I". .i., 1 1 2 3 4 6 7 6 9 10 1\ 12 I 2 10 50 30 20 (Period - 3484 Weeks Jon. 1897 - June 1964)-; O-J Induslriole) The detailed data are charted in Figures AlB, A2e, and A2D. In these charts the number of runs is charted against the length of the r un , Note the large difference between expected and actual in the hourly chart. (Fig. A2B) In the daily and weekly charts, the actual is not far from expected, except that the difference in the case of a one-day r un is significant. 4-5
(App. A3-p. 1) (e) Fig. A3A (e)
4-7 (App. A3-p. 2) Appendix A3: HOW SHOULD TURNING POINTS BE MEASURED? "Nat'ralists observe a Flea "Hath smaller Fleas that on him prey "And these have smaller Fleas to bite 'em, "And so proceed ad infinitum. " (Dean Swift - 1733) In this appendix a method of c Ias sification and measurement is proposed which permits the definite measurement and tagging of every market turning point. This method has been found useful m the analysis of the Dow Theory and the Elliott Wave Theory. It has helped in establislunent and testing of the "50/0 Penetration Method" described in Chapter 18. The method is quite simple. Turning points are first grouped into definite pairs; the vertical distance between the two points in the pair is a measure of the importance of the two turning points in the pair. The following is the proposed method: (1) Pairing must follow these requirements: (See Figure A3A) (a) Betwen points (c) and (d), in either chart, the curve has reached the level of (A) twice and twice only, at points (A) and (d). (b) Between points (c) and (d) the curve has dropped to the level of (B) twice and twice only, at points (B) and (c). (2) The importance of turning points (A) and (B) is called "degree". This is equal to the vertical distance between the turning points (A) and (B) in percent of the lower turning point (B): Degree of (A) =Degree of (B): (e)xlOO% (B)
(App. A3-p. 3) co iii -----.----l. ._--------j ,. I i K H ,. . _~_.,,_. .. .,; .... 1-" -_._-- .,------- 11- 0 co ... .. '" --~'" II- .. .. .. TURN ING POINTS OCT_ . 5% DEGREE 6 HIGHERIIco'" = I f---+-+----+-I-----------------i -\ff----arllI [ E 11- #. ,. .. .... "! 0 "" 01 .. 250 J 200~-- 350 \--~I-+~'------ - ----- ------ 1919 ~·------,-----l---- _PEAK ___ 386.10 ... 9EPT. 3 ....__. --- _..- --_.._--- --- S -DO W JONES INDUSTRIALS ~t--'- .__ .. '--1 -0 oi Iy - I-~u ~I 0 -- A c IL ~I - H N E J1~ L ,m·~'.h J lIP! !I ''''0 >- 'h.: ·W ., 0 ~.~ ... :J II M " 1 0 Q .. ;n 1 -. G 0 K --_.. L--__ 'l---l ---_._-- I OCT. NOV. OEC_ 20 250 390 350 300 Fig. A3B
4-9 (App. A3-p. 4) The paumg is not difficult. You will find that a turning point can be paired with one and only one other turning point. The 1929 peak, for example, is definitely paired with the 1932 low point; the November 1961 peak is definitely paired with the June 25, 1962 low point. In the case of the most recent turning points, the classification may have to be tentative until the two requirements (above) have been fulfilled. When turning points are paired and tagged, the swings or waves between them can be measured. It is suggested that the following nomenclature be used: (1) A swing connecting two paired turning points is called "a complete swing." A swing between two nonpaired turning points is called a "partial swing". (2) The amplitude of a swing is considered to be the vertical distance in percent of the lower turning point. This will make upward swings comparable to downward swings. (3) The duration of a swing is the time interval between the two turning points. Figure A3B is an illustration of this proposed method of classification.
4-11 (App. A4-p. 1) Appendix A4: IN ELLIOTT1S THEORY, WHAT ARE THE VARIATIONS? All of ElliottI s published writings have been reviewed. The notes are summarized in this appendix. An analysis and an application to the movements of the market are included in the next Appendix AS. In Figure A4A and A4B we have summarized and combined all of Elliott's various examples for the period 1929 through 1945. This period spans the time beginning with the first Dow Jones high-low statistics and ending with the last analysis published in "Natur e ts Law, a few months before his death. The nomenclature has been standardized, in order to make it easier for a student to trace through Elliott's interpretation of the wave patterns. In addition to his basic conclusions listed in Chapter IS, he tabulated many variations. which are charted completely on the following pages. He listed some subsidiary conclusions: (l) No confirmation is required by a companion average. (The Dow Theory requires confirmation of the Industrials by the Rails.) (2) Actual high and low figures are used, rather than the closing prices. Elliott said "in fact it was only with the establishment of the daily range in 1928 and the hourly averages in 1932 that sufficient reliable data became available to establish the rhythmic recurrence of the phenomenon called the "Wave Principle".
(App. A4-p. 2) (3) News has little effect on the course of a wave series. It may affect the amplitude and timing. (4) Prices tend to move in channels. These can be useful in the interpretation of waves. (5) Elliott listed his names for the degree of waves in the following order: Subminuette (only in the hourly data) Minuette Minute Minor Intermediate Primary Cycle Super Cycle Grand Super Cycle (6) There are many exceptions to the basic pattern. These are described in Figures A4C through A4L.