I tend to be more ready to take market action on extreme divergences such as seen in Figure 3.4 for 1999, perhaps not waiting for confirmation. However, this steps outside the bounds of Dow theory and in another similar situation I might be premature in assuming an end to the primary trend. Also, the 1999 circumstances were unusual; the Industrials did eventually confirm a downside primary trend reversal and the next rally in the Industrials after that was a high-potential shoring opportunity within the tenets of Dow theory.
VOLUME CONSIDERATIONS
An important advantage that exists in stocks is that volume information is readily available. One of the great lost arts is that of tape reading. When brokerage offices made widespread use of the big running tapes, it was very clear when a rally or decline was significant—you could easily see the blocks of stock being traded, indicating big institutional activity. Volume should go in the direction of the trend and expand as prices moved that way. Dow related this to the rule that volume will increase in the direction of the primary trend. However, the same rule is often true for intermediate trends. It is likely that volume will ratchet up even more in the direction of the primary or major trend. We are talking here about the volume trend over time. I especially like to watch upside volume activity. It should increase as the market moves up and decline as prices fall. Upside volume is the sum of transactions done on up ticks. A true test of buying interest or strength is the willingness to pay up for stocks. However, this is an aside from Charles Dow’s writings on volume.
The corollary of volume increasing in the direction of the primary trend is that volume will tend to subside on price swings counter to the direction of this trend. In general, volume will expand on a move with the trend and contract on a move against the prevailing trend. Volume is however, secondary to price in terms of forming conclusive evidence of a trend or trend reversal. Price is king in terms of studying market trends and volume is like the prince of it.
LINE FORMATIONS
Dow described a sideways price movement in one or both of the averages, lasting anywhere from a week or two up to a few months, as a line. This would typically be where prices fluctuate within a relatively narrow price range, such as within a few percentage points of the high or low that preceded the line formation. The line can substitute for a secondary up or down trend. Such a sideways trend—I consider a sideways movement to be a third type of trend, whereas many analysts consider trends to define only an up or down direction—indicates that buying and selling are in relative balance. Eventually, buyers are willing to pay more or sellers take less and this moves the market back into an up or down trend. A penetration of the upper or lower part of the line formation usually signals the direction of the next intermediate price swing.
Usually, the longer that these sideways trends go on, the more significant is the next move in the average. There is often a direct correlation between the time duration and the extent of the next price move above or below the line. The sideways move in the Dow Industrials, seen in Data from 2000 on, while more on the order of a 10 percent fluctuation (between approximately 11,500 and 10,000), shows a duration of more than two years. The number of tops and bottoms made within the same pricearea, forming well-defined upper and lower boundaries, define this pattern as a line. These well-defined boundaries are more important than the fact that the price range lacked the more typical narrowness between the highs and lows. The line formation today is more often called a rectangle pattern, especially as it relates to individual stocks.
Lines mostly form as a pause in the trend or a period of price consolidation of the averages. The line in this situation is part of the formation of the major trend and can take the place of an up or down secondary move.
Sometimes a line forms after a lengthy bull or bear market. Some technical analysts assume that a major line formation is a distribution top if the trend was up preceding it and an accumulation bottom if the prior trend was down. Dow himself did not indicate that the direction of the next price move after a line pattern ends could be forecast.
USE OF CLOSING PRICES
Dow theory does not take into account intraday highs or lows in terms of determining a change in trend. Only a new closing high or low is considered. There has been discussion in the past by interpreters of Dow theory as to whether the averages should simply clear an old high or low by any amount or whether they should be by some point margin or even some percentage amount. I would look at the circumstances and tend to look for some degree of separation. If the new high or low is very close to the other, this second high or low could qualify as a double top or bottom, if prices then reversed from there.
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