of the previous primary swing, 65% last between three weeks and three months, and 98% last from two weeks to eight months. Another distinguishing characteristic is that the rate of change of price movements in secondary reactions are typically swifter and sharper than the movement of the primary trend.

Secondary reactions should not be confused with minor reactions that occur frequently within primary and secondary price movements. Minor reactions move in opposition to the intermediate trend and last less than two weeks (14 calendar days) 98.7% of the time. They have virtually no impact on the intermediate or long-term trends. Only nine movements lasting less than two weeks of the 694 intermediate movements (both up and down) in the history of the Transports and Industrial averages to date (October 1989) warrant classification as secondary corrections.

The key term in Rheas definition of a secondary reaction is important. As a general rule, any movement retracing more than V3 of the previous primary swing is important if it occurs as a result of fundamental changes in the economy, not just technical factors. For example, if the Fed raised margin requirements from 50 to 70% in the stock market, there would be a substantial liquidation that had nothing to do with the health of the economy or of the companies whose stocks were affected. Such a movement would be minor. If on the other hand, half of California fell into the sea in a major earthquake and the market sold off 600 points in three days, the s ell-off would be major because the eamings of companies would be affected.

1978 Dow Jones Industrial and Transportation Averages

1973

Bonds

AUG SEP OCT NOV

Figure 4.8 The Dow Industrial and Transportation Averages-a secondary reaction in the 1978 bull market. Secondary reactions in bull markets are usually marked by sharp rates of price decline relative to the preceding and ensuing price increases. The beginnings of secondary reactions are usually markednby high volume, with the lows made on low volume.

Making the distinction between minor reactions and secondary corrections isnt always this clear-cut, however, and is the only somewhat subjective element of Dow Theory.

Rhea likened secondary reactions to the pressure control system on a boiler system. In a bull market, the secondary correction is the safety valve which relieves the pressure of an overbought market. In a bear market, the secondary reaction is additional fire in the furnace to build up pressure that is lacking from an oversold condition.

CONCLUSION

Dow Theory alone is by no means the comprehensive way to forecast market behavior,9 but it is an invaluable component of knowledge that no prudent speculator should ignore. Many of the principles of Dow Theory are implicit in the language of Wall Street and the vocabulary of market participants without their even knowing it. For example, most market professionals have a general impression of what a correction is, but no one that I know of has defined a corr ection in the objective terms that Dow Theory does.

By reviewing the basic tenets of Dow Theory, we have leamed a general method of gauging the future of market price movements by studying both currant and historical price movements of the market averages. We now have a general idea of what a trend is. We know that there are three trends that are simultaneously active in any market and the relative importance of each to the trader, speculator, and investor.

Bearing these ideas in mind, it is now time to gain a deeper understanding of price trends. After all, if you know what the trend is, and if you know when it is most likely to change, then you really have all the knowledge you need to make money in the markets.

Trae Understanding of Trends

UPTREND, DOWNTREND, MOVE ALL AROUND TREND

One of the most amazing things to me is how few people, even market professionals, understand what a trend is. For example, if someone threw Figure 5.1 at me and asked me what the trend was in gold, what do you think I would answer" The best answer would be, "Which trend are you talking about?

When I look at this chart, I see three separate and distinct trends: the long-term trend, which is down; the intermediate trend, which is up; and the short-term trend (or the minor trend), which is down (see Figure 5.? 1. When identifying a price trend, you have to be very spec ific and very consistent.

When I was training traders, virtually every one of them would come up to me with a chart with the trendline drawn incorrectly, and say something like. "Vic. look at this, the trendline has been broken. Isnt this a terrific on\.)" If you dont traly understand what a trend is, you can draw a trendline on a chart irtually any way you want to, and the conclusions you draw from looking at this so -called *trendline" will be useless.

Ill demonstrate in detail how to correctly and onsistently draw a trendline in Chapter 7. For now, lets gain some broader insights into what a trend i5 exactly, and how it changes.

LETS REDUCE IT TO BASICS

Probably the single most important piece of information you can get from Dole, Theory is the definition of a trend, which is implied but never clearly stated, and the distinction between the long-term, intermediate-term, and short-term trends. It is only by understanding what a trend is that you can determine when a change of trend occurs. An d it is only by accurately identifying a change of trend that \on