I was thinking about Dow theory, and the premise that the markets move like the oceans. Market movements have been compared to Tide, Wave & Ripple, and so in preparation for this blog post I started looking up sayings pertaining to these three; Tide, Wave & Ripple. Here are some of my favorites:
“Time & Tide Wait for No Man” –St. Marher, 1225
Then there was:
-“The Breaking of a Wave Cannot Explain the Whole Sea” –
“Each time a man stands up for an ideal, or acts to improve the lot of others, or strikes out against injustice, he sends forth a tiny ripple of hope, and crossing each other from a million different centers of energy and daring, those ripples build a current that can sweep down the mightiest walls of oppression and resistance” –Robert Kennedy
It’s important that, as traders and analysts, we recognize some common and academically accepted terms in order to communicate effectively. Pretty as they are, perhaps it’d be best not to employ terms as flowery and distracting as Tides, Waves and Ripples. In every asset, especially the most liquid ones, we see fluid movements of price, and to some degree volume, in three types of trends. And, like our oceanic example, they are beset on both sides by time & size. They are as follows:
Primary Trends- These are the large movements of large indices or issues that are visible on a chart displaying one to several years of market history. They are often displayed using “Daily” candles (or bars); What some traders commonly refer to as “The Daily Chart”. In some cases, Weekly or Monthly candles are also used. If the primary trend is moving upward, it is often said that “We are in a Bull Market”. Conversely, if this trend points to the downside, we would be in a “Bear Market”. Of course, for these market reversals to be verified, it is often quoted that “The averages must confirm”, meaning that these trends must be confirmed by two or more major indices (such as the Industrial Average and the “Rails”, now known as the Transportation average). This large movement is equivalent to the tide in the previous paragraph.
These Primary Trends are occasionally interrupted by -secondary- swings, often referred to as “corrections”, which are considered normal for the good health of any long term trend. We will discuss these, our “waves”, next.
Secondary Trends- These are the waves in our analogy and they exist as brief interruptions in the Primary Trend. We call them “Intermediate Declines” or more popularly “Corrections” during a Bull Market, but the nomenclature changes during a Bear Market when they are called “Intermediate Rallies”, again more popularly “Recoveries”. We are an optimistic bunch aren’t we? Often times these corrections and recoveries take place over 20% to 30% but are not limited to these figures and have sometimes exceeded 50%. The secondary trend is often a confusing point for many analysts and traders.
Minor Trends- These ripples in the market are relatively meaningless to the far sighted investor but bear some importance to Day Traders since they are where the short term alpha lies. They rarely run as long as 3 weeks and often terminate in under a week. They are easily manipulated by institutions, financial consortiums and “whales”. These organizations and groups have been accused of using price manipulation in order to encourage more traders to jump in on the trade, adding liquidity and volatility to the whole thing.
Overt price manipulation is in fact illegal but that is where chart patterns come in handy. We know that many economic and psychological factors come into play during the formation of certain chart patterns, but what is less commonly referred to is the “probability” that these institutions are using “chart manipulation” to achieve an even greater degree of price manipulation.
“It is what it is”, as they say. All that is left is for us to do is study, back-test and paper-trade a well-formed plan with entries, exits and stop-losses with well defined risk management parameters; stick to our plan; document & journal our live trading extensively; And in that respect, provide ourselves with enough good data that we are able to review, resolve and revise, in order to prevent the repeating of past mistakes. It all really comes down to a discipline of principles that I suspect we could all use work on.
Cheers and good luck trading. See you all on the squawk.