The Averages Must Confirm Each Other.

1. The Averages Discount Everything.The sum and tendency of the transactions of the Stock Exchange represent the sum of all Wall Street's knowl‑edge of the past, immediate and remote, applied to the discounting of the future. There is no need to add to the averages, as some statisticians do, elaborate compilations of commodity price index numbers, bank clearings, fluc­tuations in exchange, volume of domestic and foreign trades or anything else. Wall Street considers all these things (Hamilton, pp. 40-41).Sound familiar? The idea that the markets reflect every possible knowable factor that affects overall supply and demand is one of the basic premises of technical theory, as was mentioned in Chapter 1. The theory applies to market averages, as well as it does to individual markets, and even makes allowances for "acts of God." While the markets cannot anticipate events such as earthquakes and various other natural calamities, they quickly discount such occurrences, and almost instantaneously assimilate their affects into the price action.2. The Market Has Three Trends.Before discussing how trends behave, we must clarify what Dow considered a trend. Dow defined an uptrend as a situation in which each successive rally closes higher than the previous rally high, and each successive rally low also closes higher than the previous rally low. In other words, an uptrend has a pattern of rising peaks and troughs. The opposite situation, with successively lower peaks and troughs, defines a downtrend. Dow's definition has withstood the test of time and still forms the cornerstone of trend analysis.Dow believed that the laws of action and reaction apply to the markets just as they do to the physical universe. He wrote, "Records of trading show that in many cases when a stock reach­es top it will have a moderate decline and then go back again to near the highest figures. If after such a move, the price again recedes, it is liable to decline some distance" (Nelson, page 43).Dow considered a trend to have three parts, primary, sec­ondary, and minor, which he compared to the tide, waves, and rip­ples of the sea. The primary trend represents the tide, the sec­ondary or intermediate trend represents the waves that make up the tide, and the minor trends behave like ripples on the waves.An observer can determine the direction of the tide by not­ing the highest point on the beach reached by successive waves. If each successive wave reaches further inland than the preceding one, the tide is flowing in. When the high point of each succes­sive wave recedes, the tide has turned out and is ebbing. Unlike actual ocean tides, which last a matter of hours, Dow conceived of market tides as lasting for more than a year, and possibly for several years.The secondary, or intermediate, trend represents correc­tions in the primary trend and usually lasts three weeks to three months. These intermediate corrections generally retrace between one-third and two-thirds of the previous trend movement and most frequently about half, or 50%, of the previous move.According to Dow, the minor (or near term) trend usually lasts less than three weeks. This near term trend represents fluc­tuations in the intermediate trend. We will discuss trend concepts in greater detail in Chapter 4, "Basic Concepts of Trends," where you will see that we continue to use the same basic concepts and terminology today.3. Major Trends Have Three Phases.Dow focused his attention on primary or major trends, which he felt usually take place in three distinct phases: an accumulation phase, a public participation phase, and a distribution phase. The accumulation phase represents informed buying by the most astute investors. If the previous trend was down, then at this point these astute investors recognize that the market has assimi­lated all the so-called "bad" news. The public participation phase, where most technical trend-followers begin to participate, occurs when prices begin to advance rapidly and business news improves. The distribution phase takes place when newspapers begin to print increasingly bullish stories; when economic news is better than ever; and when speculative volume and public partic­ipation increase. During this last phase the same informed investors who began to "accumulate" near the bear market bot­tom (when no one else wanted to buy) begin to "distribute" before anyone else starts selling.Students of Elliott Wave Theory will recognize this divi­sion of a major bull market into three distinct phases. R. N. Elliott elaborated upon Rhea's work in Dow Theory,to recognize that a bull market has three major, upward movements. In Chapter 13, "Elliott Wave Theory," we'll show the close similari­ty between Dow's three phases of a bull market and the five wave Elliott sequence.