On this date in 1983, Richard Russell published Issue 859 of the Dow Theory Letter [526]. At the time, the Dow Jones Industrial Average was at the 1,191.47 level and the Transportation Average was at 531.53.
The following Richard Russell Review details the topics of the Elliott Wave and 50% Principles as outlined by A.J. Frost, Robert Prechter and Charles H. Dow.
In the past month, gold and gold stocks have been on a rollercoaster ride. Gold declined as much as –4.59% while gold stocks, as represented by the Philadelphia Gold and Silver Stock Index (XAU), declined –17.88%.
Although there has been a recovery of sorts, we cannot be sure that the decline is over.
Posted in 50% principle, Edson Gould, gold, gold bugs, Gold Stock Indicator
Tagged members
In February of 2014, a widely publicized chart circulated about the similarity between a 1928-1929 stock chart and a 2012-2013 chart. According to Tom McClellan of the McClellan Market Report:
“…between now [February 11, 2014] and May 2014, there is plenty of reason for caution.”
Since February 11, 2014, the Dow Jones Industrial Average has increased +11.06%. In the period from February 11th to May 31st the index gained +4.52%. So far, the scary 1929 chart has not held up to the lofty claim of presaging a bear market or a even a –10% decline. We offered up our own interpretation regarding the chart and said the following:
“We love a declining stock market as much as the next value investor. However, implying that an -89% decline is in the works because the pattern appears similar to 1929 is ignoring the path to far more achievable downside targets.”
Our preliminary downside targets seemed reasonable at the time but were never achieved. One downside target that we thought was important was the ascending trendline from the 2009 low.
We still think that investors should watch the ascending line in the chart above, which currently sits at the 15,780 level. An additional downside target is the Dow Theory 50% Principle level of 12,286.68.
Posted in 3PDh, 50% principle, Dow Theory, downside
The following from Richard Russell’s Dow Theory Letters is what we believe to be one of the most valuable examples of Charles Dow’s 50% Principle in action.
“I am publishing this arithmetic chart of the D-J Industrials (high and low monthly) from M.C. Honey, Salisbury, Md. 21801. I am using an arithmetic chart because I want to show distance or ground covered by the Dow, not percentages.
“The 50% Principle states the following: After an extended advance, the termination point of the ensuing correction should be watched carefully. If the correction can halt while retaining 50% or more of the previous advance, it is a positive indication, and there is a good chance that movement will rally to test the area of the high again. Conversely, if the correction wipes out more than 50% of the previous extended advance, it is a negative indication, and there is a good chance that the movement will continue down, ultimately testing the area from which the entire advance started.
“It should be remembered that this is a theory, and although it has worked many times in the past there is nothing immutable about this theory (or observation, if you wish to call it that). Second, the 50% Principle should not be applied to short-term movements; it should only be applied to major movements lasting six months to a year or many years.
“There are two important applications of the 50% Principle which may be coming into prominence. First, referring to the chart, note that the Dow has broken the long-term trendline connecting the 1953 and 1962 bottoms. This is obviously a bearish indication, suggesting a reversal of the entire rising trend since 1949. The fact that this occurred within the framework of a primary bear markets makes the penetration of the trendline doubly significant. I do not believe, in other words, that this was a “false” penetration.
“If we measure advance, in the 1962 low of 535.76 on the Dow to the final 1966 peak of 995.15, we note that the movement carried 460 points. The halfway point of the 1962 to 1966 rise was thus 765. This means that during the 1966 and again during the most recent decline the Dow decisively broke the 50% level. The implication under the 50% Principle is that the Dow will probably test the area from which the movement began, or the 1962 area of 535. Whether this will happen remains to be seen, but at any rate that is the implication of the 50% Principle.
“The second important consideration is that the entire primary bull market covered a distance of 834 point; from the 161.60 of 1949 to 995.15 of 1966. The halfway point of the whole bull market rise is thus 578. I feel that if the Dow breaks to lower levels, it will be important to see what happens if and when 578 is approached.
“If a bottom can be formed at or above 578, particularly during a period which shows third phase characteristics, it will be a positive sign. Conversely, if 578 is decisively penetrated, I would take it as a most bearish and tragic sign. If 578 is broken decisively on the downside, my guess is that the final bottom of the bear market will arrive at an area far lower than anyone now thinks possible. (source: Russell, Richard. Dow Theory Letters. May 1, 1970. Page 3. www.dowtheoryletters.com)”
After the May 1, 1970 article by Richard Russell, the Dow Industrials had the following performance:
On December 6, 1974, the Dow Jones Industrial Average closed at 577.60. After this point, the Dow Industrials never closed lower. In the January 2, 1975 issue of the Dow Theory Letters, Russell said the following:
“Unless both Averages now break to new lows (Industrials below 577.60, Transports below 125.93) history will record October 3 as the bottom for the bear market (although December 6 will stand as the low day for the D-J Industrial Average alone).”
The 50% Principle is a necessary tool for all investors to gauge how much a decline is expected to run it’s course in the worst case scenario. A conservative investor should make use of the 50% Principle as a means of determining downside risk. With this in mind, the expectation is that at some point the stock (or index) will decline by nearly –50%. The 50% Principle sets the framework for how to interpret the price action from almost any prior peak.
In a roundabout way, even Charlie Munger, Warren Buffett’s long-time investment partner, considers the prospect of a decline by –50% in the following commentary:
“I think you can argue that if you’re not willing to react with equanimity to a market price decline of 50% two or three times a century you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get, compared to the people who do have the temperament who can be more philosophical about these market fluctuations.”
The 50% Principle Today
Below is the current 50% Principle for the Dow Jones Industrials Average.
While falling to 11,561.85 isn’t required, it doesn’t hurt to have a sense of the downside risk. Additionally, as the Dow goes higher, the level for the 50% Principle will increase. A retest of the ascending trendline should be expected at minimum.
Posted in 50% principle, Dow Fair Value
From a Dow Theory perspective, downside targets rely heavily on the concept of the 50% principle. Although mistakenly attributed to E. George Schaefer by Richard Russell, the 50% principle is derived from Charles H. Dow’s “great law of action and reaction.” Dow describes the “law” in the following manner:
“The market is always responsive to the great law of action and reaction. The longer the swing one way the longer it will be the other. One of the best general rules in speculation is the theory that reaction in an advance or a decline will be at least one-half of the primary movement [50% principle].
“The fact that the law is working through short ranges and long ones at the same time makes it impossible to tell with certainty what any particular swing may do; but for practical purposes, it is not infrequently wise to believe that when a stock has risen 10 points, and as a result of one or two short swings [double tops] does not go above the high point, but rather recedes from it, that it will gradually work off 4 or 5 points.[1]”
In another excerpt from Dow’s work, on the topic of the 50% principle, Dow says:
“It often happens that the secondary movement in a market amounts to 3/8 to ½ of the primary movement.[2]”
Again, Dow emphasis the concept of the 50% principle:
“Whoever will study our averages, as given in the Journal for years past, will see how uniformly periods of advance have been followed by periods of decline, amounting in a large proportion of cases to from one-third to one-half of the rise. [3]”
Finally, George Bishop, one of the greatest authors on the topic of Charles H. Dow, concludes:
“The law of action and reaction applies to both the general market and to individual stocks. This law states that the reaction to an advance or decline will approximate half the original movement.[4]”
Dow Theory 50% Principle for Gold
Dow Theory downside targets for the price of gold, based on the peak of $1,895 and the initial low of $252.80 based on the closing price, is charted below (July 20, 1999 and September 5, 2011, respectively):
Citations:
Posted in 50% principle, Charles Dow, Charles H. Dow, gold, gold bugs
In a MarketWatch article titled “7 Ways to Spot a Market Top” (found here), it is suggested that there are key ways to tell whether or not we are at a top in U.S. stock markets. First, we’re going to selectively choose (cherry pick) the points that we can refute or demonstrate weaknesses. Second, we’re going show how, even at a stock market peak, abandoning new investment opportunities can potentially be a mistake.
Starting with the first of the “7 Ways to Spot a Market Top” is the claim that:
While the U.S. stock market is trading at record highs, three blue-chip Chinese companies -- Petro China (PTR), China Mobile (CHL) and Yanzhou Coal are trading near 52-week lows, points out Brad Lamensdorf, chief investment officer of the Lamensdorf Market Timing Report. All three stocks peaked in January [2013]and have been skidding ever since. Given the key role China plays in the global economy, ‘this looks like a bad sign for US stocks,’ Lamensdorf said.
While it cuts us deep to suggest that a 52-low implies proof that a top in the market is at hand (don’t forget our vested interest on this topic), there are clear weaknesses in this argument. First and foremost, look at the chart for the respective stocks.
For PetroChina (PTR) the stock peaked in April 2011. Since then, the stock has been unable to exceed the prior peak. A technical analyst would have immediately recognized this and would not make the basis of their analysis the 2013 peak because it is lower than the 2011 top.
In the case of China Mobile (CHL), the stock peaked in August 2012.
In the instance of Yanzhou Coal (YZC), the stock peaked in May of 2011. If what Mr. Lamensdorf says is true, U.S. stocks should have shown more signs of weakness before the most recent declines. Based on the information that we’ve provided, the first of 7 ways to spot a market top is very weak at best.
The second of 7 ways to spot a market top reflects on the performance of the Spanish stock market indexes. Unfortunately, there is no PROOF that, based on the movement of the three indexes, that we’ve seen the top in the U.S. stock market. Instead, it only reflects on what has happened in Spain. In addition, the time span that is used is narrow at best. What is a better alternative to indicate a possible top in the market? First and foremost, Dow Theory could have been a better guide for consideration of when and if we were at a market top in advance of the actual peaks. As an example, the Spanish IBEX 35 Index, is shown below from 2006 to the present.
From the peak of the IBEX 35 Index in 2007, the decline was down to the March 2009 low near 6,936.90. The increase of the IBEX 35 Index could have been expected to increase at least half of the prior decline before giving clear indications of a change in direction in the market. According to Dow Theory the best case scenario would be for the market to retrace 50% of the previous decline.
Our own example of a real-time application of Dow Theory projections in advance of a market top is our April 3, 2009 posting titled “Bear Market Rally Targets” (found here), when the Dow was at 8,017.59. At that time, we said that the Dow Jones Industrials Average had an upside target of 10,360.02 based on the Dow Theory 50% principle. Dow Theory clearly outlines how to interpret market direction based on the stock market movement after the retracement of the 50% principle. Therefore, it would have been clear that the decline was in the cards and not helped by the European Financial crisis.
In our considered opinion, calling the top is easy after the fact, however the tools were in place to allow for understanding the potential upside limits beforehand. Additionally, there is no proof that the Spanish markets have topped out, based on such a short time frame (June 2012 to June 2013). In fact, according to the precepts of Dow Theory, the marginal top of January 2013 could not be considered to be “in” until the IBEX 35 declines below the 2012 low.
The third of 7 ways to spot a market top is based on the FTSE Europe relative strength index. The indicator only shows the last year of movement. The problem with this is that we don’t have a “relative” view on which to test the accuracy of this indication. Although not the exact index and without the exact measure of time for which the indicator is at (a considerable weakness to leave out such information because we cannot independently test what should be widely available), we’ve outlined the Vanguard FTSE Europe ETF (VGK) with a relative strength indicator on a 28-period trailing interval.
As can be seen above, the RSI has not necessarily give a clear indication of where the top in the market is when reviewed over a period from 2006 to the present. As an example, in 2012, the two RSI peaks resulted in higher market levels afterwards. Likewise, the RSI low of 2010 resulted in an even lower level for the Vanguard ETF in 2012. Worse still, the early 2008 low in the RSI was much lower than the early 2009 RSI low. However, the 2009 low in price was a staggering –58% lower than the early 2008 price for the Vanguard ETF.
Again, without the source of the RSI provided and the exact index that was used over a substantial period of time to verify the quality of the indicator, it would be difficult to suggest that the information provided was enough to prove that we could use the information to identify a market top, or bottom.
The fourth of the 7 ways to spot a market top refers to the Schiller P/E or CAPE ratio valuation of global equity markets. Again, this view only reflects the current point in time. It leaves out the perspective of other times in history, relative to when the S&P 500 Index was at respective peaks and troughs in history, compared to the same countries. However, we do have a good source to help see how this may not be the top, according to CAPE valuations.
The chart above is the Shiller P/E or CAPE ratio from GuruFocus.com (found here). According to the chart, it would appear that on a historical basis, the U.S. stock market should trade back to the mean P/E level of 16.5 after trading to the historical peak level of 22.9. However, there are two serious problems with this perspective. First, it ignores the fact that at nearly 50% of the times that the S&P has been at the same level in the past, the market continued much higher than the current level in 1929 and 2000. In the case of the year 2000, the market doubled the P/E level that we are currently at. The second problem is that the S&P 500 index didn’t exist before 1957. Therefore, anything before 1957 is based on a theoretical P/E ratio that is not even “real.” In fact, everything prior to 1957 is based on the belief that an imaginary S&P 500 would have replicated the performance of the Dow Jones Industrial Average). We’ve already pointed out the deceptiveness of P/E ratios and how they can be astronomical at market bottoms and miniscule at market tops in our article titled “P-E Ratios: Lessons from Confliction Indications” (found here).
In the fifth of the 7 ways to spot a market top, the article refers to the S&P 500 activity from 1996 to the present. Yes, it is true that the S&P 500 has failed to exceed the prior peaks of 2000 and 2007 by a wide margin. However, choosing the S&P 500 strictly fits the argument. Additionally, it seems to be the point of the author that prior peaks are a indication of a market top. However, if the Dow Jones Industrial Average were applied to the same period of time then it could be argued that you cannot pick a market top based on prior peaks.
In each instance of a peak for the Dow, the index went higher, as opposed to the S&P 500. Furthermore, If we looked at the Nasdaq Composite Index, then we could say, based on the flawed logic of prior peaks being the top in the market, that we’re a long way from the top in the stock market, as seen in the chart below.
The sixth of 7 ways to spot a market top relates to the 50-moving average of the S&P 500 Index. According to the article, Mark Luschini, chief investment strategist at Janney Montgomery Scott says:
“'As a matter of fact, with the S&P 500’s recent pullback to 1,600, it actually suggests an interim bottom,’ says Luschini. The index has bounced around and off of the 50-day moving average of 1,615, ‘so for the time being, that’s pretty good support for the market,’ he adds.”
Suffice to say, this wasn’t actually a way to spot a market top. We’re not sure why this was included.
Finally, the seventh of the 7 ways to spot a market top discusses the price of oil but it doesn’t relate this back to the stock market as the previous 6 points attempted, somewhat. Despite this fact, we have to point out the comment made by the analyst about the price of oil. The article states:
“As crude gets more expensive, OPEC members have an incentive to ramp up production. But in such times, [Tim] Evans doesn’t view the higher prices as bullish.”
Unfortunately, in the chart that is included with Mr. Evans commentary, we can see that the price of oil increased from January 2007 and peaked June 2008 and collapsed to the April 2009 low. Coincidentally, the stock market had a similar movement over the exact period of time. As Charles H. Dow, co-founder of the Wall Street Journal, said:
“For the past 25 years the commodity market and the stock market have moved almost exactly together. The index number representing many commodities rose from 88 in 1878 to 120 in 1881. It dropped back to 90 in 1885, rose to 95 in 1891, dropped back to 73 in 1896, and recovered to 90 in 1900. Furthermore, index numbers kept in Europe and applied to quite different commodities had almost exactly the same movement in the same time. It is not necessary to say to anyone familiar with the course of the stock market that this has been exactly the course of stocks in the same period ( source: Dow, Charles. Review and Outlook. Wall Street Journal.February 21, 1901.)”
With this in mind, it is possible to suggest that because oil is relatively far from the peak, there may still be some upside left. After all, in the period from 2007 to the present, whenever oil rose, so too did the stock market. Why should we expect anything different going forward? Especially when the price for oil hasn’t exceed the 2008 peak.
Our next point is regarding the abandonment of investments if and when you “know” that the stock market has peaked. In our posting titled “Complete 2008 Transaction Summary” (found here), we show every position that we took in 2008, the length of time that we held each position and the gain or loss for each position. It is important to note that although the stock market was in the process of collapsing, we were able to make long only positions based on stocks from our U.S. Dividend Watch List and end the year with gains of +14% as opposed to Dow Industrials and S&P 500 declines of -38% and greater.
Another source for inspiration of investing in stocks at stock market peaks can be derived from the work of Jeremy Siegel’s article titled “Nifty Fifty Revisited” (PDF here). In the article by Siegel, the highest P/E stocks (at a market peak; 1972) for that era were selected to determine their performance over a long-term basis (1972 to 1995). If, as a long-term investor, you’re interested in beating inflation by a wide margin, then avoiding new purchases at the peak in the market, because you think we’re at a peak, isn’t as rational as it would seem. It might make sense if you have a well established system (that is profitable, of course) in place. However, the work of Siegel suggests that for long-term investors, avoiding new purchases at market peak could be a costly trade off.
In our personal experience, a la 2008, we can’t suggest that our performance will be replicated again. However, what we can claim is that, aside from dumb luck, abandoning investment opportunities because the market has peaked or is falling could be just as mistaken as calling market tops, and bottoms, based on spurious notions that are unsubstantiated.
Posted in 50% principle, Charles Dow, Charles H. Dow, commodities, Market cycles, S&P 500
Below are the Nasdaq 100 companies that are within 10% of their respective 52-week lows. Stocks that appear on our watch lists are not recommendations to buy. Instead, they are the starting point for doing your research and determining the best company to buy. Ideally, a stock that is purchased from this list is done after a considerable decline in the price and rigorous due diligence.
| Symbol | Name | Price | P/E | EPS | Yield | P/B | % from low |
| BIDU | Baidu, Inc. | 92.68 | 20.97 | 4.42 | - | 8.87 | 0.95% |
| VOD | Vodafone Group | 25.27 | - | -0.55 | 7.9 | 1.11 | 1.28% |
| BBBY | Bed Bath & Beyond Inc. | 56.4 | 13.1 | 4.3 | - | 3.27 | 1.48% |
| MCHP | Microchip Technology Inc. | 29.37 | 27.94 | 1.05 | 4.8 | 2.93 | 1.56% |
| ^NDX | NASDAQ-100 | 2,534.16 | - | - | - | - | 1.59% |
| FLEX | Flextronics Int’l | 5.54 | 7.55 | 0.73 | - | 1.51 | 1.65% |
| DELL | Dell Inc. | 8.86 | 6.03 | 1.47 | 3.3 | 1.63 | 1.94% |
| AMAT | Applied Materials Inc. | 10.15 | 118.02 | 0.09 | 3.5 | 1.74 | 2.01% |
| NVDA | NVIDIA Corporation | 11.38 | 14.21 | 0.8 | 2.6 | 1.53 | 2.06% |
| INTC | Intel Corporation | 20.19 | 8.81 | 2.29 | 4.5 | 2.03 | 2.12% |
| ALTR | Altera Corp. | 30.45 | 17.02 | 1.79 | 1.3 | 2.97 | 2.91% |
| TEVA | Teva Pharmaceutical | 38.29 | 15.6 | 2.45 | 2.1 | 1.46 | 3.82% |
| EXPD | Expeditors Int'l of WA | 35.76 | 22.35 | 1.6 | 1.5 | 3.62 | 4.56% |
| CTXS | Citrix Systems, Inc. | 59.21 | 32.34 | 1.83 | - | 3.56 | 4.67% |
| MRVL | Marvell Technology | 7.4 | 12.67 | 0.58 | 3.2 | 0.88 | 4.96% |
| NUAN | Nuance Communications | 20.35 | 77.38 | 0.26 | - | 2.4 | 5.28% |
| KLAC | KLA-Tencor Corporation | 44.33 | 10.78 | 4.11 | 3.6 | 2.18 | 5.35% |
| APOL | Apollo Group Inc. | 19.51 | 5.61 | 3.48 | - | 2.37 | 5.69% |
| ATVI | Activision Blizzard, Inc. | 11.05 | 14.26 | 0.78 | 1.7 | 1.08 | 5.75% |
| MU | Micron Technology Inc. | 5.47 | - | -1.04 | - | 0.72 | 6.01% |
| FFIV | F5 Networks, Inc. | 86.64 | 25.11 | 3.45 | - | 5.19 | 6.87% |
| WCRX | Warner Chilcott plc | 11.98 | 8.2 | 1.46 | 4.2 | -4.48 | 6.87% |
| CHKP | Check Point Software | 43.67 | 15.21 | 2.87 | - | 2.71 | 7.56% |
| DLTR | Dollar Tree, Inc. | 38.82 | 15.6 | 2.49 | - | 5.9 | 7.71% |
| GRMN | Garmin Ltd. | 37.18 | 12.57 | 2.96 | 4.8 | 2.14 | 8.05% |
| XLNX | Xilinx Inc. | 32.56 | 17.6 | 1.85 | 2.7 | 3.12 | 8.53% |
| FAST | Fastenal Company | 41 | 29.71 | 1.38 | 2.1 | 7.29 | 9.01% |
| MSFT | Microsoft Corporation | 26.52 | 14.34 | 1.85 | 3.5 | 3.26 | 9.14% |
Watch List Summary
In the November 2, 2012 Watch List summary we pointed out NetApp (NTAP) as a viable investment candidate. In the two weeks since, NTAP has managed to rise +9% while the Nasdaq 100 and Apple Inc. declined –4% and –9%, respectively. NTAP is sitting at $30.26 price and may have found some support at that level. Although we’re hopeful about the prospects of this company, we recommend putting +9% gains in two weeks into perspective and decide if selling the principle is the most prudent approach to take.
On the November 2, 2012, we discussed the prospects for Dell (DELL). At the time we felt that the stock had a high probability of going back to the $8 level. On Friday November 16, 2012, we believe that DELL has fallen through the last line of technical defense against going to the $8 level. We believe that on a short-term basis DELL will rise on a possible market reaction. However, the intermediate-term seems to indicate that DELL will go to $8 before any “true” indication of prospects is revealed, unless the company gets acquired which seems possible. Dell would be one of the best acquistion target of any computer manufacturer since Lenovo bought the personal computer division from IBM.
Apple Inc (AAPL) and short-term Dow Theory analysis
As described in our last Nasdaq 100 Watch List dated November 2, 2012, Apple Inc. (AAPL) is the stock to watch. Right now, there are many who are suggesting that the bottom is in for AAPL. For various reasons, we believe that the verdict has not been delivered on this stock. Especially since AAPL managed to close below the May 2012 low, a previous technical low point for the stock. Regardless of our view on the matter, we’d like to see what Dow Theory has to say about the upside prospects from the current price. The chart below outlines the four upside targets for AAPL.
Starting with the first upside target is the $572.19 level. This is an easily attainable level for the stock and would equal an +8.44% gain from the closing price of Friday November 16, 2012. After coming off of such a dramatic decline that was started on September 17th, we should expect this as the minimum reaction of a declining trend. There is little in the way to suggest that AAPL is clearly on the ascent when it reaches $572.19. However, in theory, this would be the easiest money every made in AAPL stock.
The next upside target for Apple Inc. (AAPL) is $605.41. This level is based on Dow’s 50% principle which indicates the average price paid by long-term investors and would be compelled to continue holding the stock if it rises above this level. If AAPL can manage to rise above this level then long-term investors are likely to hold their positions in the stock, leaving speculators to push the stock higher. However, failure to rise above the $605.41 level and falling below the $505 level will be confirmation that the trend of the stock is much lower than the $505 level.
The $638.63 price falls in line with Dow’s assertion that stocks then can retrace 1/3 to 5/8 of the previous move. In this case, the $638 level is 2/3 of the previous decline. Rising to such a level almost assures that the stock will rise to the previous high. However, those wishing to take advantage of such a “guaranteed” move to the upside should be aware of the risk that any gains that are achieved can be quickly taken away. This would be the hardest money ever made for any speculator in AAPL’s stock.
Finally, rising above the $705 level would be the only indication that the stock is going higher in a meaningful fashion. We believe that if AAPL manages to exceed prior high then there are great opportunities of other tech companies near a new 52-week low to take advantage of the renewed faith in Apple Inc.
Posted in 50% principle, Dow Theory, Nasdaq 100 Watch List, upside target
Tagged members
“The market is always responsive to the great law of action and reaction. The longer the swing one way the longer it will be the other. One of the best general rules in speculation is the theory that reaction in an advance or a decline will be at least one-half of the primary movement [50% principle].“The fact that the law is working through short ranges and long ones at the same time makes it impossible to tell with certainty what any particular swing may do; but for practical purposes, it is not infrequently wise to believe that when a stock has risen 10 points, and as a result of one or two short swings [double tops] does not go above the high point, but rather recedes from it, that it will gradually work off 4 or 5 points.[1]”
“It often happens that the secondary movement in a market amounts to 3/8 to ½ of the primary movement.[2]”
“Whoever will study our averages, as given in the Journal for years past, will see how uniformly periods of advance have been followed by periods of decline, amounting in a large proportion of cases to from one-third to one-half of the rise. [3]”
“The law of action and reaction applies to both the general market and to individual stocks. This law states that the reaction to an advance or decline will approximate half the original movement.[4]”
“The second type of market low is based on the premise that the Dow fulfills the Wave principle and falls below the upward trending line (red) to the old support level 8100 and then 6440. A true Wave move down to the old low would bring the market below 6440. However, the last time this was fulfilled, in the period from 1970 to 1974, the market only fell 8.5% below the previous low of 631.16 on the Dow Industrials in 1970. Additionally, the Industrials ran up from 631.16 in 1970 to 1051.70 in 1973, an increase of 118% of the previous peak. As more time passes I expect the index to fall to 5474 if we do manage to complete a Wave formation on the downside.”
"Even in a bear market, this method of trading will usually be found safe, although the profits taken should be less because of the liability of weak spots breaking out and checking the general rise.[5]"
[1] Sether, Laura. Dow Theory Unplugged. W&A Publishing. 2009. page 112.
[2] Dow, Charles H. Wall Street Journal. January 22, 1901.
[2] Bishop, George. Charles H. Dow and the Dow Theory. Appleton-Century-Crofts. New York. 1960. page 120.
[2] Sether, Laura. Dow Theory Unplugged. W&A Publishing. 2009. page 117.
[3] Dow, Charles H. Wall Street Journal. January 30, 1901
[3] Bishop, George. Charles H. Dow and the Dow Theory. Appleton-Century-Crofts. New York. 1960. page 120.
[3] Sether, Laura. Dow Theory Unplugged. W&A Publishing. 2009. page 199.
[4] Bishop, George. Charles H. Dow and the Dow Theory. Appleton-Century-Crofts. New York. 1960. page 231.
[5] Schultz, Harry D. A Treasury of Wall Street Wisdom. Investors' Press. (New Jersey, 1966). p. 12. Additional commentary here.
Posted in 50% principle, Dow Theory, law of action and reaction
One of the easiest and most sure-fire ways to avoid losing money in stocks is to assume that every investment at some point will lose 50% or more. From this standpoint, all investments will be the most judicious and thoughtful. Transaction will not be entered into lightly.
Throughout my writing on the topic of investing, I have repeatedly stated that I always factor in losing 50% before buying a stock. Some readers have asked me, “Why in the world would you invest in something that you think could decline in value by 50%?” My response is always the same, if you haven’t accounted for the worst-case scenario then you aren’t really investing, instead you’re gambling.
I have found that by accounting for the downside risk of 50%, my mind is capable of assessing market declines with a more objective approach. Additionally, I am able to sleep soundly at night.
Below is a transcription of a BBC News interview of Charlie Munger who addresses the idea of accepting 50% loss in Berkshire Hathaway.
BBC News: How worried are you by the share price decline of Berkshire Hathaway?
Munger: Zero. This is the third time that Warren and I have seen our holdings in Berkshire go down, top tick to bottom tick, by 50%. I think it’s in the nature of long term shareholding with the normal vicissitudes and worldly outcomes and in markets, that the long term holder has his quoted value of his stock go down and then by say 50%. I think you can argue that if you’re not willing to react with equanimity to a market price decline of 50% two or three times a century you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get, compared to the people who do have the temperament who can be more philosophical about these market fluctuations.
It should be noticed that Munger mentions that he has experienced 3 instances of 50% declines in Berkshire Hathaway in the 42 years of its existence. This means that, on average, a portfolio is going to take a massive hit every 14 years or so. This assumes that you have the investment acumen of Warren Buffett and Charlie Munger. If you don’t have the investment savvy of Buffett and Munger, then the likelihood of losing 50% in your portfolio increases significantly.Now you know how easy it is to adhere to Warren Buffett’s rule number one, “don’t lose money.” After all, if you expect that your investments will lose 50% then you really start losing at 51%. Just be sure that you have the right strategy before you buy.
Posted in 50% principle, Dow Fair Value, Uncategorized