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:
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[1] Dow, Charles H. Wall Street Journal. October 19, 1900.
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[1] Bishop, George. Charles H. Dow and the Dow Theory. Appleton-Century-Crofts. New York. 1960. page 119.
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[1] Sether, Laura. Dow Theory Unplugged. W&A Publishing. 2009. page 112.
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[2] Dow, Charles H. Wall Street Journal. January 22, 1901.
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[2] Bishop, George. Charles H. Dow and the Dow Theory. Appleton-Century-Crofts. New York. 1960. page 120.
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[2] Sether, Laura. Dow Theory Unplugged. W&A Publishing. 2009. page 117.
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[3] Dow, Charles H. Wall Street Journal. January 30, 1901
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[3] Bishop, George. Charles H. Dow and the Dow Theory. Appleton-Century-Crofts. New York. 1960. page 120.
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[3] Sether, Laura. Dow Theory Unplugged. W&A Publishing. 2009. page 199.
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[4] Bishop, George. Charles H. Dow and the Dow Theory. Appleton-Century-Crofts. New York. 1960. page 231.
