Richard Russell, author of Dow Theory Letters, offers wisdom on price movements, explaining the nature of upside moves, particularly, bear market rallies.
“The most difficult and puzzling study of the stock market is that which deals with secondary reactions against the primary trend. Because we’re in a bear market, I’m going to limit the following discussion to (upward) reactions in bear markets.
“Over the weekend I pulled out my volume of Robert Rhea’s ‘The Dow Theory’. I went over some of Rhea’s comments on secondary reaction in bear market.
“‘For the purpose of this discussion, a secondary reaction is considered to be an important advance in a bear market, usually lasting three weeks to as many months, during which interval the price movement generally retraces from 33% to 66% of the primary price change since the last preceding secondary reaction.
“‘Those who try to place exact limits on secondary reactions are doomed to failure, just as surely as would be the weather man who forecasted a snowfall of exactly three and one half inches within a specified time.
“‘In a bear market steady liquidation of securities by those who prefer or need cash reduces quotations day after day, with professionals, realizing there is more room on the bottom than on the top, hastening the decline with short sales. Eventually, the market is forced to a lower level than is warranted by conditions. The short interest is perhaps too extended, with wise traders sensing the fact the liquidation has, for the time, at least, run its course.
“‘Quiet, weak spots in bear markets are generally good ones to short, as they generally develop into serious declines.
“‘In a primary bear market the rallies are apt to be violent and erratic, and always occupy less time than the decline, which they partially recovery. Often the primary movement of several weeks is retracted in a few days.
“‘Rallies in a bear market are sharp, but experienced traders wisely put out their shorts again when the market becomes dull after a recovery.
“‘In bear markets, primary movement has an average duration of 95.6 days, whereas the secondary movement averages 66.5 days or 69.6% of the time consumed in the preceding primary movements.’
“All the above pertains to the price action during rallies in bear markets. But what about business conditions during bear market rallies? My studies show that bear market rallies are technical phenomenons which do not necessarily reflect on business. I’m looking at a chart of the great 1929 to 1930 rally which occurred after the 1929 crash. The Federal Reserve Index turned down in late-1929, and despite the great bear market rally, the Fed Index continued lower into early 1932.”
Source: Richard Russell, Dow Theory Letters, May 18, 2009.
Hat tip: Investment Postcards
