LINES OR CONSOLIDATIONS and WHAT’S A LEGITIMATE PEAK

Sometimes, reactions within a trend develop as a sideways
movement, where the price experiences a trading range.
Figure 4 shows some ranging action following an advance.
(The same could be said in a declining market.) These trading
ranges are also known as lines (as originally referred to in
Dow theory).
Whenever the price experiences a breakout from such a
trading range, it has the same effect as if the range were a rally
or reaction. This means it is possible for a breakout from a
trading range to either act as a peak and trough buy or sell
signal, or a reconfirmation of the prevailing trend. In effect,
when the price breaks out of a line (range), it is violating
Consolidation
takes 1⁄3 – 2⁄3
of the time of
the previous
advance
Consolidation
100% 33 – 66%
Retracement should be
1⁄3 – 2⁄3 of the previous
advance
100%
FIGURE 5: CONSOLIDATION. As a rule, consolidation will take from one-third to two-thirds the time of a
preceding advance or decline. But then —
FIGURE 6: RETRACEMENT. The classic retracement ranges between one-third
and two-thirds of the previous move.
New high!
X
FIGURE 4: HALF-SIGNAL. At X, a lower trough occurs, but subsequently, the high
is taken out and the alert for a downtrend is canceled. Half-signals are not as reliable
as full concordance of peak and trough movement.
several minor turning points that are really
support or resistance areas. Taken together,
they represent the equivalent of more significant
peaks or troughs.
WHAT’S A LEGITIMATE PEAK
AND TROUGH?
Most of the time, the various rallies and
reactions are distinct enough so that it is
relatively easy to identify their turning points
as legitimate peaks and troughs. A reaction
to the prevailing trend should retrace approximately
one-third to two-thirds of the
previous move. Thus, the rally from the
trough low to the subsequent peak in Figure
5 is 100%. The ensuing reaction should then
fall between a one-third to two-thirds correction
or retracement of that move; on
occasion, it can reach to 100%. Technical
analysis is far from precise, but if a corrective
move is less than the minimum one-third, then the peak
or trough in question is suspect.
A line is a fairly controlled period of profit-taking or
digestion of losses, so the depth of the trading range may fall
short of the minimum approximate one-third retracement
requirement (Figure 6). In such instances, the correction
qualifies more on the basis of time than magnitude. It is
important to note that we are dealing with psychology here —
in this case, the bullish psychology associated with the runup
in prices. That sentiment needs to be tempered, either with a
price reaction or with time.
A rule of thumb you might want to use is for the correction to
last between one-third and two-thirds of the time taken to
achieve the previous advance or decline. In Figure 5, the time
length between the low and the high for the move represents
100%. The consolidation prior to the breakout constitutes roughly
two-thirds, or 66% of the time taken to achieve the advance —
ample time to consolidate gains and move on to a new high