DEFINITION of 'Ripple'

A term used by The Dow Theory author, Robert Rhea, to describe the day-to-day fluctuations in stock market prices. Rhea wrote that three simultaneous movements of stock prices occur that can be compared to tides, waves, and ripples. Rhea's book, The Dow Theory, published in 1932, suggested that speculators attempt to ride the tides and the occasional big waves, and that only reckless investors would ever attempt to profit from day-to-day price ripples.

BREAKING DOWN 'Ripple'

The Dow Theory has been around for nearly 100 years, but the core concepts remain valid to this day. While the authors admit that it’s not a sure-fire way to beat the markets, the theory provides guidelines designed to assist investors and traders in their own study of the market. These guidelines were primarily focused on short, intermediate, and long-term trends that underlie all securities and indexes in the market.

The term ripple comes from the Dow Theory’s idea of simultaneous price movements, including tides, waves, and ripples. Most speculators find success riding the tides and occasional big wave, but those chasing ripples tend to be the most reckless. In modern terms, those chasing the ripples may be day traders that trade based on short-term price movements rather than long or intermediate term trends over time.

The Dow Theory authors believe that these ripples can be important when viewed as a group, but dangerous and unreliable when looked at individually. It’s important to note that the authors did not completely discount daily ripples, but rather, always used them in the context of the bigger picture rather than looking at them in isolation.

Beyond the Ripple

Dow Theory teaches traders how to identify the primary trend and trade along with that trend to realize the greatest success. While predicting the duration and extent of the trend can be difficult, the book insists that traders can catch the big moves of the primary trend and realize success in the stock market.

Secondary movements that run counter to the trend – or reaction highs or lows – may take place alongside the primary trend. In these cases, traders may find occasional opportunities to trade against the primary trend with some success. The problem is that these moves tend to be sharper and faster than primary moves, which makes them difficult to trade.

The period between secondary moves are the ripples that can be even more erratic and difficult to trade with any level of success.

The Dow Theory states that all of these moves come from the three primary stages of the market action. In bullish uptrends, these three moves include accumulation, the big move, and a period of excess. In bear markets, these three moves include distribution, the big move, and despair. Traders that are familiar with these stages can increase their odds of success in the market by underlying the underlying psychology and trends.

 

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