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| Some Definitions about Day-Trading / Part 4 |
| What means : The DOW - Theory ? |
Charles Dow formed the foundations of technical analysis around 1900.The Dow theory comprises six assumptions: 1.The averages discount
everything 2.The market is comprised of three trends (Primary, Secondary, Minor) 3. Primary trends have three phases 4.The averages must
confirm each other 5. The volume must confirm the trend 6. A trend remains intact until it gives a definite reversal signal.
Originally designed by Charles Dow as a means of forecasting the business cycle, this theory requires that a move in the Dow Jones Industrial
Average be confirmed by a corresponding move in the Dow Jones Transportation Average, and vice versa. If one of the averages makes a new high
or a new low, then that new high or low is suspect until the other average 'confirms' the move by also making a new high or low.
Charles Dow (1851-1902) was a journalist, first editor of the Wall Street Journal and co-founder of Dow Jones and Company. It was refined after
his death by William P. Hamilton, Charles Rhea and E. George Schaefer. Charles Dow himself never used the term "Dow Theory".
It was also one of the first ideas that formed the beginnings of technical analysis, the Dow Theory holds that all major trends can be sub-divided
into three phases: entrance, whereby savvy market participants enter the market; acceleration, whereby a slew of additional participants see the
trend and enter the market, thereby accelerating the trend; and consolidation, a period characterized by the initial participants exiting their trade.
everything 2.The market is comprised of three trends (Primary, Secondary, Minor) 3. Primary trends have three phases 4.The averages must
confirm each other 5. The volume must confirm the trend 6. A trend remains intact until it gives a definite reversal signal.
Originally designed by Charles Dow as a means of forecasting the business cycle, this theory requires that a move in the Dow Jones Industrial
Average be confirmed by a corresponding move in the Dow Jones Transportation Average, and vice versa. If one of the averages makes a new high
or a new low, then that new high or low is suspect until the other average 'confirms' the move by also making a new high or low.
Charles Dow (1851-1902) was a journalist, first editor of the Wall Street Journal and co-founder of Dow Jones and Company. It was refined after
his death by William P. Hamilton, Charles Rhea and E. George Schaefer. Charles Dow himself never used the term "Dow Theory".
It was also one of the first ideas that formed the beginnings of technical analysis, the Dow Theory holds that all major trends can be sub-divided
into three phases: entrance, whereby savvy market participants enter the market; acceleration, whereby a slew of additional participants see the
trend and enter the market, thereby accelerating the trend; and consolidation, a period characterized by the initial participants exiting their trade.
| The SIX Believes of the Dow Theory |
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Dow defined an uptrend (trend 1) as a time when successive rallies in a security price close at levels higher than those achieved in
previous rallies and when lows occur at levels higher than previous lows. Downtrends (trend 2) occur when markets make lower lows and
lower highs. It is this concept of Dow Theory that provides the basis of technical analysis' definition of a price trend. Dow described what he
saw as a recurring theme in the market: that prices would move sharply in one direction, recede briefly in the opposite direction, and then
BELIEVE 2 ==) Trends have three phases
Dow Theory asserts that major market trends are composed of three phases: an accumulation phase, a public participation phase, and a
distribution phase. The accumulation phase (phase 1) is a period when investors "in the know" are actively buying (selling) stock
minority absorbing (releasing) stock that the market at large is supplying (demanding). Eventually, the market catches on to these astute
investors and a rapid price change occurs (phase 2). This occurs when trend followers and other technically oriented investors
participate. This phase continues until rampant speculation occurs. At this point, the astute investors begin to distribute their holdings
to the market (phase 3).
BELIEVE 3 ==) The stock market discounts all news
Stock prices quickly incorporate new information as soon as it becomes available. Once news is released, stock prices will change to
reflect this new information. On this point, Dow Theory agrees with one of the premises of the efficient market hypothesis.
BELIEVE 4 ==) Stock market averages must confirm each other
In Dow's time, the US was a growing industrial power. The US had population centers but factories were scattered throughout the country.
Factories had to ship their goods to market, usually by rail. Dow's first stock averages were an index of industrial (manufacturing)
companies and rail companies. To Dow, a bull market in industrials could not occur unless the railway average rallied as well, usually first.
According to this logic, if manufacturers' profits are rising, it follows that they are producing more. If they produce more, then they have to
ship more goods to consumers. Hence, if an investor is looking for signs of health in manufacturers, he or she should look at the
performance of the companies that ship the output of them to market, the railroads. The two averages should be moving in the same
direction. When the performance of the averages diverge, it is a warning that change is in the air.
BELIEVE 5 ==) Trends are confirmed by volume
Dow believed that volume confirmed price trends. When prices move on low volume, there could be many different explanations why. An
overly aggressive seller could be present for example. But when price movements are accompanied by high volume, Dow believed this
represented the "true" market view. If many participants are active in a particular security, and the price moves significantly in one
direction, Dow maintained that this was the direction in which the market anticipated continued movement. To him, it was a signal that a
trend is developing.
BELIEVE 6 ==) Trends exist until definitive signals prove that they have ended
Dow believed that trends existed despite "market noise". Markets might temporarily move in the direction opposite the trend, but they will
soon resume the prior move. The trend should be given the benefit of the doubt during these reversals. Determining whether a reversal is
the start of a new trend or a temporary movement in the current trend is not easy. Dow Theorists often disagree in this determination.
Technical analysis tools attempt to clarify this but they can be interpreted differently by different investors.
previous rallies and when lows occur at levels higher than previous lows. Downtrends (trend 2) occur when markets make lower lows and
lower highs. It is this concept of Dow Theory that provides the basis of technical analysis' definition of a price trend. Dow described what he
saw as a recurring theme in the market: that prices would move sharply in one direction, recede briefly in the opposite direction, and then
BELIEVE 2 ==) Trends have three phases
Dow Theory asserts that major market trends are composed of three phases: an accumulation phase, a public participation phase, and a
distribution phase. The accumulation phase (phase 1) is a period when investors "in the know" are actively buying (selling) stock
minority absorbing (releasing) stock that the market at large is supplying (demanding). Eventually, the market catches on to these astute
investors and a rapid price change occurs (phase 2). This occurs when trend followers and other technically oriented investors
participate. This phase continues until rampant speculation occurs. At this point, the astute investors begin to distribute their holdings
to the market (phase 3).
BELIEVE 3 ==) The stock market discounts all news
Stock prices quickly incorporate new information as soon as it becomes available. Once news is released, stock prices will change to
reflect this new information. On this point, Dow Theory agrees with one of the premises of the efficient market hypothesis.
BELIEVE 4 ==) Stock market averages must confirm each other
In Dow's time, the US was a growing industrial power. The US had population centers but factories were scattered throughout the country.
Factories had to ship their goods to market, usually by rail. Dow's first stock averages were an index of industrial (manufacturing)
companies and rail companies. To Dow, a bull market in industrials could not occur unless the railway average rallied as well, usually first.
According to this logic, if manufacturers' profits are rising, it follows that they are producing more. If they produce more, then they have to
ship more goods to consumers. Hence, if an investor is looking for signs of health in manufacturers, he or she should look at the
performance of the companies that ship the output of them to market, the railroads. The two averages should be moving in the same
direction. When the performance of the averages diverge, it is a warning that change is in the air.
BELIEVE 5 ==) Trends are confirmed by volume
Dow believed that volume confirmed price trends. When prices move on low volume, there could be many different explanations why. An
overly aggressive seller could be present for example. But when price movements are accompanied by high volume, Dow believed this
represented the "true" market view. If many participants are active in a particular security, and the price moves significantly in one
direction, Dow maintained that this was the direction in which the market anticipated continued movement. To him, it was a signal that a
trend is developing.
BELIEVE 6 ==) Trends exist until definitive signals prove that they have ended
Dow believed that trends existed despite "market noise". Markets might temporarily move in the direction opposite the trend, but they will
soon resume the prior move. The trend should be given the benefit of the doubt during these reversals. Determining whether a reversal is
the start of a new trend or a temporary movement in the current trend is not easy. Dow Theorists often disagree in this determination.
Technical analysis tools attempt to clarify this but they can be interpreted differently by different investors.
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