Chapter 2 Dow theory 道氏理論

Brief history 1882 Dow Jones & Company 1884 Dow average Wall Street Journal 1884 Dow average mixed railroad and industry firms, 11 stocks in total 1897 Dow proposed industry (12 stocks) and transportation (20stocks) indices 1928 Dow industry average (30 stocks) 1903 The term Dow theory was formally introduced in “The ABC of stock speculation” by Nelson. 1978 Reprint 1922 “The stock market barometer” by Hamiton 1932 “Dow theory” by Rhea (New York: Barron’s)

Basic tenets The averages discount everything. (see Ch. 1) The market has three trends. (Primary, Secondary, Minor) Major trends have three phases. The two averages must confirm each other. (指Dow industry and transportation averages須同一方向) Volume must confirm the trend. Volume should increase in the direction of the major trend. A trend is assumed to be in effect until it gives definite signals that it has reversed. (see Ch. 1)

2) The market has three trends: major, intermediate, minor Primary/major (tide): more than a year, and possibly for several years Secondary/intermediate (wave): three weeks to three months Minor (ripple): less than three weeks

Figure 4-1 Intermediate cycles in a primary trend (uptrend, downtrend)

Figure 13-2 (Frost and Prechter, p. 21 Figure 13-2 (Frost and Prechter, p.21. Copyright ©1978 by Frost and Prechter.)

Time span of the three trends Murphy Pring Primary 1 to several years Average 18 months, From less than 1 year to several years Secondary 3 weeks to 3 months 4 weeks minimum Minor Less than 3 weeks 1 to 6 weeks

3) A major trend has three phrases Accumulation phase Public participation phase Distribution phase

4) The two averages must confirm each other. Two averages: Dow industry and transportation weighted averages A trend is assumed to be in effect until it gives definite signals that it has reversed * (major reversal) No important bull or bear signal could take place unless both Dow industry and transportation averages gave the same signal. * (continuation) When the two averages diverge from each other, Dow assumed that the prior trend was still maintained.

The two averages must confirm each other

The two averages must confirm each other

Figure 3-4 Dow Theory requires both averages to confirm

5) Volume must confirm the trend Definitions: Uptrend has a pattern of rising peaks and troughs. Downtrend has successively lower peaks and troughs. Volume should increase in the direction of the major trend. In a major uptrend, volume would then increase as prices move higher, and diminish as prices fall. In a major downtrend, volume should increase as prices drop, and diminish as they rally.

6) A trend is assumed to be in effect until it gives definite signals that it has reversed Question: Is it a correction in the existing trend or the first leg of a new trend in the opposite direction? 修正或反轉(新趨勢)

Failure Swing (reversal pattern) C is higher than A or not Figure 2.3a Failure Swing. The failure of the peak at C to overcome A, followed by the violation of the low at B, constitutes a “sell” signal at S. Q: Sell at point S? (Yes)

Non-failure Swing C is higher than A or not Figure 2.3b Non-failure Swing. Notice that C exceeds A before falling below B. Some Dow theorists would see a “sell” signal at S1, while other would need to see a lower high at E before turning bearish at S2. Q: Sell at point S1 or S2? (S2)

Failure and Non-failure Swing C is below than A or not

Some words about Dow Dow relied exclusively on closing prices. The presence of lines in the averages are referring to horizon patterns, lateral patterns, or sideways, that sometimes occurred in the charts. The sideways trading ranges usually play the role of corrective phrases and are usually referred to as consolidations. Dow signal A Dow Theory buy signal usually occurs in the second phase of an uptrend as price penetrates a previous intermediate peak. From 1920 to 1975, Dow Theory signals captured 68% of the moves in the Industrial and Transportation Averages and 67% of those in the S&P 500 Composite Index (Source: Barron’s). Stock as economic indicators. Stock market averages as a leading economic indicator. For an excellent review of Dow theory, see Technical analysis of stock trends (Edwards & Magee).

Stocks at yahoo finance Options on the Dow Dow industry average DJX Dow transportation average DJTA Dow utility average DJUA Stocks at yahoo finance Dow industry average ^DJI Dow transportation average ^DJT Dow utility average ^DJU