The ‘Dow Theory’ which was created 100 years ago by Charles Dow was also the owner of the Dow Jones news company. It is considered by many the foundation of Technical analysis. We explore the first 4 concepts Dow Theory explains.
Names of papers written about the Dow Theory: The Stock Market Barometer” (1922), Robert Rhea’s “The Dow Theory” (1932), E. George Schaefer’s “How I Helped More Than 10,000 Investors To Profit In Stocks” (1960) and Richard Russell’s “The Dow Theory Today” (1961).
Today the Nifty and Sensex are accepted as the barometer of the economy, but Dow was the first person to say that the overall market is a reflection of business conditions, by analysing the trend we could gauge direction of the overall economy and individual companies through their stock prices.
Dow created the Dow Jones industrial index and the Dow Jones rail index. Les learn what the Dow theory encompassed
1) Markets Discount Everything
The first premise is that the all available information in the market will reflect in price. This includes everything from emotions, earnings, inflation and the fear of a world war breaking out! Okay maybe not, but what it really means is that the market has all information available but only as soon as it becomes relevant will it reflects in price.
2) Markets Trend
Markets will trend upwards, downwards or sideways for long periods of time. Think HCL when we talk about uptrends, JP Associates when we see downtrends and CAIRN India for sideways. Sideways trends occur when no clear trend emerges.
3) Phases of These Trends
Now an uptrend for example has phases separated by aggressiveness. The accumulation phase, public participation marked as awareness and excess phase marked as mania (see video for chart) .
This is interesting that we can see the same behaviour in the Nifty chart even after 100 years showing that human behaviour really doesn’t change a lot even after 100 years. Maybe we are hardwired in certain behaviours.
4) The Averages Must Confirm Each Other
100 years ago it made sense to compare averages against each other to judge strength. In today’s world information flow more freely and instantaneously. Perhaps this is less relevant today.
Following the Nifty or Sensex is enough to gauge market trends.