DOW THEORY

INTRODUCTION

The Dow Theory is developed by Charles Dow (1851-1902) who was journalist, founder and editor of WALL STREET JOURNAL this theory is refined by William Hamilton (1902-1929) after Dow’s death. The term Dow Theory was not used by Dow himself. Dow Theory provides basis for Stock price movements as well as Technical analysis. Dow Theory indicates that stock market behaves same today as it did 100 years ago.

Robert Rhea further refined the Dow’s theory in1932. Rhea studied the Dow’s and William concept and conveyed their thoughts on the market.

Dow Theory consist 6 basics concept for stock market movements as follows

Basically market has three types of trends upward, downward and volatile.

Dow said when prices are higher levels than those which was achieved in previous levels and prices are low than previous levels lows it means market is upward.(higher lows higher highs).

When there are lower lows and lower highs than it means market is downward. Market was volatile when there are both upwards and downwards.

Trends have three phases Accumulation phase, Public participation phase and Distribution phase.

In Accumulation phase stock prices does not change much more because in this phase investor is actively buying & selling securities against the general opinion of the market.

In public participation phase prices are rapidly changes because of participation by Technical investors.

In Distribution phase investors begin to distribute their holdings to the market.

Market hypothesis are efficient.

Stock prices are changes quickly (minute by minute). Once news about prices released prices will change to reflect this new information. At this point Dow Theory provides basis for efficient market hypothesis.

Trends are confirmed by volume.

Dow believed that trends are confirmed by volume. Low volume shows trend of aggressive seller. Dow believed that if many participants are active in particular security and prices moves significantly in one direction it is a signal of developing trend.

Stock market averages must confirm each other.

Dow first stock averages were an index of manufacturing and rail co.’s. Because goods were ship from manufacturing companies into the market by rail. According to this logic when profits of manufacturers become high than it means they will produce more goods. If they produce more then they have to ship more goods to consumers and therefore profits of railway also become high.  Soboth the averages should be moving in same direction.

Trends exist until definitive signals proved that they have ended.

Dow believed that market may be temporarily moved in opposite the trend but it will soon come on prior level. Trends become exist despite of market noise.