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THE DOW THEORY

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ About a hundred years ago, CHARLES DOW presented his observations. Not only it is still valid (sharpened but not altered in its essence), but it also forms the foundation for todays tools. No matter how much Technical Analysis has evolved, taking aid of computers, statistics, etc, you will notice that what Charles Dow had observed can still be described as the backbone of Technical Analysis. Charles H. Dow (1897) observed that most stocks move in conjunction with the overall market. If the stock market moves up, the vast majority of stocks move up, and vice versa. Before we move on, lets understand the concept of market average. In brief, it is a way of understanding the overall trend of the market or the market trend, in general. Obviously, it is difficult to individually read the price movements of all the shares quoted in a stock exchange. The prices of some of the popular shares in a stock exchage are computed together in a certain way, so as to arrive at an average price of all those shares with respect to certain predetermined base year. Such a figure then represents the average price of all those shares in the Stock Exchange. Each stock exchange usually has its own popular average eg. B. S. E. Sensitive Index, B. S. E. National Index, or internationally the Standard and Poors 500 Stocks Average, Dow Jones Industrial Average of U. S. A., the Nikkei Average of Japan, the F.T. Index of London, or the Deutscher Aktienindex of Germany etc. Most of these indices include a variety of actively traded and popular stocks in their respective exchanges. It will be seen that the market (average) tends to move in three directions. 1. Upwards 2. Downwards 3. Sideways. Charles Dow identified three basic movements in the stock market. According to him, three different movements are occurring in the stock prices simultaneously. He classifies them as, primary movement or simply put, the major trend. The primary trend is a broad movement, which is interrupted by secondary reactions or intermediate reactions. The third movement is identified with the day to day fluctuations of stock prices. This movement is called the minor movement. The represent the overall market, Dow devised two market indices, the Industrial Average and the Rail Average. These indices evolved over time to be now called the Dow Jones Industrial Average and the Dow Jones Transportation Average, each representing 30 and 20 scrips respectively. Only closing prices are used to form the averages. Tenets of the Dwo Theory :

1. 2.

The averages discount everything. There are three trends in the market, namely primary trends, secondary reactions and minor trends. All three movements occur simultaneously. (eg : tides, waves and ripples of the sea)

3. 4. 5. 6.

Primary uptrends usually have three up moves. (primary down trends usually have three down moves.) To signal a bull or a bear trend, the two averages must confirm each other. Volume must confirm the trend. A trend remains effective until a reversal signal is given by both averages.

Various concepts can be used to signal a reversal.