Charles Dow Theory

Fundamental analysis seeks to show the causes of the behavior of certain values
and indexes. The graphic analysis, also known as a technique, in turn, demonstra
tes how was the behavior of prices. Note that nothing prevents the analyst use b
oth simultaneously, for the fundamentalist state stocks for investing and graphi
cs, the most appropriate time to invest. Unlike fundamental analysis, technical
analysis does not consider important aspects of internal company studied, such a
s pay-out, profit etc, but the behavior of stock prices in the market, ie the pa
rticipation of investors (the "mass") and its influence on asset prices.
The main information for the technical analysis is the price history because it
is based on the principle that you can predict future trends based on past behav
ior. Thus, according to the technical school, there are d sets market prices and
these patterns are discernible, competing for the analyst to identify such tren
ds and make their interpretation of it. In summary, the principles on which to b
ase this analysis are: 1) The future is a reflection of the past 2) The movement
of prices is given on the basis of trends 3) The price of the stock market embe
ds all the factors that are involved it. Charles Dow Theory
Charles Henry Dow was the creator of the Wall Street Journal, which emerged from
financial information published by and about the behavior of the market in the
late nineteenth and early twentieth centuries. These writings became the basis o
f the theory of technical analysis. Although Dow never published a book about th
ese theories, his ideas were published after his death and became known as Dow T
heory.
According to Dow Theory, the shares follow a trend (which may be high or low). T
hus, to understand the market you should use an average of price changes, using
a sample of the relevant assets in question. The Dow Theory was based on two pri
nciples:
1) The first principle says that "prices all cash" ie, the trial of all investor
s operating in the market is deemed to occur variations in the indexes. 2) The s
econd principle is that there are three types of oscillation. They are: a. Long
Term: includes periods equal to or greater than one year. b. Medium Term lasts t
hree weeks to several months. c. Short-term: lasting from six days to three week
s.
Determining Trends According to the theory of Charles Dow, the trends can be det
ermined by means of certain techniques, exposed below: - Tracing trendlines. - I
dentification of formations that indicate such trends. - Study of discontinuity
in prices, or gaps. The trends are included in one of three categories, which ar
e: (source: PINHEIRO, 2006) Trends Primary (long term), is the most important an
d can last several years. Can be high or low and leads to a major appreciation o
r depreciation of assets.
Secondary Tendency (medium term): It may last from weeks to several months. It i
s considered that reaction occurs in the markets within the primary trend and ma
y correct up to two thirds of the primary trend, which is a part.
Tertiary trend (short term): it has short duration, ie a few hours to weeks. Can
be seen as a small fluctuation of secondary and behaves in relation to this as
secondary in relation to the primary.
Trends in Characteristics of High and Low
The upward trend in purchasing power resulting from a greater magnitude, while t
he low reflects the dominance of sellers. The uptrend is characterized by rising
funds, and the tops of sick children. Funds are peer support, ie the power of b
uyers is greater than that of sellers. Funds up indicate that those who are buyi
ng has available to buy at prices even higher, supporting and continuing this tr
end. Moreover, the tops are points of resistance, ie those in which the strength
of the sellers is the largest qu buyers. Topos descendants indicate the willing
ness of sellers to sell at prices ever lower, supporting and continuing the down
ward trend.
Some Important Terms of the Technical Analysis Bar Graph: This is the way to rep
resent the maximum and minimum prices of the asset. The maximum price is shown i
n the top spot of the line and the minimum in the bottom (both concerning the sa
me day). A short horizontal line on the right, which cuts the vertical line indi
cates the closing price of that action.
Candlestick Chart: As the Bar Chart represents the prices high, low, opening and
closing.€The difference for the Bar Chart is that at Candlestick, the body of
the candle is hollow, indicating high, ie the closing price was higher than the
opening. On the other hand, if the candle is filled, indicating that market clos
ed lower (opening price higher than the closing).
Gap: The formation of a gap occurs when there is no business for a certain perio
d of time. For example, a stock that closed at $ 25 and opened the $ 30 indicate
s the formation of a gap. This range is shown in the chart by a small visual spa
ce.
Moving Average: This is a factor calculated based on a period of time determined
by the analyst. Calculate the average price during this period included the day
s, simply adding them and dividing by the number of days in question. For exampl
e, if the analyst has selected a period of 13 days, add up the closing prices an
d divide the result by 13. The Moving Average is so named because it is subtract
ed from the average first day included in the analysis and include the new tradi
ng day. Thus in the example where 13 days will be considered permanently.
Volume: This is the trading volume in the period observed. In general, when the
market is high (it is, with value stocks) and with good volume, the movement has
consistency. If the volume is low, it is read as holding down, or sales in a ro
w. The volume demonstrates the range of motion in exchange for ownership shares.
Relative Strength Index or RSI: It relates to the speed of the market, to gauge
the best time to enter it. It is useful to guide the investor if the market is n
o definite trend (aside). The IFR monitors the strength of buyers and sellers, m
easuring the behavior of closing prices. The calculation of the IFR is done as f
ollows: the average is divided by the sum of the positive variations of the aver
age negative changes with the average positive, as shown below:
IFR = 100 x
Average high mean low high mean +
The average increase is calculated by adding up the high occurred at that paper
in the period and dividing by the days in question. The average low following th
e same procedure, using the sum of the values of the low occurred and the same a
mount of days.
Example: Suppose a stock, priced at $ 59 on day 1 of our analysis (IFR 9 days) r
each $ 52 on day 9. Suppose further that this role has had increases of $ 2, $ 3
, $ 6 and $ 1 on alternate days during this time and admit low of $ 3 $ 1, $ 10,
$ 2 and $ 3. Doing the calculation of IFR, first calculate the average high, ad
ding to the high values and dividing by the number d days: Average high = 2 + 3
+ 6 + 1 = 1.33 9 Proceeding similarly for the low, we find the average low: Aver
age low = 3 + 1 + 2 + 3 + 10 = 2.11 9 Calculating the IFR, we obtain: RSI = 100
x 1.33 = (1.33 +2.11) 38.71%
Thus, the greater the relative strength of buyers, the greater the IFR and more
he is around 100. The greater the strength of the sellers, closer to zero is the
IFR. Theoretically, when the indicator passes of 80, indicating high burnout. T
he depletion of already low occurs when the indicator is below 20. The IFR is an
indicator of depletion of high and low, and plotted on a linear scale ranging f
rom 0 to 100. In the chart below are the terms explained exposed, for better vie
wing:
Support and Resistance Before joining the concepts of support and resistance, ve
ry important in the graphical analysis, let us remember that "the upward trend r
esults from a purchasing power of larger magnitude, while the low reflects the d
ominance of sellers." Thus, the uptrend may end when the force overcomes the sel
lers of buyers, thus demonstrating the concept of resistance. Already the concep
t of support appears when buyers are equal or outweigh the sellers. The price le
vel where selling pressure overcomes buying and no interruption of the movement
of low signals the support. Already the resistance is identified by a price leve
l where selling pressure overcomes buying and no interruption of the upward move
ment. The supports and resistances act as a sort of barrier, temporary fluctuati
ons in stock price. The tops function as resistance zone and funds as props. Sup
porters and stamina may be high or low, as shown in the figure below (RA = high
resistance; RA = low resistance, high SA = Support; Support SB = low). Do not fo
rget that the whole top is a resistance, the entire background is a support, the
ir roles may be reversed after exceeded and the higher the volume on the bottom
or top, the greatest potential for reversal
There are some significant characteristics about support and resistance,€as exp
lained below: - The drawings of a graph can give good indications of the market.
The signal to buy is when the price penetrates the line of resistance line from
the bottom up. But the sell signal occurs when the price line penetrates the su
pport line from top to bottom. - In general, there is an increase in trading vol
ume following a break of a support or resistance. - Overcome resistance becomes
support, as well as when it is disrupted it becomes resistance. - The more recen
t the support or resistance, the greater its significance.
Also known as "formations", the figures may represent patterns related to the co
ntinuity or reversal of a trend. Because there are patterns that recur frequentl
y in the behavior of the mass market investors, those turn out to be "registered
" on graphs that resemble figures such as triangles, rectangles, and others that
resemble different shapes, such as head-and-Shoulders. The groups of formations
that can be discovered are the following: - continuation: they suggest that the
trend will remain in that already. Here are figures like rectangles, triangles,
flags and pennants - reversal: they suggest that there will be a change in dire
ction. Here are the figures Head-Shoulders, Shoulder-deVentilador, Cunha, drift
etc.. Examples of these configurations are shown below with their characteristic
s:
Triangle Pennant Flag Rectangle Head-shoulders Cunha Paddle Fan
Triangle can be High, Low or Symmetric. Triangle High demonstrates a greater pow
er of buyers and is formed by a line of resistance (horizontal, upper) and a tre
nd line (lower). By the time the triangle is projected movement. In the case of
the Triangle of downtown, there is a support line (horizontal, bottom) and a tre
nd (downward, top), demonstrating the strength of the sellers. How High the Tria
ngle, the projection is made by the height of the figure. Symmetrical Triangle i
n no support or resistance, only the trend, tilted. By breaking the top corner,
one can perceive the continuation of the uptrend, while the breaking of the bott
om indicates a reversal of this trend.
Rectangle is characterized by a line of resistance and other support almost para
llel horizontal. Surge in times of congestion, and reflects a great balance betw
een the opposing forces of the market, ie, not signaling trend.
Source: Matsuura, 2006
Flag also indicates continuation of the trend. Results of a short period of acco
mmodation of the price back then to move towards the mainstream. They always exi
st in the opposite direction to the main trend.
Source: Matsuura, 2006
As the pennant flag, is also formed in the opposite direction to the main trend.
The Streamer has its formation preceded by a long trend that becomes the 'pole'
of the figure.
Source: Matsuura, 2006
Head-shoulders These are the tops and bottoms in sequence, with the upward trend
until the "head" form. It is also called "Neck Line," which indicates the conne
ction between the two funds of the figure, ie connecting the shoulders together.
By breaking the neckline appears to indicate a downtrend.
This wedge formation, there are two converging lines that contain the price fluc
tuations. Wedges resemble the triangles, but these are different because both li
nes have the same slope (up or down)
The following are some examples of the main protagonists:
Shovel The Shovel Fan-to-Fan is a simple correction of the trend lines, but with
the remarkable feature of having the same origin point for the tracing of these
lines. Graphically, if high, they are formed as follows:
After the formation of a top, we have a first drop very fast. This allows the tr
acing of the 1st line of low resistance. Reacting naturally to the speed of the
fall, prices break the line but unable to return to the upward movement before.
This triggers new low, with the route of the 2nd line of resistance. At this poi
nt the analyst now realizes that the downswing is losing strength and as the two
lines of resistance have the same point of origin, is setting up a paddle-to-fa
n discharge. He awaits the disruption of the 2nd line of low resistance, sure th
is is not the ideal time to purchase. If it is a Paddle-to-fan, there will furth
er drop, giving chance to track the 3rd and usually definitive line of fall. At
the moment it is defined, the picture is complete and simply await the court up
to the last line under the appropriate place for placements. This figure, histor
ically,€is responsible for substantial upward movement after cutting the 3rd li
ne, so that we can patiently wait for the confirmation of the new high. To set u
p training-of-Man fan is necessary that low prices are in an uptrend. It is the
loss of strength of this bull move that will allow the redrawing of lines of sup
port, and cutting the 3rd and final sign of the change in trend from high to low
.
Fibonnacci and Elliot Wave Theory The Elliot Wave Theory is useful to anticipate
certain stages and cycles of exchange. According to its creator, Ralph N. Ellio
t, there is an identifiable behavior that emerges in the form of "waves". In thi
s theory, argues that the stock market follows a pattern of five waves up and th
ree waves of descent in order to complete an entire cycle. Elliot studied the Fi
bonacci series, created by Italian mathematician of the same name, to draw impor
tant conclusions, as discussed below: The Fibonacci series is as follows: 1, 1,
2, 3, 5, 8, 13, 21, 34 , 55, 89, 144, 233, 377, ....... That is, a series starte
d with a following whose numbers are the sum of the actual number and your previ
ous one. For example, 5 = 3 +2, 5 +3 = 8 and so on. Something important to reali
ze is that after the fourth number in the series, to divide a number by its succ
essor, the result is always 0.618 (approximately). Dividing a number by its pred
ecessor, the result is
approximately 1.618, also known as "Golden Ratio", called Ï (the Greek letter phi
). For instance, one can see that 13 / 8 â 1.62; 144/89 â 1.62 etc.. Elliot perceive
d properties used in the Fibonacci series to study and understand the movement o
f shares. Thus, concluded that: a) The first wave (first wave of a sequence) is
the basis for determining the reasons for the other waves. b) The second wave (s
econd wave of the sequence) is related to a wave, a ratio of 50% to 62% of this.
c) The third wave is related to the wave 1 according to the proportion 1.618, 2
.618 or 4.236. d) The fourth wave is related to the wave by one of three ratios:
24%, 38% or 50% of this. e) The fifth wave is related to a one second wave of p
roportion: 1.00, 1.618 or 2.618 is commonplace to find a wave that corrects the
former by a ratio of about 0.62, or 62%. That is, the Wave 2 Wave 1 fixes in the
following figure. Wave 3 now exceeds the peak of Wave 1 also at 62% or so.
Source: Matsuura, 2006 In the chart below, one can see other instances of the Go
lden Proportion and one reason most commonly found, according to Elliot, which i
s 38%: For the first Wave is exceeded by 62% by Wave 3, which is corrected by 38
% in Wave 4. Wave 5 is corrected by "A" 62% or so.
According to Elliot, the market moves in five distinct waves when it rises and w
hen it falls into three, as mentioned earlier. In the following figure, we obser
ve the upward movement in waves 1, 3 and 5. The fix is observed in waves 2 and 4
. The negative waves are shown in A and C, and the wave B is the only upward mov
ement at a time low.
The following is an example of analyzing the Ibovespa:
MACD / The MACD OBV (in English: Moving Average Convergence-Divergence) consists
of three exponential moving averages, but about the graphics appear as two line
s whose intersections generate buy and sell signals. Just remembering the Moving
Averages represent the average of a number of trading days, and crosses indicat
e points of sale or purchase. Using the averages of 4 and 9 days, which are the
most used, the signals are given when high prices break up the middle, ie when t
he average shorter (four days in this case) is above the longest (9 days, in thi
s example). Already the low signal occurs when the average of nine days is up fo
r four days. The original MACD consists of two lines: a solid line, called "line
of the MACD, and a dotted, called the Signal line." The MACD line is formed by
the difference between two
exponential moving averages, which respond to price changes relatively fast. The
line of signal is formed by the MACD line smoothed by another exponential movin
g average, responding to price changes more slowly. Indeed, the line of signal i
s a moving average of MACD. Originally, buy and sell signals are given when the
faster line of MACD crosses up or down, the line signal. This indicator is inclu
ded in most programs of technical analysis. The higher in the positive field, th
e crossing is, the greater the expectation of a fall. The reverse, the negative
field, means higher highs. The crossing of the lines of the MACD and Signal iden
tify changes in the balance of power between buyers and sellers. The line of the
MACD, the fastest€reflects the consensus of the mass in a short period of time
. The line of the signal, the slower, reflecting the consensus of the mass over
a period of long-term. When the faster line crosses above the slower line, shows
that buyers dominate the market and it is better to operate on the buy side. Wh
en the line falls below the faster slower, it shows that sellers dominate the ma
rket and it pays to trade in the sale.
The balance of volume traded, also known as the OBV (On Balance Volume) is one o
f the most used indicators of volume. The main objective of the OBV is detected
by the combined action of the evolution of price and volume, if an asset is bein
g accumulated (to rise) or distributed (to fall), on the premise that the moveme
nt of volume precedes price. Thus, his message, most often, comes ahead of price
s. When a stock closes at higher levels in terms of financial turnover, the trad
ing volume is given as positive. However, when the closing takes place at lower
levels, the amount is given as negative. With this indicator you can follow when
investors are entering or exiting the market or particular stock, regardless of
the conduct of its price at that time.
Bibliography Bibliography: Sources Consulted: 1) Pine, Julian L. Capital Markets
: Principles and Techniques. São Paulo: Ed Atlas, 2005. 2) Matsuura, Eduardo. B
uy or Sell? How to Invest in the stock market using technical analysis. São Pau
lo: Ed Scott, 2006. 3) Nichols, Giselle. Graphics or balances, You Decide. Inves
tment Magazine, Issue of February 3, 1997. 4) Course of Fundamental Analysis, Pr
ofessor José Faria de Azevedo Filho, held at the National Association of Financ
ial Market Institutions - Andima. Sites consulted: http://www.timing.com.br/down
load/AG02.pdf http://pt.portaldebolsa.com/pt/analysis/abc_at.asp?id=45 http://ww
w.rmac3.com .br / articles / teoriadedow.htm http://www.nelogica.com.br/tutoriai
s/introtec/introtec01.php