Technical Analysis Cornerstone Dow Theory Interpretation

First, the origin of Dow theory, the founder of the theory is Charles H. Dow (Charles H. Dow) in the United States. It refers to Charles Dow's views and theories on the formation of the stock market. It is a market analysis theory founded on the basis of the Dow Jones Industrial and Transportation Stock Average Index to measure the movement trend of the stock price index. It is generally believed that Dow theory is the foundation of market analysis and technical analysis. Most of the widely used technical analysis theories to date originated from Dow theory and were developed in various forms.

Charles H. Dow created the stock market average price index on July 3, 1884, which laid the foundation for various existing indices. These indices are seen as a barometer of stock market activity and an indispensable tool for market technical analysts.

On July 3, 1984, the (Centennial) Market Technical Analysts Association (MTA) also presented Dow Jones with the Silver Bowl Award for outstanding contributions to the field of investment research.

Dow never wrote a book on his theory, and in the late 19th century he published a series of editorials in the Wall Street Journal expressing his insights into stock market behavior. It was not until 1903, a year after his death, that these articles were collected and published in A. Nelson's Common Sense of Stock Market Speculation. Richard Rosso's preface to the book compares Dow's contribution to stock market theory to Freud's influence on psychiatry. Today, both day-to-day stock investing and institutional market research such as Societe Generale are often framed on this basis.

In 1922, Dow's assistant and successor at the Wall Street Journal, William Peter Hamilton, summarized Dow's theory and published "The Stock Market Barometer" (published by Harp Brothers in New York).

Robert Ray further refined Dow Theory and published Dow Theory in 1932 (Barron's, New York).

Dow's research was based on his invention of the average stock market price, namely the industrial stock index and the railway stock index, but most of his theory is also applicable to the commodity futures market.

II. Key Points of Dow Theory

Dow Theory has a core idea. The key point of the theory is that the average price is all-inclusive. He believes that prices digest and reflect all information, including market confidence, economic information, policies, etc. The establishment of Dow Theory is based on the following conditions:

Condition one

Human manipulation: The daily and weekly fluctuations of an index or security may be subject to human manipulation, and secondary reversal reactions may also be limited in this regard, such as common correction movements, but the main trend (Primarytrend) will not be subject to human manipulation.

One might argue that the main capital can manipulate the main trend of the securities. In the short term, if no intervention is made, the internal quality of the suitable securities will also be manipulated by others; in the long run, changes in the fundamentals of the company continue to create the conditions suitable for the operation of the securities. In general, the main trend of the company is still impossible to manipulate artificially, but the securities are exchanged for different institutional investors and different operating conditions.

Condition two

Market indices reflect every message: all the hopes, disappointments and knowledge of every market person who knows something about financial affairs are reflected in the daily closing price fluctuations of the index; therefore, market indices will always properly anticipate the impact of future events. In the event of a sudden event such as a fire or an earthquake, market indices will also quickly evaluate it.

In the market, people constantly evaluate and judge endless topics such as financial policies, expansion, leaders' speeches, institutional violations, and growth enterprises markets every day, and constantly reflect their psychological factors into market decisions. Therefore, the market always seems difficult to grasp and understand for most people.

Condition three

Dow Theory is an objective analytical theory: successfully using it to assist speculation or investment behavior requires in-depth research and objective judgment. When used subjectively, it will continue to make mistakes and lose money. The vast majority of investors in the market use subjective operations, which also leads to the phenomenon of "seven losses, two draws and one profit". And objective trading strategies and investment concepts are particularly important.

III. Definition of Dow Theory Trends

1. Define the trend: "If successive price peaks and troughs are correspondingly higher than the previous peak and troughs, then the market is in an uptrend."

(1) Basic trends

The ascending peaks and troughs are upward trend.

Descending peaks and troughs are downward trend.

The peaks and troughs extending laterally in turn are the trend of lateral extension

Characteristics: The most important trend, a broad or comprehensive increase or decrease in prices; the duration is usually one year or more; the overall increase (decrease) is more than 20%.

Composition: Consists of a basic uptrend (bull market) and a basic downtrend (bear market).

The basic downtrend: also known as a bear market or a bear market, is usually (but not necessarily) divided into three phases.

Outbound or Diversified Phase: At the end of the bull market, forward-thinking investors accelerate the pace of shipments. At this time, the volume is still high, but there is a tendency to gradually decrease during the rebound. At this time, the public is still enthusiastic about trading.

The panic phase: People who want to buy start to retreat, while those who want to sell rush to get rid of them, prices accelerate and volumes increase. After the panic phase ends, there is usually a considerable secondary rebound or sideways movement.

Bottom-building stage: Negative news is frequent and confirmed, but the downward trend has not accelerated. The decline is mainly concentrated in some stocks with better performance.

The fundamental trend in stock prices is of greatest concern to long-term investors, with the aim of buying stocks as soon as possible when a long market forms and selling stocks in time before a short market forms

No two bull or bear markets are exactly the same, and there is no clear time limit.

(2) Secondary trends:

It is opposite to the movement of the basic trend and has a certain restraining effect on it, so it is also called a corrective trend. In the long market, it is a medium decline or "correction"; in the short market, it is a medium rise or rebound. The duration of this trend varies from three weeks to several months, and its rise or fall is generally 1/3 or 2/3 of the basic trend.

Features: Contrary to the main trend for at least three weeks.

Return to at least 1/3 of the previous increase

(3) Short-term trends

Also known as minor trends, they are short-lived fluctuations that rarely last longer than three weeks and are usually less than six days. They do not have much meaning in themselves, but give the development of major trends a mysterious and changeable color.

Short-term trends are the only ones that can be "manipulated."

Trends of different grades in the same market coexist.

The three trends are very similar to the fluctuations of ocean waves. Tides, waves, and ripples represent the main trend of the market, the secondary trend, and the short-term trend. Waves can be predicted in advance, but stock prices cannot.

IV. Supplement to Dow Theory

1. Various average prices must verify each other

The market trend must be determined by two indices, and the movements of the two indices are consistent in order to reflect a reliable and effective trend.

There can be no big bull or bear market unless both indices are giving a bullish or bearish signal. The movement shown by any single index cannot be used as a signal to conclude that the trend has effectively reversed. Of course, both indices do not have to signal at the same time, but the shorter the interval, the better.

If the performance of the two average prices diverges from each other, it cannot be confirmed, indicating that the original trend is still valid and the forecast may be wrong.

(Elliott Wave Theory differs from Dow Theory in this regard, requiring only a single average price to give a signal.)

2. The trading volume must verify the trend

Dow believes that volume analysis is secondary, but it has important value as circumstantial evidence to validate price chart signals.

Based on the volume of transactions, a judgment can be made about the main trend, but the signal of a price reversal can only be sent by the closing price.

Transaction volume principle:

The volume level is an estimate of the strength or urgency of the market behind the price movement. The higher the volume, the more intense and stressful the market is. By analyzing the volume level that matches the price change, it is possible to better estimate the buying or selling pressure behind the market movement.

1. Volume and price matching (volume varies with major trends)

Usually, in a long market, the price increases and the price decreases; in a short market, the price decreases and the price decreases.

2. Volume and price deviation

In an upward trend, if the price does not increase or the price return does not decrease, it is a signal that the upward trend is about to change, which is called a volume-price deviation.

In a downward trend, the price drop is light or the price elasticity does not decrease, which is a bottom signal that the downward trend is difficult to continue

3. Trading volume is ahead of price (volume comes first)

Whether it is the decrease in upward pressure on prices in an uptrend or the decrease in downward pressure on prices in a downtrend, it is reflected in advance through trading volume data. As for the price itself, this will not be reflected until the price trend actually reverses.

4. The sky volume sees the sky price, and the land volume sees the land price

Grandway: The relationship between volume and price trends

Stock volume and stock price

In the rising market:

Under normal circumstances, the price increases in volume and continues to rise;

The stock price has reached a new high, but the trading volume has not reached a new high, and the rally is difficult to continue.

The price increase decreases (divergence), the reason for the increase is insufficient, and the trend has changed;

The price rise from slow to fast, blowout, the volume of transactions increased sharply, followed by a major contraction, the beginning of a major decline;

After consecutive increases, the volume increases sharply, the price stagnates (spirals), and the decline is a harbinger;

Low level, price increase is not increasing, and the increase is weak