The Dow Theory was first established by Charles H. Dow, who was the first editor and founder of the famous Wall Street Journal. Charles also co-founded Dow Jones and Company. The Dow Theory offers a base for the technical analysis that is used in today’s stock market. It helps in performing technical analysis on the price fluctuations of the securities by keeping in mind of all the things related to sector rotation.
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Now, there are six opinions regarding the Dow Theory that can be described as the following–
1. Market Fluctuation – 3 broad types of market fluctuation are shown as below –
- Primary fluctuation, which is also known as the major trend and lasts for a single year or extended to several years.
- Secondary effect which is also termed as the intermediate response can last starting from few days to over a period of few months.
- Minor fluctuations, which are also called the Short Swing, can last for a few hours, a month or even somewhat more than that.
2. Market Trend – 3 stages are seen in terms of market trend, which are as below –
- First phase, which is called the accrual phase in which the investors generally purchase those securities that the common public are not buying. In this stage, there are not many variations in the prices of the security because the demand for such securities is quite low and the supply is quite high.
- Second phase, which is also called Public Participation. Once the market comes to know about investors of this category, a quick price movement occurs in those particular stocks. This category comes into play once the technical investors participate in security purchase.
- Third phase is also called the Distribution phase and it comes into picture once the speculation activity begins and these investors start giving out their accumulated stock prices in the market.
3. Impact of Information – The third most important view of this concept is that all information regarding the security market is discounted. Any fresh information that is related to the security market is applicable on all the security prices once the news is available to the retail investors. As soon as the information regarding securities concerned is out in the open, the prices would change to reflect the impact of that information. This fluctuation of price of securities with the real-time impact of information shows the efficiency of market hypothesis.
4. Averages – The fourth bit of the Dow Theory is that the average in the security market should verify about each other. Once in stock market, performances of the averages of securities start diverging; this is a clear signal that there is a major change that will be soon seen in the market.
5. Volumes – Tendencies in the market are validated by their respective volumes. This can be explained as – if the prices in the market are fluctuating on lower volume, there can be several clarifications for that but on the contrary if the price fluctuations are moving with higher volume, according to Dow Theory this movement will signify the true market view.
6. Market Signals – The sixth and the vital most opinion of the Dow Theory is that until any fool-proof signals are received, the prevailing trend would continue to exist in the current market. Dow was of the belief that trends always existed although there were some noises, which were heard in the market. The markets can begin to move in a different direction, which can be completely the opposite of the market trend intermittently but they will again follow the trend once they realize that they are moving in a different direction. However, it is very difficult to establish that the reversal shown is a permanent trend or temporary trend.
So, we can conclude that the Dow Theory was a very important invention by Charles Dow, however, the technical analysis tools provided by him are observed differently by different investors in the securities market.