Page 179 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Security Analysis and Portfolio Management

Notes The use of technical 'indicators' to measure the direction of overall market should precede any
technical analysis of individual stocks, because of systematic influence of the general market on
stock prices. In addition, some technicians feel that forecasting aggregates an more reliable,
since individual errors can be filtered out.
First, we will examine the seminal theory from which much of the substances of technical
analysis has been developed – the Dow Theory – after which the key indicators viz., price and
volume relating to entire market and individual stock performance as shown in Table 6.3 will
be examined.

Dow Theory

The Dow Theory is one of the oldest and most famous technical tools. It was originated by
Charles Dow, who founded the Dow Jones company and was the editor of The Wall Street
Journal. Charles Dow passed away in 1902.
The Dow Theory was developed by W.P. Hamilton and Robert Rhea from the editorial written
by Dow during 1900-02. Numerous writers have altered, extended and in some cases abridged
the original Dow Theory. It is the basis for many other techniques used by technical analysts.
The Dow Theory is credited with having forecast the Great Crash of 1929. On October 23, 1929,
The Wall Street Journal published a still famous editorial "A Twin in the Tide" which correctly
stated that the bull market was then over and a bear market had started. The horrendous market
crash which followed the forecast drew much favourable attention to the Dow Theory. Greiner
and Whitecombe assert that "The Dow Theory provides a time-tested method of reading the
stock market barometer."
There are many versions of this theory, but essentially it consists of three types of market
movements: the major market trend, which can often last a year or more; a secondary intermediate
trend, which can move against the primary trend for one to several months; and minor
movements lasting only for hours to a few days. The determination of the major market trend
is the most important decision for the Dow believer.
The Theory: According to Dow, "The market is always considered as having three movements,
all going at the same time. The first is the narrow movement from day-to-day. The second is the
short swing running from two weeks to a month or more, the third is the main movement
covering at least four years in duration".
These movements are called:
1. Daily fluctuations (minor trends)

2. Secondary movements (trends), and
3. Primary trends
The primary trends are the long range cycle that carries the entire market up or down (bull or
bear markets). The secondary trend acts as a restraining force on the primary trend. It ends to
correct deviations from its general boundaries. The minor trends have little analytical value,
because of their short duration and variations in amplitude. Figure 6.1 represents the Dow
Theory.

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