Page 203 - DCOM507_STOCK_MARKET_OPERATIONS

Stock Market Operations

Notes 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:
 Daily fluctuations (minor trends)

 Secondary movements (trends), and
 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 10.1 represents the Dow Theory.
The Dow Theory is built upon the assertion that measures of stock prices tend to move together.
It employs two of the Dow Jones’ averages.

 Dow-Jones Industrial Average (DJIA)
 Dow-Jones Transportation Average (DJTA)
Accordingly, the terminologies used for the markets with respect to the averages are as follows:
 Bull market - If both the averages are rising

 Bear market - If both the averages are falling
 Uncertain - If one is rising and other is falling
Although Charles Dow believed in fundamental analysis, the Dow Theory has evolved into a
primarily technical approach to the stock market. It asserts that stock prices demonstrate patterns
over four to five years and these patterns are mirrored by indices of stock prices. The Dow
Theory employs two of the Dow Jones’ averages, the industrial average and the transportation
average. The utility average is generally ignored.
The Dow Theory is built upon the assertion that measures of stock prices tend to move together.
If the Dow Jones industrial average is rising, then the transportation average should also be
rising. Such simultaneously price movements suggest a strong bull market. Conversely, a decline
in both the industrial and transportation averages suggests a strong bear market, both move in
opposite directions; the market is uncertain as to the direction of future stock prices.

If one of the averages starts to decline after a period of rising stock prices, then the two are at
odds. For example, the industrial average may be rising while the transportation average is
falling. This suggests that the industries may not continue to rise but may soon begin to fall.
Hence, the market investor will use this signal to sell securities and convert to cash.
The converse occurs when after a period of falling security prices, one of the averages starts to
rise while the other continues to fall. According to the Dow Theory, this divergence suggests
that this phase is over and that security prices in general will soon start to rise. The astute
investor will then purchase securities in anticipation of the price increase.
These signals are illustrated in Figure 10.1. Part A that illustrates a buy signal. Both the industrial
and transportation average have been declining when the industrial starts to rise. Although the
transportation index is still declining, the increase in industrial average suggests that the declining
market is over. This change is then confirmed when the transportation average also starts to rise.

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