WITH EXPERIENCE
The Dow Theory: Part II
This article will start by mentioning some of the shortcomings of the Dow Theory, which is explained in detail in: My First Post Examining Dow Theory. For example, the Dow Theory, on average, might miss around 20 to 25% of a move before generating a signal identifying it. For many traders this is too late. A Dow Theory buy signal usually occurs in the second phase of an uptrend as the price penetrates a previous intermediate peak. This is about where most of the trend following technical systems begin to identify the existing trends.
There is never a time when the Dow Theory does not lend itself to presumptions as to questions concerning the direction of the primary trend, because this is an area that is highly prone to misjudgment, particularly at the beginning of each major trend and ensuing for a short time after when the answer given by Dow will usually be prove wrong. There will be a certain time then when the Primary Trend will be up according to Dow, but analysts may advise not to invest at that stage because the looks of the trend are showing on the trend being diminished somewhat and the smart investor better stay out, and the one who is already invested may wish to opt out at this point, being that there is a larger chance that the trend will fail.
However as you see in the Chart below, one can do pretty nicely for himself over the years if he buys and sells only of Dow Theory signals:
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The Dow Theory: Part I
The Dow Theory is a major corner stone of Technical Analysis. It is one of the oldest and best known methods used to determine the major trend of stock prices. It was derived from the writings of Charles H. Dow as published in the newspaper he founded, “The Wall Street Journal”. It was later refined further by analysts and writers during the first few decades of the 20th century.
Seven Basic Principles of Dow’s Theory:
The Dow Jones Industrial Average and the Dow Jones Transportation Average reflect all information, experience, knowledge, opinions and activities of all stock market investors. Therefore, everything that could possibly affect the demand for or supply of stocks is not worthy of consideration.
There are 3 trends in stock prices. The Primary Tide is the major long-term trend. But no trend moves in a straight line for long, and therefore there come up Secondary Reactions in the form of intermediate-term corrections that interrupt and move in an opposite direction against the Primary Tide. Within these are Ripples, or minor day-to-day fluctuations that are or concern only to short-term traders and not Dow Theorists at all.
When the Primary Tide is upward pointing, this is also known as a “Bull Market”, there are usually three upwards pushes in stock prices. The first move up is the result of far-sighted investors accumulating stocks at a time when business is slow but anticipated to improve. The second move up is a result of investors buying stocks in reaction to improved fundamental business conditions and increasing corporate earnings. The final upwards push occurs when the general public finally notices that all the financial news is good. During this move there is usually rampant speculation seen.
When the Primary Tide is downward pointing, this is also known as a “Bear Market”, there are usually three downwards pushes in stock prices. The first push down occurs when far-sighted investors sell based on their experienced judgment that high valuations and booming corporate earnings are unsustainable. The second move down reflects panic as a now fearful public dumps at any price the same stock they just recently bought at much higher prices. The final push down results from distress selling and the need to raise cash.
The two Averages must confirm each other. To signal a Primary Tide Bull Market major trend, both Averages must rise above the latest highs made by their previous Secondary Reactions. To signal a Primary Tide Bear Market major trend, both the DJIA and DJTA must drop below their last Secondary Reaction lows. One average meeting these conditions alone in meaningless, but it is not uncommon for one Average to signal a change in trend before the other, with no set time limit as to when the second Average gives the trend confirmation.
Only end-of-day, closing prices on the Averages are considered. Intra-day price movements are ignored.
The end of a Primary Tide is confirmed only after being signaled by both Averages.
The next article will focus on some of the shortcomings of this Historic Theory.
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Four Q’s Showing a Famous Pattern
This Chart I am showing below , and when do I not show a chart below, shows clearly a classical pattern in technical analysis which you will find often enough if you can discern it. It is a Cup and Handle pattern. As the name implies, it is the act of the price line which forms a cup shape then, getting at the s/r (support/resistance) line that started the cup, makes a very small cup, relatively, that really could be a handle to that cup shape. When and only when that pattern is complete and the price breaks the major s/r line (pattern break), then one can invest with some certainty and analytic philosophy behind him. This is the chart I am showing now of the QQQQ Powershares, a NASDAQ ETF. It should be self-explanatory.
This is the way the Chart looks:
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Let’s put a TECHNO flag on that play!
A flag in Technical Analysis is a price pattern made by the measuring candlesticks in the shape of a flag preceded by a pole, as in Techno Math’s chart shown below. The pole tends to be almost straight up on the given time frame (daily, weekly, or monthly) and the flag should be, classically, pointed at a downwards angle. It becomes smaller as it nears breakout. The notes on the Chart help explain the flag. Basically, when it breaks the triangular pattern of its’ last section, it is supposed to (and does in a high number of cases) break—but—-either up OR down, what is called a bearish move or breakout. So be careful and BUY OR SELL SHORT AFTER BREAKOUT. Check out the Graph I’ve prepared.
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This is the way the Chart looks:
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S&P in a triangular set up
This picture (see chart below) says it all. But first an explanation. what is shown is a symmetric triangle ( > ) with very acute angles. We build it when we see the high and lows start to match up in this pattern. The vertical line at the start of the triangle, which is determined mainly by practice and experience, show us the amount in points that the triangle is valued at, in this case 55 or about 5.5%. At the end, when the break occurs it is to break the boundaries of the triangle either up or downwards for the length equal to the value (price height) of the triangle itself (in this case 55). As you all see on the vertical line in the right hand side the break was as expected. We count the break from the beginning of the green (+) candlestick that break the triangular pattern. In this case the break was almost perfect, hitting the +55 from its’ break almost dead right at 1110.
This is a fine and classic triangle scenario. They happen often, more than any other pattern of Technical Analysis so it is worth looking out for them. Don’t forget, play it safe and buy or sell short on break!
Here is the way the Chart looks:
