Dow Theory-History of Dow Thoery, Six basic Tenets of Dow Theory, Technical Analysis - Primary Trend and Secondary Trends

1. DOW THEORY
RADHIKA.R
Department of Commerce
Pondicherry University

2. HISTORY
 Dow Theory was formulated from a series of Wall Street Journal
editorials authored by Charles H Dow from 1900-1902.
 Charles H Dow was an American journalist who co-founded Dow
Jones & Company with Edward Jones and Charles Bergstresser.
 Dow also founded The Wall Street Journal, which has become
one of the most respected financial publications in the world.

3. DOW THEORY
 Dow Theory is an analysis that explores the relationship
between the Dow Jones Industrial Average (DJIA) and the Dow
Jones Transportation Average (DJTA). When one of these
averages climbs to an intermediate high, then the other is
expected to follow suit within a reasonable amount of time. If
not, then the averages show "divergence" and the market is
liable to reverse course.

4.  The theory explains how the stock market can be used by
investors to understand the health of the business environment.
 It was the first theory to explain that the market moves in
trends.
 While a lot has changed in the stock markets over the years,
the basic tenets of Dow Theory still remain valid.

5. 6 BASIC TENETS OF DOW THEORY
1. The market discounts all news
This principle explains that any information available in the
market is already reflected in the price of stocks and indices. This
includes all data such as earnings announcements by companies,
rise (or fall) in inflation or even sentiments of investors. As a
result, it is better to analyse price movements instead of studying
earnings reports or balance sheets of companies.

6. 2. The market has three trends
TRENDS
PRIMARY SECONDARY MINOR
3. Primary Trends have 3 Phases
PRIMARY TREND TYPES
UPTREND DOWNTREND

7. 3 PHASES OF PRIMARY UPTREND
ACCUMULATION PUBLIC PARTICIPATION EXCESS
PHASE PHASE PHASE

8. 3 PHASES OF PRIMARY DOWNTREND
DISTRIBUTION PUBLIC PARTICIPATION PANIC
PHASE PHASE PHASE

9. 4. Indices must confirm each other
In order for a trend to be established, Dow postulated, indices or
market averages must confirm each other. Dow used the two
indices the Dow Jones Industrial Average (DJIA) and the Dow Jones
Transportation Average (DJTA), on the assumption that if business
conditions were in fact healthy, as a rise in the DJIA might
suggest, the railroads would be profiting from moving the freight
this business activity required. If asset prices were rising but the
railroads were suffering, the trend would likely not be
sustainable. The converse also applies: if railroads are profiting
but the market is in a downturn, there is no clear trend.

10. 5. Volume must confirm the trend
The trend in the market should be supported by trading volumes.
For example, in a bull market, volume should increase as the price is
rising, and fall during secondary pullbacks and vice-versa in the case
of a bear market.
6. Trends continue until definitive signals indicate otherwise
Reversals in primary trends can be confused with secondary trends.

11. TECHNICAL ANALYSIS
 Technical Analysis is the Financial Analysis that uses patterns in
market data to identify trends and make predictions.
 It is used to evaluate investments and identify trading
opportunities in price trends and patterns seen on charts.
 Technical analysts believe past trading activity and price
changes of a security can be valuable indicators of the
security's future price movements.

12. PRIMARY TREND
 Largest trend-lasting more than a year
 Affects the movements in stock prices
 Generally lasts between 1-3 years but could vary in some
instances
 Regardless of trend length, it remains in effect until there is
confirmed reversal.
 Eg: If in an Uptrend, the price closes below the low of a
previously established Trough, it could be a sign that the
market is headed lower and not higher.
 It is important to identify the direction of this trend and trade
with it, until evidence of reversal is received.

13. WIPRO LTD
INTERPRETATION: Given above is the Candle Stick Chart of the stock prices of Wipro Ltd. The
graph shows a PRIMARY DOWNTREND during the years 2000-2001, then a PRIMARY UPTREND
through the years 2002-2007 and again a PRIMARY UPTREND during 2012-2015.

14. SECONDARY TREND
 Intermediate trend lasting 3 weeks – 3 months, usually
associated with movement against primary trend
 It is a correction to the primary trend
 Eg: Upward Primary Trend will be composed of Secondary
Downtrends ie; movement from a consecutively Higher High to
a consecutively Lower High. In a Primary Downtrend, Secondary
trend will be an upward move or rally ie; movement from
consecutively Lower Low to consecutively Lower Low
 Traders would use this to confirm the validity of the correction
within a Primary trend if the short-term highs fail to create
successively higher peaks (suggesting that a short-term
Downtrend is present)

15. WIPRO LTD
INTERPRETATION: The graph shows that though the Primary Trend is UPWARD, the
SECONDARY TREND is moving DOWNWARDS ie; a movement against the PRIMARY TREND
which shows the validity/proof of DOW THEORY.

16. MINOR TREND
 Lasts less than 3 weeks and is associated with movements in the
secondary trend/ intermediate trend
 Goes against the direction of Secondary trend
 Due to its short-term nature and long-term focus of Dow
Theory, this trend is not of major focus to Dow Theory followers
 Traders will get distracted by short-term volatility and lose
sight of bigger picture

17. WIPRO LTD
INTERPRETATION: The previous graph (SECONDARY TREND) points out that during the month of JANUARY
2019, there is a SECONDARY DOWNTREND whereas the present graph shows that during the same time
period ie; during the month of JANUARY 2019, there is a Uptrend of the MINOR MOVEMENT ie; a
movement against the secondary movement.