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Module 1 - Technical Analysis and the Dow Theory

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These are my notes and observations on the Technical Analysis and the Dow Theory pertaining to Stock Market Trading and Investing.

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Module 1 - Technical Analysis and the Dow Theory

  1. 1. The Responsible Trader Lessons The Responsible Traders - POV Module 1 – Technical Analysis and the Dow Theory The Responsible Trader Lessons
  2. 2. The Responsible Trader Lessons The Responsible Trader’s - POV • The Responsible Trader's POV (Point of View). • These are my notes, my own additional research and studies on the Topic that I posted, and my personal observations and opinions that I am sharing to further enhance our knowledge and understanding. • Some of these were previously posted on “The Responsible Trader” thread, Stock Market Pilipinas (www.stockmarketpilipinas.com). This is the latest version of previous posts I made. • Some of these plus further explanations and discussions will be appearing in my forthcoming book “The Responsible Trader.” The Responsible Trader Lessons
  3. 3. The Responsible Trader Lessons Technical Analysis and the Dow Theory The Responsible Trader Lessons The Dow Theory Dow imagesource: http://www.enational.ro/dosarele-enational/dow-jones-cel-mai-important-indice-bursier-65340.html/ • My research on the origins of technical analysis eventually led me to the Dow theory. This theory is the foundation of much of what we know today as technical analysis.
  4. 4. The Responsible Trader Lessons Dow&Jones imagesource: http://www.enational.ro/dosarele-enational/dow-jones-cel-mai-important-indice-bursier-65340.html/ The Responsible Trader Lessons Charles Dow and Edward Jones • Technical analysis started with the work of Charles H. Dow, who teamed with Edward Jones, and both are still remembered today in the name of the leading stock market index, the Dow Jones Industrial Average (DJIA).
  5. 5. The Responsible Trader Lessons The Dow Theory • Both founded Dow Jones & Co., in 1882, a news agency in an obscure Wall Street basement. They started by distributing a small handwritten newsletter to banks and brokerages called the Customer’s Afternoon Letter. • The newsletter later on became the Wall Street Journal in 1889, and Dow continued as its editor. • Dow theory was formulated from a series of Wall Street Journal editorials authored by Charles H. Dow from 1900 until the time of his death in 1902. • These editorials reflected Dow's beliefs on how the stock market behaved and how the market could be used to measure the health of the business environment. The Responsible Trader Lessons
  6. 6. The Responsible Trader Lessons The Dow Theory • Dow was not able to publish his complete theory on the markets because of his death. • Several followers and associates have published works that have expanded on the editorials. Some of the most important contributions to Dow theory were: • William P. Hamilton's "The Stock Market Barometer" (1922), • Robert Rhea's "The Dow Theory" (1932), • E. George Schaefer's "How I Helped More Than 10,000 Investors To Profit In Stocks" (1960) and • Richard Russell's "The Dow Theory Today" (1961). The Responsible Trader Lessons
  7. 7. The Responsible Trader Lessons The Dow Theory Much of what we call today as technical analysis has its roots in Dow's work. For this reason, all traders using technical analysis should get to know the six basic tenets of the Dow theory. 1. The Averages Discount Everything 2. The market Has Three Trends 3. Major Trends Have Three Phases 4. The Averages Must Confirm Each Other 5. Volume Must Confirm the Trend 6. A Trend Is Assumed to Be in Effect Until It Gives Definite Signals The Responsible Trader Lessons That It Has Reversed Source: Murphy, John. Technical Analysis of the Financial Markets; (c) 1999.
  8. 8. The Responsible Trader Lessons The Dow Theory Much of what we call today as technical analysis has its roots in Dow's work. For this reason, all traders using technical analysis should get to know the six basic tenets of the Dow theory. 1. The Averages Discount Everything 2. The market Has Three Trends 3. Major Trends Have Three Phases 4. The Averages Must Confirm Each Other 5. Volume Must Confirm the Trend 6. A Trend Is Assumed to Be in Effect Until It Gives Definite Signals The Responsible Trader Lessons That It Has Reversed Source: Murphy, John. Technical Analysis of the Financial Markets; (c) 1999.
  9. 9. The Responsible Trader Lessons The Responsible Trader Lessons Technical Analysis – The Six Tenets 2. The Market Has Three Trends - Uptrend Dow defined an uptrend as a situation in which each successive rally closes higher than the previous rally high, and each successive rally low also closes higher than the previous rally low. In other words, an uptrend has a pattern of rising peaks and troughs
  10. 10. The Responsible Trader Lessons The Responsible Trader Lessons Technical Analysis – The Six Tenets 2. The Market has Three Trends - Downtrend The opposite situation, with successively lower peaks and troughs, defines a downtrend. Dow's definition has withstood the test of time and still forms the cornerstone of trend analysis.
  11. 11. The Responsible Trader Lessons The Responsible Trader Lessons Technical Analysis – The Six Tenets 2. The Market has Three Trends -Sideways or Flat Trend This is a sideways or flat trend with the Highs and the Lows on the Same Level with each other.
  12. 12. The Responsible Trader Lessons The Dow Theory Much of what we call today as technical analysis has its roots in Dow's work. For this reason, all traders using technical analysis should get to know the six basic tenets of the Dow theory. 1. The Averages Discount Everything 2. The market Has Three Trends 3. Major Trends Have Three Phases 4. The Averages Must Confirm Each Other 5. Volume Must Confirm the Trend 6. A Trend Is Assumed to Be in Effect Until It Gives Definite Signals The Responsible Trader Lessons That It Has Reversed Source: Murphy, John. Technical Analysis of the Financial Markets; (c) 1999.
  13. 13. The Responsible Trader Lessons The Dow Theory Much of what we call today as technical analysis has its roots in Dow's work. For this reason, all traders using technical analysis should get to know the six basic tenets of the Dow theory. 1. The Averages Discount Everything 2. The market Has Three Trends 3. Major Trends Have Three Phases 4. The Averages Must Confirm Each Other 5. Volume Must Confirm the Trend 6. A Trend Is Assumed to Be in Effect Until It Gives Definite Signals The Responsible Trader Lessons That It Has Reversed Source: Murphy, John. Technical Analysis of the Financial Markets; (c) 1999.
  14. 14. The Responsible Trader Lessons The Dow Theory Much of what we call today as technical analysis has its roots in Dow's work. For this reason, all traders using technical analysis should get to know the six basic tenets of the Dow theory. 1. The Averages Discount Everything 2. The market Has Three Trends 3. Major Trends Have Three Phases 4. The Averages Must Confirm Each Other 5. Volume Must Confirm the Trend 6. A Trend Is Assumed to Be in Effect Until It Gives Definite Signals The Responsible Trader Lessons That It Has Reversed Source: Murphy, John. Technical Analysis of the Financial Markets; (c) 1999.
  15. 15. The Responsible Trader Lessons The Dow Theory Much of what we call today as technical analysis has its roots in Dow's work. For this reason, all traders using technical analysis should get to know the six basic tenets of the Dow theory. 1. The Averages Discount Everything 2. The market Has Three Trends 3. Major Trends Have Three Phases 4. The Averages Must Confirm Each Other 5. Volume Must Confirm the Trend 6. A Trend Is Assumed to Be in Effect Until It Gives Definite Signals The Responsible Trader Lessons That It Has Reversed Source: Murphy, John. Technical Analysis of the Financial Markets; (c) 1999.
  16. 16. The Responsible Trader Lessons The Responsible Trader Lessons Technical Analysis • Technical analysis comprises the study and interpretation of ‘market action’ to try and project future price trends. All the information we have comes from the past, and with it we use technical analysis to try to predict the future so that we can trade profitably. • The stock chart is the weapon of choice for this type of analysis. This is the reason why Technical Analysts are often referred to as Chartists.
  17. 17. The Responsible Trader Lessons Fundamental Analysis • Fundamental analysis is the study of a company’s financial details. Its purpose is to determine whether a company would make a good investment based on an assessment of its financial health, potential for profitability, growth prospects, and the value of the company compared to the price of its shares. • The balance sheet, profit & loss statement, and cash flow statement are the focus of this type of analysis. • Fundamental analysis can also include a consideration of a company’s ‘story’. To examine a company’s story you look at what it does, how it makes its money, and how it is positioned to perform in the future given the current economic climate. The Responsible Trader Lessons
  18. 18. The Responsible Trader Lessons Technical Analysis vs. Fundamental Analysis Technical Analysis Advantages • Technical analysis is based on objective data. You can look at a stock chart and plainly see what’s happening right now. You can see which direction the price is moving in. You can see how popular the stock is based on its volume characteristics. Technical Analysis Disadvantages • Technical analysis doesn’t care about the company behind the stock. You might want to know what industry the company is in, but apart from that, the underlying company isn’t really a concern. • The company might be carrying more debt than it can handle, its revenues and cash flows might be weak, and it might not even be making a profit – who knows? Technical analysis doesn’t concern itself with such matters. Conclusion: For most investors, technical analysis is about “timing” your entries and exits. For traders using technical analysis exclusively (i.e. no fundamental analysis), they also use technical analysis to determine which stocks to buy. The Responsible Trader Lessons
  19. 19. The Responsible Trader Lessons Technical Analysis vs. Fundamental Analysis Fundamental Analysis Advantages • Fundamental analysis gives you an idea of what a company’s future prospects are likely to be. Large institutional investors like to buy shares in companies with good fundamentals. Fundamental Analysis Disadvantages • The timing of the financial statements used with fundamental analysis can sometimes cause problems. If you get the information too late you might end up buying the stock after it leaves the buy zone. • Also, do the numbers make sense? Do they tell a story, or do they just add to the confusion? Conclusion: Fundamental analysis is useful for stock selection. It isn’t ideal for determining entry and exit points, and for this reason, it’s mostly used by the long-term buy and hold crowd. The Responsible Trader Lessons
  20. 20. The Responsible Trader Lessons The Responsible Trader Lessons To get more of this: • My Blog: www.theresponsibletrader.com • Facebook Page: https://www.facebook.com/theresponsibletrader • YouTube Channel: https://www.youtube.com/theresponsibletrader

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