Dow Theory - What To Look For
Dow Theory - What to Look For
Most of you know now that I’ve started the process of working toward my Chartered Market Technician (CMT) designation, and I’ve now taken a back seat to most things Social Media, but what I do have is a bank of blogs that I’ve yet to release to the world, so I’ll make sure to hit up your inbox from time to time with information that I think can help in some way.
I’ve wrestled with sending this out for a while, because I know the importance of it (and many of you reading this will be reading this thinking - what the hell is Dow Theory) - well, I’m here to tell you, if you’re a Trader with a mid term time horizon, and you want to be on the correct side of the market - I suggest you keep reading.
You see, back in the day (somewhere around 1900), Charles Dow created the 1st Stock Market Index, and made a very distinct case for the Industrial Average (we know it now as the Dow)… and the Railroads Average (we now know it as the Transports Average) running the direction of the Stock Market.
It was after Charles Dow’s death, someone (with a lot of time on their hands) - come up with the theory which we now know as Dow Theory, and this is where you need to pay attention.
When the Dow and Transports are moving in alignment and creating new highs… the Stock Market creates new highs… there is a very clear correlation in place and it’s why the Dow is considered by many to be the most important Index on the planet.
However things are slightly different from 100 years ago…
“Today, because the makeup of the economy is so different than in Dow's and Hamilton's time, with the advent of a wider base of industrial stocks and technology stocks, the usual method of confirming a primary trend is to use confirmation between the two indexes: Standard & Poor's 500 and the Russell 2000. The economic rationale is that the Standard & Poor's 500 represents the largest, most highly capitalized companies in the United States, and the Russell 2000 represents smaller companies with higher growth and usually a technological base. When these two indexes confirm each other, the primary trend is confirmed.” Quoted from the CMT Level 1 Curriculum
This is where things get interesting…. let’s look at the charts (as at June 2019)
Exhibit A - S&P 500 (SPY)
Exhibit B - Russell 2000 (IWM)
If we REALLY study those charts… do they look like they’re in alignment? do they look like they’re likely to break out together? I’m not so sure, and it definitely poses a few questions that we need to consider.
Whilst there are many more factors we should also be considering, I seen it written once, that history in the stock market doesn’t repeat itself, but it most definitely rhymes, and if we take the time to understand Dow Theory, and understand the concept of Technical Analysis (and combine it with a sprinkling of Fundamentals), then we can usually make the correct decision… sometimes we’ll get it wrong, and sometimes we’ll get it wrong again, but being on the correct side of the market will oftentimes help you to make the best decisions.
That is the key to successful Trading, and if you take the time to research, analyze, do your own due diligence, you’ll know when to get defensive and when to get aggressive (either to the up side OR the down side).
Happy Trading all.