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Dow theory |
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Dow TheoryUsed in the context of general equities. Technical theory that a major trend in the stock market must be confirmed by simultaneous movement of the Dow Jones Industrial Average and the Dow Jones Transportation Average to new highs or lows.Dow theoryIn 1887 Charles Dow (as in 'The Dow Jones') developed two stock market 'averages':The Industrial Average, made up of 12 blue chip stocksThe Rail Average, made up of 20 railroad companiesIn 1900 he wrote a series of articles noting that the direction of prices in each average appeared to be based on a set of rules. Collectively, these became known as The Dow Theory and the key precepts are summarised below.Dow TheoryA share price reflects everything that is known about a stockThis means that all the positives and all the negatives about a company are assumed to be known by the market and built into the share price. Implicitly, no stocks are undervalued, because the market has 'perfect' knowledge.At any given time, there are 3 trends unfolding in the stock market:The primary trend lasting for more than one yearThe secondary trend which is a corrective reaction to the primary trend and usually lasts form one to three monthsThe tertiary or minor trend which is a short term movement lasting from one day to three weeks.Primary trends have three phasesAggressive buying by well informed investors ahead of economic recovery while most investors are still bearish about the marketGeneral buying by the majority of investors as company earnings pick up and economic conditions improveHeadlong rush into stocks by everybody, as companies report record earnings. Meanwhile, the well informed investors are starting to sell even though prices may be rising.Volume Confirms the TrendRallies in the market are accompanied by increasing volume, and falls with decreasing volume.A Trend Continues Until a Reversal SignalIf a primary trend is confirmed by the movement of both averages it will continue until there is a definite reversal signal. So once a primary trend has started the chances are it will continue, but once it has been around for a while the chances of continuation are less.Similar MatchesOdd lot theoryOdd lot theoryThe theory that profits can be made by making trades contrary to odd-lot trading patterns, since odd-lot investors have poor timing. This theory is no longer popular. Presidential election cycle theoryPresidential election cycle theoryA theory that stock market trends can be predicted and explained by the four-year presidential election cycle. Complexity TheoryComplexity TheoryThe theory that processes with a large number of seemingly independent agents can spontaneously organize themselves into a coherent system. New Trade TheoryNew Trade TheoryModels of trade that, especially in the 1980s, incorporated aspects of imperfect competition, increasing returns, and product differentiation into both general equilibrium and partial equilibrium models of trade and trade policy. Many contributed to this literature, but the most prominent was Krugman, starting with Krugman (1979). Modern portfolio theoryModern portfolio theoryPrincipals underlying the analysis and evaluation of rational portfolio choices based on risk-return trade-offs and efficient diversification. Further SuggestionsPortfolio theoryGame Theory Bubble theory Cushion theory Short interest theory Efficient markets theory(EMT) Normal backwardation theory Purchasing power parity theory Labor theory of value Greater fool theory Local expectations theory Theory of second best capital market theory Product cycle theory Bicycle Theory Expectations theory of forward exchange rates Conduit theory Dependency Theory Dow dividend theory efficient market theory Elliott Wave Theory Trade theory Agency theory Preferred habitat theory Game theory |
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