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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 MatchesElliott Wave TheoryElliott Wave TheoryTechnical market timing strategy that predicts price movements on the basis of historical price wave patterns and their underlying psychological motives. Robert Prechter is a famous Elliott Wave theorist. Local expectations theoryLocal expectations theoryA form of the pure expectations theory that suggests that the returns on bonds of different maturities will be the same over a short-term investment horizon. Capital market theoryCapital market theoryThe generic term for models which aim to price assets, usually shares or baskets of them, in terms of the trade-off between risk and return that investors seek.The best known and most influential of these is the Capital Asset Pricing Model. Cushion theoryCushion theoryThe theory that a stock with many short positions taken in it will rise, because these positions must be covered by the stock. Product cycle theoryProduct cycle theoryTheory suggesting that a firm initially establish itself locally and expand into foreign markets in response to foreign demand for its product; over time, the MNC will grow in foreign markets; after some point, its foreign business may decline unless it can differentiate its product from competitors. Further SuggestionsBubble theoryEfficient markets theory(EMT) Greater fool theory Agency theory Trade theory New Trade Theory Theory of second best Modern portfolio theory Preferred habitat theory Dow dividend theory Dependency Theory Game Theory Purchasing power parity theory Expectations theory of forward exchange rates Complexity Theory Conduit theory Presidential election cycle theory Labor theory of value Bicycle Theory Portfolio theory Game theory Normal backwardation theory efficient market theory Odd lot theory Short interest theory |
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