Dow Theory and its Implications

Continued from...Cycles and Stock Market Records

Dow's Theory

Dow's theory is fundamentally simple. He showed that there are, simultaneously, three movements in progress in the stock market. The major is the primary movement, like the bull market which set in with the re-election of McKinley in 1900 and culminated in September, 1902, checked but not stopped by the famous stock market panic consequent on the Northern Pacific corner in 1901; or the primary bear market which developed about October, 1919, culminating June-August, 1921.

It will be shown that this primary movement tends to run over a period of at least a year and is generally much longer. Coincident with it, or in the course of it, is Dow's secondary movement, represented by sharp rallies in a primary bear market and sharp reactions in a primary bull market. A striking example of the latter would be the break in stocks on May 9, 1901. In like secondary movements the industrial group (taken separately from the railroads) may recover much more sharply than the railroads, or the railroads may lead, and it need hardly be said that the twenty active railroad stocks and the twenty industrials, moving together, will not advance point for point with each other even in the primary movement. In the long advance which preceded the bear market beginning October, 1919, the railroads worked lower and were comparatively inactive and neglected, obviously because at that time they were, through government ownership and guaranty, practically out of the speculative field and not exercising a normal influence on the speculative barometer. Under the resumption of private ownership they will tend to regain much of their old significance.

The Theory's Implications

Concurrently with the primary. and secondary movement of the market, and constant throughout, there obviously was, as Dow pointed out, the underlying fluctuation from day to day. It must here be said that the average is deceptive for speculation in individual stocks. What would have happened to a speculator who believed that a secondary reaction was due in May, 1901, as foreshadowed by the averages, if of all the stocks to sell short on that belief he had chosen Northern Pacific? Some traders did, and they were lucky if they covered at sixty-five points loss.

Dow's theory in practice develops many implications. One of the best tested of them is that the two averages corroborate each other, and that there is never a primary movement, rarely a secondary movement, where they do not agree. Scrutiny of the average figures will show that there are periods where the fluctuations for a number of weeks are within a narrow range; as, for instance, where the industrials do not sell below seventy or above seventy-four, and the railroads above seventy-seven or below seventy-three.  This is technically called "making a line," and experience shows that it indicates a period either of distribution or of accumulation. When the two averages rise above the high point of the line, the indication is strongly bullish. It may mean a secondary rally in a bear market; it meant, in 1921, the inauguration of a primary bull movement, extending into 1922.

If, however, the two averages break through the lower level, it is obvious that the market for stocks has reached what meteorologists would call "saturation point." Precipitation follows - a secondary bear movement in a bull market, or the inception of a primary downward movement like that which developed in October, 1919. After the closing of the Stock Exchange, in 1914, the number of industrials chosen for comparison was raised from twelve to twenty and it seemed as if the averages would be upset, especially as spectacular movements in stocks such as General Electric made the fluctuations in the industrials far more impressive than those in the railroads. But students of the averages have carried the twenty chosen stocks back and have found that the fluctuations of the twenty in the previous years, almost from day to day, coincided with the recorded fluctuations of the twelve stocks originally chosen.

Dow Jones Averages the Standard

The Dow-Jones average is still standard, although it has been extensively imitated. There have been various ways of reading it; but nothing has stood the test which has been applied to Dow's theory. The weakness of every other method is that extraneous matters are taken in, from their tempting relevance. There have been unnecessary attempts to combine the volume of sales and to read the average with reference to commodity index numbers. But it must be obvious that the averages have already taken those things into account, just as the barometer considers everything which affects the weather. The price movement represents the aggregate knowledge of Wall Street and, above all, its aggregate knowledge of coming events.

Nobody in Wall Street knows everything. I have known what used to be called the "Standard Oil crowd," in the days of Henry H. Rogers, consistently wrong on the stock market for years together. It is one thing to have "inside information" and another thing to know how stocks will act upon it. The market represents everything everybody knows, hopes, believes, anticipates, with all that knowledge sifted down to what Senator Dolliver once called, in quoting a Wall Street Journal editorial in the United States Senate, the bloodless verdict of the market place.

Previous...Cycles and Stock Market Records Next...Wall Street of the Movies

From The Stock Market Barometer by William P. Hamilton, published in 1922

More in this chapter:
Cycles and Stock Market Records Dow Theory and its implications

Home for more online stock market information

Encoding, design and images © PandaCash