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Stock Market Technical Analysis: The Dow Theory

 

To make a stock market investment, is a big and crucial step for many of the investors, mainly because of the money in line. Technical analysis helps to suffice this endeavor. Stock market technical analysis uses a number of different tools and indicators that help investors in judging the investment worthiness of a security. It does so by carefully reading the market, thriving knowledge on the stock market actors like price and volume, with supply and demand factors that actually help defining the worthiness of a share.

The basic idea behind this term dictates that if you are buying a share in the stock market, how you are going to justify your purchase analytically. It is because of this reason that the concept is used by market participants for trading and investment.

Stock Market Technical Analysis

Technical analysis

This is the second article of the series on the stock market technical analysis. The previous article detailed the concept of Elliott wave theory and how it can be applied to help investors take investments decisions. This article will discuss at length the Dow Theory and its role in forecasting the future of stock investments.

Charles Dow presented the concept of Dow Theory. The theory helps in investment and trading by identifying and pointing the alterations in stock market trends. Now, what is worth discussing is how the theory is applied in practical settings both by long and short term investors. The investors take help from the Dow theory by thriving on the four main components of this theory. These are as follows:

  • The markets are characterized with three fundamental movements
  • There are three important phases of the market trend
  • Stock prices are translated through the dissemination of all news
  • Market tends are confirmed by volume

Let’s have a detailed look at each of the factors separately to see how it helps in making stock market long term and short term investment decisions.

Market Movements

The stock markets have three basic movements defined as: Primary trend, secondary trend and minor trend. Primary trends are the major market movements. When a trend continues from many months to many years, the stock market is said to be hit by primary trend. The medium movements are the secondary trends that define the market when continued from ten consecutive days to three persistent months. Minor trends are the smallest movements lasting from few hours to one month.

Market Phases

The market trends, discussed above, have three different phases. These are the accumulation phase, public participation phase and distribution/panic phase. The occurrence of these phases follows an upward or downward trend.  The accumulation phase starts with the buying or selling of the stocks. This phase is seen in action in the stock market settings with the beginning of an upward or downward trend. The next phase is named as public participation phase. It occurs during the middle of an upward or downward trend. This phase is characterized with the influence that fundamental news have on stock prices. As the name implies, the phase takes place with the actual participation of investors. This participation impacts the price of stocks. Since, there is volatility in the stock prices at this stage; participants have the power to drive the stock prices higher in an upward trend and lower in downward trend. In the last phase of the trend movements, stock prices have peaked or bottomed. This is the distribution phase. This phase is characterized with the general trend of investors that sell stocks during the upward trend and buy during the downward trend. Usually, there is a unanimous agreement in the market about the stock prices trading up or below their basic value.

Market phases

Stock Prices and Dissemination of News

It is important to note that there is a direct relationship between the political, economic, financial and social events occurring in an economy and the stock prices. It is because of this reason that the stock prices react to these fundamental news which is reflected in the upward or downward stream in the prices of shares. As soon as the information is available, it hits the market by storm

Market Trend and Volume Relationship

The upward or downward movements of the stock should reflect in an increase in volume. The direction of trend in the market cannot be determined if the volume is low. If there is a simultaneous increase in the volume and price of stocks, it is an indicative of the fact that investors’ decision follows basic or physiological factors. This shows that stock prices will increase. Hence, the trend directions are confirmed.

Stock Market Technical Analysis

Dow Theory is instrumental in comprehending the stock market technical analysis. It is a beneficial trading strategy that helps investors in trend identification of the market. The concept has been applied to stocks like Ford motors, General Motors, Tesla Motors, etc.

The next article in the series will detail useful information to investors on the moving averages theory of the stock market technical analysis.  Stay tuned on the page to get your investment decision right by following the right market trend.

 

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About Emaad Qureshi