Dow Theory Overview Topic learning outcomes .. Further resources . 1 Introduction to Dow Theory 4.4 Dow's original main ideas ...ssesssees 2 The basic principles of Dow Theory 25 2.1 The averages discount everything, 2.2 The market has three movements... 2.3. Primary movements have three phases 2.4 Determining the trend... 2.5 Both averages must confirm. 2.6 Volume provides adcitional evidence 2.7 Other aspects . 2.8 The record of Dow Theory.. 3 Dow Theory example: The Australian stock market 2.22 3.1 The big picture ....... 3.2. The recovery from the crash 3.3. The 1989-90 bear market ... 3.4 The 1994 bull market 3.5 The 1992-93 trEndS.sacseieeses 3.6 The 1994-95 tum. 3.7. The bull market — 1995 to the 4997 Asian Crisis. 3.8 The end of the 1990s bull market?. References 2.36 PROFESSIONALTopic 2: Dow Theory 2, Overview Dow Theory is the name for the ideas widely attributed to Charles Dow, but which were actually a composite of the ideas of Dow, William Hamilton and Robert Rhea. These ideas lie behind many of the concepts in modern technical analysis. This topic examines the main ideas of Dow Theory in detail, showing how they may be used. Many of these ideas are of importance to other approaches as well. Dow Theory is still used today, by itself, as a powerful way of looking at markets and guiding global investmentitrading strategy. This topic specifically addresses the following subject learning outcomes: * Define and apply key concepts in technical analysis and understand how it complements other forms of analysis. + Identify trends and turning points using various techniques. Topic learning outcomes On completing this topic, you should be able to: * explain the three movements of markets and identify them on a price chart © explain the three phases of a bull or bear market and assess the current market in terms of these phases * determine the trend of a market from a chart © identify when a market changes from a bull to a bear trend using the idea that the average for industrial stocks and for transport stocks must confirm each other. Further resources * Gartley, H M 1935, ‘Chapter VII: Tenets of the Dow Theory’ (especially), Profits in the stock market, republished by Gann-Lambert Publishing, Washington. * Russell, R 1981, The Dow Theory today, Fraser Publishing Company, Virginia. (© Kapian Higne Edveaton22 Technical Analysis (FIN231) Introduction to Dow Theory Dow Theory is the name given to the ideas that derive from Charles Dow, the first editor of the Wall Street Journal and inventor of the stock market average, known roday as the Dow Jones Average. What is known today as Dow Theory is the cumulative work of Charles Dow, William Hamilton, who followed Dow as editor of the Wall Street Journal, and Robert Rhea who pulled together the work of Dow and Hamilton into a coherent theory. Dow devised the stock market average because he saw that most stocks moved together in the general up and down movements of the markets. By taking a basket of stocks and averaging their prices, he was able to plot the general rise and fall of the stock market as a single value. Most later commentators describe Dow as not primarily interested in the stock market itself. Rather, it was said that he had observed that, by the time news of improved business conditions made its way into the Wall Street Journal, the stock market was found to have been already moving up for some time. The reverse could also be observed; when bad news began to appear, the stock market had alzeady been falling. Therefore, commentators say that Dow concluded that the stock market anticipated changes in general business conditions and, hence, is what is known in economic jargon as a ‘leading indicator’. Thus, Dow’s primary motivation in studying the stock market was as a way of anticipating changes in the real economy. ‘While this may be true and have been one of Dow’s motivations, his editorials ae clearly about trading individual stocks and he repeatedly talked of swings in the prices of those stocks as well as of the overall market. The interesting thing is that Hamilton, who wrote extensively on Dow Theory, only ever applied it to the overall market. Hamilton was not a trader, he was a journalist commentator, and this probably explains why he did not pick up Dow’s ideas and apply them to individual stocks. Since Rhea used Hamilton’s writings as a primary source, itis not surprising that he also saw Dow Theory as having application primarily to anelysing the overall stock market movement with the objective of determining its trend. This is probably the origin of later commentators’ inaccurate observations that Dow was concerned only with the business cycle. Because of the way in which what has come to be known as Dow Theory was developed by Hamilton and Rhea, it deals primarily with analysing the swings in the overall market. However, many of Dow’s other observations about trading, which are not generally included under the umbrella of Dow Theory, were also novel insights into market behaviour. Many of them have been picked up and developed by later analysts and underlie much of modern technical analysis. The remaining discussion of Dow Theory, deals with the ideas that are accepted as making up the theory as it applies to analysis of the overall market. nasa si.3|14 Topic 2: Dow Theory 23 Dow's original main ideas There is no doubt that Dow had many insights into the way markets operate. However, he wrote few of them down. He must have discussed them with his colleagues though, because Hamilton seemed able to refer to Dow’s thinking beyond what was conveyed in his writing. S.A, Nelson also records that he unsuccessfully tried to persuade Dow to write a book on his ideas. The only written record of Dow’s ideas is in a few Wall Street Journal editorials he wrote in 1901 and the first half of 1902, just before his death. Nelson republished them in his book The ABC of stock speculation in 1903 and it was Nelson who first called them ‘Dow's Theory’. As might be expected from its title, Nelson’s book is about trading stocks and Dow's editorials were incorporated as chapters within it because they also had their primary focus on trading stocks. The references to analysis of the overall marker are really quite sparse and some of the references that Hamilton and Rhea took to apply to the overall market were framed by Dow with reference to trading individual stocks. Instead, Hamilton was relied upon to add other ideas, which he claimed were Dow’s. Whether what Hamilton added was purely Dow’s work is open to question. Indeed, Hamilton’s ideas seemed to evolve over time as he wrote regularly for the Wall Street journal and Barron’s, 50 it will probably never be known precisely who is the real father of each part of the theory. In turn, Rhea tried to add rigour to the definition of the theory and his contribution must also be recognised. The following are the quotations from Dow’s editorials that pertain to what is now called Dow Theor Bull markets and bear markets run four and five years at a time. Determine by the average prices, which one is under way. (Nelson 1903, p. 33) The market is always to be considered as having three movements, all going on at the same time, The first is the narrow movement from day to day. The second is the short swing, running from two weeks to.a month or ‘more; the third is the main movement covering at least four years in duration. ‘The day to day movement should be disregarded by everybody, except traders, who pay no commissions. The medium swing is the one for ordinary consideration. The outside trader should not attempt to deal in ‘more than two or three stocks at a time. He should keep a chart of the price movements of these stocks so as to know their swings for months or years, and thus be able to tell readily where in the general swing his particular stocks appear to be. He should keep with his price movement a record of the volume of transactions. ...He should observe the movement of the general market as indicated by the averages published daily, as this shows the market more clearly than is shown by any one stock. (Nelson 1903, pp. 36-37) (© Kalen Higher Edveaton24 Technical Analysis (FIN234) Many people seem to think that the change in prices in any one day is complete in itself and bears no relation to larger movements which may be under way. This is not so. Nothing is more certain than that the market has three well defined movements which fit into each other. The first is the daily variation due to local causes and the balance of buying and selling at that particular time. The secondary movement covers a period ranging from ten days to sixty days, averaging probably between thirty and forty days. The third move is the great swing covering from four to six years. It is a bull period as long as the average of one high point exceeds that of previous high points. It is a bear period when the low point becomes lower than the previous low points. It is often difficult to judge whether the end of an advance has come because the movement of prices is that which would occur if the main tendency had changed. Yet it may only be an unusually pronounced secondary movement. It seems to be a fact that a primary movement in the market will generally have a secondary movement in the opposite direction... It is impossible to tellin advance the lengtb of any primary movement, but the further it goes, the greater the reaction when it comes, hence the ‘more certainty of being able to trade successfully on that reaction. (Nelson 1903, pp. 39-44) There comes a time when a stock with a good degree of activity will stay within a narrow range of prices, say 2 points, until there has formed quite a long horizontal line... The formation of such a line sometimes suggests that the stock has been accumulated or distributed... (Nelson 1903, p. 42) The market is not like a balloon plunging hither and thither in the wind. As a whole, it represents a serious, well considered effort on the part of far-sighted and well-informed men to adjust prices to such values as exist or which are expected to exist in the not too remote future. (Nelson 1903, p. 45) These quotations give a taste of Dow's writings on the overall market. They also contain Dow’s principal ideas on the overall market which were taken by Hamilton and Rhea and developed into what is now known as Dow Theory. Hamilton (1922) wrote a book and a great many editorial articles on Dow Theory. Rhea painstakingly assembled all of Hamilton’s writings and distilled what he thought was Dow’s theory. However, Rhea added his own thinking in the sense that he needed to interpret ideas chat were sometimes unclear or inconsistent. It is Rhea’s version that is accepted today as the definitive statement of Dow Theory. rwaen.sMa.3|Topic 2: Dow Theory 25 2 The basic principles of Dow Theory This section outlines the fundamentals of Dow Theory, including the application of averages, the types of movements in the market and the phases within these movements, the concept of ‘trend? and the usefulness of volumes as evidence. 2.1 The averages discount everything The fluctuations of the daily closing prices of the Dow-Jones rail and industrial averages afford a composite index of all the hopes, disappointments and knowledge of everyone who knows anything of financial matters and for that reason the effects of coming events (excluding acts of God) are always properly anticipated in their ‘movement, The averages quickly appraise such calamities as fires NaUAR Ov quality and earthquakes. 7 ok. estimate the (Rhea 1932, p. 12) This powerful idea is a basic assumption of all of technical analysis. Clearly it has application beyond the averages to individual stocks and to any other financial market. 2.2 The market has three movements ‘There are three movements of the averages, all of which may be in progress at one and the same time, + The first, and most important, is the primary trend: the broad upward or downward movements known as bull or bear markets, which may be of several years duration. + The second, and most deceptive movement, is the secondary reaction: an important decline in a primary bull market or a rally in a primary bear market. These reactions usually last from three weeks to as many months. + The third, and usually unimportant, movement is the daily fluctuation. (Rhea 1932, pp. 12-13 (bullets added)) None of Dow, Hamilton or Rhea used diagrams to explain these points, but they are easier to grasp if presented visually: (© Keplan Higher Education26 Technical Analysis (FIN231) Primary movements The big picture of the primary movements will look like thi Figure 4 Primary movements average Primary Bul market Primary bear market pe Eee eee Primary movements are the principal focus of Dow Theory: The primary movement is the broad basic trend generally known as a bull or bear market extending over periods which have varied from: less than a ‘year to several years. The correct determination of the direction of this movement is the most important factor in successful speculation. There is no known method of forecasting the extent or duration of a primary movement. A primary bull market is a broad upward movement, interrupted by secondary reactions and averaging longer than two years. During this time, stock prices advance because of a demand created by both investment and speculative buying caused by improving business conditions and increased speculative activity. A primary bear market is the long downward movement interrupted by important rallies. It is caused by various economic ills and does not terminate until stock prices have thoroughly discounted the worst that is apt to occur. (Rhea 1932, p. 13) || be discussed in more detail in section 2.3 below. Primary markets pres su.3Topic 2: Dow Theory 27 Secondary movements Secondary movements will look like this: Figure 2. Secondary movements Average Secondary movements \ / ~ Time According to Rhea (1932, p. 14): sa secondary reaction is considered to be an important decline in a bull market or advance in a bear market, + usualy lasting from three weeks to as many months, © during which intervals the price movement generally retraces from 33% t0 66% of the primary price change since the termination of the last secondary reaction (bullets added]. ‘These reactions are frequently erroneously assumed to represent a change ¢ of primary trend, because obviously the first stage of a bull market must always coincide with a movement which might have proved to have been merely a secondary reaction in a bear market, the contra being after the peak has been attained in a bull market. (© Kepian Hehe EaveatonTechnical Analysis (FIN234) A secondary reaction may take the form of a ‘line’ Figure 3 Secondary movements may appear as lines Average Secondary reactions appear as lines Primary bull merit Primary bear market Time A ‘line’ is a price movement extending two to three weeks or longer, during which period the price variation of both averages move within a range of approximately five percent. Such a movement indicates either accumulation or distribution. + Simultaneous advances above the limits of the ‘line’ indicate accumulation and predict higher prices; conversely, + Simultaneous declines below the ‘ine’ imply distribution and lower prices are sure to follow. (Rhea 1932, p. 15 (bullets added)} Rhea required that the line appear on both the industrial and rail averages. However, later Dow theorists might allow a line on one and a normal secondary movement on the other, fanaa SM. eC23 Daily fluctuations ‘The daily fluctuations occur all the time and will look like this: Figure 4 Daily fluctuations aueroee Dally fluctuations ina secondary reaction Daily fluctuations in a | Primary movernent Primary bull markat Prmaty bear market Tine Topic 2: Dow Theory 29 According to the theory, daily fluctuations are of no importance for determining the trend of the overall marker, and they were regarded by Dow, Hamilton and Rhea as misleading and to be ignored. It must be remembered that they were concerned with the primary and secondary movements only. Much of modern technical anal concerned with short-cerm trading and seeks to analyse the daily fluctuations. Primary movements have three phases There are conceptually three phases to primary movements. These phases are characterised by the market behaviours that can be detected by studying the chart of the averages. This is not a precise matter, though, with the start and finish of each phase blending into one another. 1 Kaplan Mier EeveationTechnical Analysis (FIN231) Conceptually, the three phases can be visualised like this: Figure 5 Three phases of primary trends Iversge Phase 1: Aandonment of hopes. Phase 3: Rempent speculation puieaay Decreased earnings Phase 2: Improved earings once $ 182 3 Distress seting Phase 4: Reviving confidence Primary bull market Primary bear market $$$ tine There are three phases of a bull period: © the first is represented by reviving confidence in the future of business; + the second is the response of stock prices to the known improvement in corporate earnings, and + the third is the period wher speculation is rampant and inflation ‘Apparent —a period when stocks are advanced on hopes and expectations. ‘There are three principal phases of a bear market: + the first represents the abandonment of the hopes upon which stocks were purchased at inflated prices; + the second reflects selling due to decreased business and earnings, and oO + the third is caused by distress selling of sound securities, regardless of their value .. (Rhea 1932, p. 13 (bullets added)) Itis interesting that Dow, Hamilton and Rhea sought to describe the market behaviour that was reflected in the charts of the averages. The chart was not something they looked at as a tool divorced from what was happening in the marker. They were concerned with the way the averages reflected the behaviour of market participants in the various phases of the business cycle and used it as a way of mapping where they were in the cycle. Today, technical analysts are not concerned only with the business cycle, but also with short-term trading. However, the most effective use is made of having of technical analysis when it is employed as a way of discerning the behaviour of market ‘ participants, from which a strategy for trading can be conceived. ahowing geod Judgontnt ev Night. rAnasu.ske.32.4 Topic 2: Dow Theory aaa In order to determine the current phase, some of the relevant observations are: * the average price earnings ratio for the market + the average dividend yield for the market * the marker’s reaction to news + the level of new capital raisings and initial public offerings (IPOs), also known as ‘floats’ * the apparent trend of the market (see section 2.4 ‘Determining the trend’) * the level of public participation in the market + the level of interest in the markets by the main media — TV, newspapers, magazines and the internet + broker employment levels, consolidations or bankruptcies and interest in private clients ‘the level of activity, employment, business failures etc. in the economy. Determining the trend Rhea distilled the ideas of Dow and Hamilton into a precise definition of trend: + Successive rallies penetrating preceding high points, with ensuing declines terminating above preceding low points, offer a bullish indication, © Conversely, failure of vallies to penetrate previous high points, with ensuing declines carrying below former low points is bearish. (Rhea 1932, p. 14 (bullets added)) Key concept: Trend “Trend! is probably the most important single idea in Dow Theory and is absolutely fundamental to a large part of modern technical analysis, The concept of trend may be visualised in the following diageams. © Kasten Kiger Education2d2 Techinical Analysis (FIN231) ; What Rhea called ‘high points’ and ‘low points’ are here called ‘peaks’ and ‘troughs’. See Glossary and Topic 1. Figure 6 Basic Dow bull trend HP Start of a bull trend when price moves above the previous peak after making a higher trough ur End of a bull trend when price moves below the previous trough at after making @ lower peak Key: HP: high point LP: low point P: peak T: trough HT: high trough LT: low trough ‘There are two important observations to be made from this diagram: + A higher trough and then 2 higher peak are needed before a bull trend can be said to be in place. ‘+ The emergence of a lower peak and then a lower trough ends the ball trend. This observation allows the analyst to be precise about where the bull trend starts. ‘Once price turns up without reaching the previous trough and then moves above the previous peak, higher trough is in place and wherever that up move ends must form a higher peak. ‘This observation also allows the analyst to be precise about where the bull trend ends. ‘Once price turns down without reaching the previous peak and then moves below the previous trough, a lower peak is in place and wherever that down move ends must form a lower trough. n283.5i.5Tople 2: Dow Theory 2.43 Notice how every peak and trough is not validated until price moves past the previous opposite swing, that is, @ new peak validates the last trough and a new trough validates the last peak. This is because, if price turns down after an up movement, it may just be a daily fluctuation; it may just move down a little and then resume the up movement, passing the last pealk. So, the existence of a new peak is uncertain until a new trough is made, and the existence of @ new trough is uncertain until a new peak is made, Figure 7 Basic Dow bear trend End of a bear trend when price moves above the previous peak ve ‘after making a higher trough Stort of a bear trend when price ‘moves below the previous trough after making a lower peak u There are two important observations to be made from this diagram: + A lower peak and then a lower trough are needed before a bear trend can be said to be in place + The emergence of a higher teough and then a igher peak ends the bear trend, This observation allows the analyst to be precise about where the bear trend starts Once price turns down without reaching the previous peak and then moves below the previous trough, a lower peak is in place and wherever that down move ends must form a lower trough. This observation also allows the analyst to be precise about where the bear trend ends. Once price turns up without reaching the previous trough and then moves above the previous peak, a higher trough is in place and wherever that up move ends must form a higher peak Notice how every trough and peak is not validated until price moves past the previous opposite swing, that is, a new trough validates the last peak and a new peak validates the last trough. This is because, if price turns up after a down movement, it may just be 2 daily fluctuation; it may just move up a little and then resume the down movement, passing the last trough. So, the existence of a new trough is uncertain until a new peak is made, and the existence of a new peak is uncertain until a new trough is made. (© Fapion Higher Education244 Technical Analysis (FIN234) The large correction dilemma Rhea was, by training, an engineer and this logically circular definition, where a bull trend becomes a bear trend and so on, must have seemed very satisfying intellectually. However, the real world is not quite so tidy. Consider these situations: / Jf / \ \ (On the left a marker ‘crash’ is evident. At some point on the downward move to A, the bull market has ended. Similarly on the right a very strong market recovery is seen. At some point on the upward move to B, the bear market has ended. A way of dealing with this is necessary to cope with the real world. The solution is found by returning to Rhea’s logic and taking it further. ‘The Dow Theory, as set out by Rhea, defined ‘trend’ in terms of the peaks and troughs made by swings in the average. Thus, as already explained, a bull trend is a succession of higher peaks and troughs, while a bear trend is a succession of lower troughs and peaks. The dilemma arises when consideration is given to what is needed for a reversal of the trend from bull to bear and back again. On the one hand, Rhea’s conservative approach can be used, and the requirement for an opposite trend to be in place should be met before the end of the previous trend is called. The other logical approach considers that an intact trend must have both the peaks and ‘troughs in the correct configuration. Once either a peak or trough breaks the sequence, the trend is no longer in place. Thus, a higher peak in a bear trend or a lower trough in a bull exend would change the trend. Figures 6 and 7 show Rhea’s definition of a trend ending, Figures 9 and 10 show the alternative trend endings that are consistent with the logic that a trend must be a succession of higher/lower peaks and also higher/lower troughs. Once one of these conditions is no longer satisfied, the trend has ended. ) AN2SL.S.3Topie 2: Dow Theory 2.45 Figure 9 Alternative bull market ending. HP. End of a bull trend when price moves below the last trough so that there are no longer HI BOTH high peaks AND higher troughs Figure 40 Alternative bear market ending End of a bear trend when price moves above the last peak so that there are no longer BOTH lower troughs AND lower peaks LP a (© Kaplan tener Eauzation2.16 Technical Analysis (FIN231) ‘Thus, there are two logical endings for a bull market. Both are shown in Figure 11. Figure 44. Both bull market endings A bull market ends when prices move below A after making a lower peak or if the market first falls below B. Likewise, there are two logical endings for a bear market. Both are shown in Figure 12. Figure 12 Both bear market endings +39.6 to 5338.4 W.@ w0s078s-260802 | 2000 4 1800 1600 f “4400 1200 ll l@lll=l«l*l1l*l*l*l=lelale Figure 46 XTP — Transport index > +84.4 to 6651.2 we woso7es-290802 sug 2000 600 | 1200 3000 a6] a7 | a8 | 9 | 00 o2| 93 | 96 97 | 98 | 99 | 00 | 01} o2 vasa. sm.9Tople 2: Dow Theory The recovery from the crash The following discussion refers to Figures 17 and 18 Following the November 1987 lows, the Industrials formed a line over several months. Eventually, the Industrial Index broke above the highs of the line in late February 1988, confirming the late December signal on the Transport Index. It is true that this may have been signalling only a strong bear market secondary reaction. However, the size of the 1987 fall and the subsequent evidence of distressed selling, suggested that the usual three phases of a bear market had been very compressed. ‘There is room for another view on the turn up after the crash: seeing the Industrials signal as early as mid-January, by discounting the idea of a line and taking the new high following the higher low in December as the signal. This is an eternal unresolved argument among Dow theorists — the ‘any high is enough’ school versus the need for the high to be significantly above the previous one ‘The next critical point on the charts is when the Industrials Index made a lower high in October 1988. However, there was no immediate confirmation from the Transport Index. It is only in February 1989 that the confirmation arose, when the Transport Index broke down from a two-month long line, The bear market was in place. Having made a low in April 1989, the Industrials Index then rose strongly above the January high in May. This gave a Dow signal based on the ‘large correction’. This was confirmed by another large correction on the Transport Index as it rose above the highs of the December/Januacy line. After a brief bear marker, the market turned into another bull trend. Figure 17 XAI— All Industrials Index >+39.6 to 5338.4 De pz2s0er-2x289 00 7 2000 ha to ran ala en Pollo allel ae © Kaplon higher Edeation2.26 3.3 Technical Analysis (FIN234) Figure 18 XTP — Transport Index > +84.4 to 6651.2 be pzziesr-2o1200 ‘cet|ow ceo an ean ae] un] sal aug sr] one wovfose] rea] ae ree sun| su] ane se ocr ou er cs The 1989-90 bear market ‘The following discussion refers to Figures 19 and 20, ‘After making a high in October 1989, the Industrials Index fell sharply in what appeared to be a secondary reaction to a low in November. However, only a weak rally ensued with a lower high in January 1990, from which there was a quick fall to below che November low. All that was needed for a bear market call was a confirmation from the Transport Index. The Transport Index had also fallen to a low in November and then rallied, like che Industrials, into a January peak. However, its fall to below the November low took longer and the confirmation of the bear market did not come until March. ‘The end of the 1990 bear market was signalled by a large correction on both indices, when they bottomed in January 1991, before rising above the previous bear market secondary highs in early February. rwass.so.3 , >Figure 19 XAI — All Industrials index > +39.6 to 5338. ‘Topic 2: Dow Theory 2.27 Dep os07e9-200601 aa Figure 20 XTP — Transport Index > +84.4 to 6654.2 suaT auc fse>[oct IyovToee | | reshana rl ane sun ut ava] se°[ocr TwovToec| sen re ann! aor ran [aun] ‘0 eo 0207e9-260603, ‘enue [se Jocr wo ote Jin reehann ama] way fun su. [ aus] ses] ocr|novfoen | sa ree war nF] wa] on 2000 2600 3000 2200 ‘© Hplen gre Education2.28 Technical Analysis (FIN234) 3.4 The 1991 bull market ‘The following discussion refers to Figures 21 and 22. ‘There was a bull market through all of 1991. However, there was one moment of, concern in August. A secondary reaction in the Transport Index began in April and appeared to bottom in June. A weak rally ensued with a lower high in early August, then the index fell to below the June low. The question was whether the Industrials Index would confirm the bear signal. The Industrials had made a marginally higher high in early August. Then, just as the Transport Index made a new low, the Industrials Index made a marginally lower low at the same time as the Transport Index. ‘This could have been seen as a large correction confirmation and the ‘any low is enough’ school would have called it a bear market. However, they would only have been wrong for a short while, as both indices rallied and began making short-term higher highs and lows. The end of the 1991 bull market was interesting, First, January 1992 saw the Industrials fail to make a new high, although the Transport Index did. After a line in February, the Industrials broke below the December secondary low in early March. ~ This confirmed a bear market, as the Transport Index had plunged below the lows of December, forming a large correction signal in late February. An alternative view is that the Transport Index fell below a line it formed in February. However, the writer does not see the February line on either chart as large enough to be a true secondary reaction. Oo Following that signal, Dow theorists would have had their hearts in their hands during the rally on both charts into a high in May. However, they both failed to take out the previous high and the bear market continued with a vengeance. Figure 21 XAI — All Industrials Index > +39.6 to 5338.4 be poaoins-a13292 aan, 2800 2000 1900 a ror a a a ce wv oa |r ol wa vn] a hue Tone rina ss.33.5 opie 2: Dow Theory 2.29 Figure 22 XTP — Transport Index > +84.4 to 6651.2 2.@ 0 o20s02-s21202 3600 2000 The 1992-93 trends The following discussion refers to Figures 23 and 24. Both indices bottomed in November 1992. The question was then to identify a reversal to a bull market. This was not to be easy. The fall into the November low on both indices had been strong and consistent, with no large secondary reactions. Indeed, it could be argued that the entire move down from the May highs on both indices was ‘one long primary bear market swing, leaving no clear secondary reaction high in the bear trend as a reference for a new trend, It also suggested that a strong bear market secondary reaction would be a possible and it would be difficult to pick from a new bull primary trend, By early January 1993, the Industrials Index had peaked and a shallow correction ensued. The first clue that more than a bear market secondary reaction was in play came in the first half of February when the Industrials moved above the early January high. The Transport Index had behaved similarly, except that it failed to make a new high in February. Confirmation occurred in March. Te would not be entirely unreasonable to see the signal just described as being based on altogether too small fluctuations. Moze conservative Dow theorists might have waited until the Industrials broke above a slightly up-sloping line in July, confirmed by a new high in the Transport Index in October. By then, the Industrials had increased by nearly 50% from the November low in a strong trend. Most observers would have suspected a bull market was in progress, especially since, after July, the rate of ascent of the Industrials Index picked up markedly. © Keplon Wigner Edueton2.90 Technical Analysis (FIN234) The end of this bull market was also a little difficult to call. The first opportunity was in March 1994, when the Industrials broke below a line and the Transport Index made a new low. In the event that the line in the Industrials was not accepted as a secondary reaction, the break below the November secondary low in May set up a large correction confirmation. The 1994 bear market was conclusively in place. Figure 23 XAI— All Industrials Index > +39.6 to 5338.4 1010782-300894 3545 2000 "Terr hos Pes ol oT Tacos nro] Figure 24 XTP — Transport Index > +84.4 to 6651.2 1 @ D0s0792-200604 3699 fngs.em.2Topic 2: Dow Theory 230 3.6 The 1994-95 turn The following discussion refers to Figures 25 and 26, The end of the 1994 bear market was also a challenge in some respects. However, the duration of the subsequent bull market made up for any lateness of the signal. The Industrials Index made its ultimate low in November and then rallied. After unsuccessfully testing the low for the second time in January 1995, it moved above the December high in late February. Meanwhile the Transport Index did not bottom till February and it was not until early April that it confirmed the Industrials by exceeding the end of February rally high. Was this a valid bull market signal? Not really — the moves described could all too easily have been a secondary reaction in the bear market. Only with hindsight could this be called a bull market signal. The more realistic signal came much later and was rather well into the bull trend. In May1995, the Industrials Index moved above the August 1994 high, to give a large ( correction signal and then, after a moderate fal, rose above its May high in July. However, a longer wait was in store for the Transport Index. In June, it planged briefly to below the February low, but then rallied. It was not until mid-September that a move above the May high finally happened, thus helping to confirm the bull market. From there it has been all bull market. However, there was great indecision in the first half of 1996 as what was, with hindsight, a severe secondary reaction, could have been seen as the start of a new bear primary. Many Dow theorists would have called it in July. They would not have been wrong for long, though, and by September the bull ‘market had clearly reasserted itself. Figure 25 XAl — All industrials Indox > +39.6 to 5338.4 0.8 0010304-311208 5555 3000 é : | 2e00 wlalmTsTsTaTsfolnlo[sTelmlal mls [a Talsfolnlo[s tr IuTalmls 1) TaTslolnto| oe = % ‘© Kaplan HgnerEaveaton2.32 3.7 Technical Analysis (FIN2S1) Figure 26 XTP — Transport Index > +84.5 to 6652.2 0.@0010994-311296 465 3000 The bull market — 1995 to the 1997 Asian Crisis The following discussion refers to Figures 27 and 28, From the 1994-95 turn to the ‘Asian Crisis’ in 1997, a fairly regular bull trend is seen to unfold. The most significant peaks and troughs have been marked on both charts, marking out the sections of bull trend and the secondary reactions between them. The test came in the sharp dip on both indexes during the Asian Crisis in late 1997. Ir was possible to see a Dow Theory trend ending at this point. There was a large correction signal on the Industrials Index and a break below a line on the Transport Index, However, while at the time some defensive action might have been taken, the writer is inclined to think that the interpretation just made was too short term in the context of the chart of the bull market and that the Asian Crisis lows only established significant higher troughs on the charts as marked, 05. 6H.3|Tople 2: Dow Theory 2.83 Figure 27 XA — All Industrials Index > +39.6 to 5338.4 D@0.080196-812207 Soy “ ipl 4000 Hr We a 7 3000 = 2600 sTeTutaTadsToTals Tol To] Tela nls TsTaTsT ols [of Tela alls TsTaTsTolsTo| 2s 96) Ea Figure 28 XTP — Transport Index > +84.4 to 6651.2 @0 030105222207 5000 he 000 ar 3000 2400 (© epian Higher Eacation2.34 3.8 Technical Analysis (FIN231) The end of the 1990s bull market? The following discussion refers to Figures 29 and 30. Figures 29 and 30 show the development of the 1990s bull market up to the point at which the ASX discontinued its All Industrials and Transport Sector indexes. The situation at that point was inconclusive in that the All Industrials Index seemed to have turned down, but there was no clear confirmation from the Transport Sector Index. Taking the All Industrials first, there was a spike to a technically higher high at the end of June 2001. However, this was on manipulation by a large trader after the regular close of the year. In any event, it was not to matter, because the late 2001 fall clearly gave a large correction signal. The strong rally that followed did not make a new high and it appears as though it may turn out co be a lower peak. So the All Industrials are clearly trending down, ‘The Transport Index is quite different. The higher trough made in 2000 is still in place. The 2001/02 rally only equalled the all-time high. There is no signal that might be seen as a trend change. Until the 2000 HT is taken out, the trend on the Transport Index is still up and a confirmed bear market cannot be called. Figure 29 XAl — All Industrials Index > +39.6 to 5338.4 ___pevonoe7.260602 ‘5000 4000 3800 rn23i.sMa.3|Topic 2: Dow Theory 2.95 Figure 30 XTP — Transport Index > +84.4 to 6651.2 Dep o20197-280602 2000 000 6000 5000 4000 3400 (© xapan tener Eovcavon2.36 Technical Analysis (FIN234) References Hamilton, WP 1922, The stock market barometer, reprinted by Fraser Publishing Company, Vermont, (Also 1998, John Wiley & Sons, Australia; also 2005, Cosimo, New York). Nelson, SA 1903, The ABC of stock speculation, reprinted by Fraser Publishing ‘Company, Vermont. [Incluces the original editorials by Charles Dow.] (Also 1997, Fraser Publishing Company, Vermont). Pring, MJ 2002, Technical analysis explained: The successful investor's guide to spotting investment trends and turning points, 4th edn, McGraw-Hill, Australia. Rhea, R 1932, The Dow Theory: An explanation of its development and an attempt to define its usefulness as an aid in speculationt, Barrons, New York (Also 1994, Fraser Publishing Company, Vermont). Nzas SMa