Dow Theory - Market Movements
The ideas of Charles Dow, the first editor of the Wall Street Journal, form the basis of technical analysis today.
Dow created the Industrial Average, of top blue chip stocks, and a second average of top railroad stocks (now the Transport Average). He believed that the behavior of the averages reflected the hopes and fears of the entire market. The behavior patterns that he observed apply to markets throughout the world.
Markets fluctuate in more than one time frame at the same time:
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. (Nelson, 1903)
- Bull markets are broad upward movements of the market that may last several years, interrupted by secondary reactions. Bear markets are long declines interrupted by secondary rallies. These movements are referred to as the primary trend.
- Secondary movements normally retrace from one third to two thirds of the primary trend since the previous secondary movement.
- Daily fluctuations are important for short-term trading, but are unimportant in analysis of broad market movements.
Various cycles have subsequently been identified
within these broad categories.