The Near Dormant Dow Theory?

The Wall Street Industrial Average remains arguably the most watched index today, despite the proliferation of market and sectoral indices around the world. Yet it monitors only the share price of 30 US stocks.

The present composition of the DJIA is as follows:

AA          Alcoa

AXP        American Express

BA          Boeing company

BAC        Bank of America

CAT        Caterpillar inc

CSCO      Cisco Systems

CVX        Chevron Corp

DD          Du Pont

DIS          Walt Disney Company

GE          General Electric Company

HD          Home Depot

HPQ       Hewlett Packard

IBM        International Business Machines

INTC       Intel Corporation

JNJ          Johnson & Johnson

JPM        JP Morgan Chase & company

KFT         Kraft Foods

KO          Coca Cola Company

MCD       McDonalds Corp

MMM    3M Company

MRK       Merck & Company

MSFT     Microsoft Corp

PFX         Pfizer Inc.

PG          Proctor & Gamble

T             AT & T Inc

TRV        The Travellers Company Inc

UTV        United Technologies Corp

VZ           Verizon Communications Inc

WMT      Wal-Mart Stores Inc

XOM      Exxon Mobile Corp


Whilst officially this index was created in 1896 with just 12 leading Industrial stocks, Charles Dow used various averages before then, to study market fluctuations; indeed ever since becoming involved in financial journalism in 1877 for the Providence Journal. It was these studies that formed the basis for his observations of the three categories of share price movement, and the basis for technical analysis.

Bull and Bear markets were defined on the basis of the high and low points of stock averages. In a bull market, the average increased, whilst in a bear market, the average fell. For example

In 1877 there was a market crash which resulted in a fall of the average of 60 stocks from a high of 76.57 in September 1872 to a low of 36.33, and a decline of 40.24. But it was followed by a bull period from April 1877 to May 1881, an era of railway expansion that saw this average recover by 63.47 to 99.8. One group of stocks which out performed in this time were the Granger stocks.

i.e.  Certain railroads whose traffic largely consist in carrying the produce of farmers or grangers; – specifically applied to the Chicago & Alton; Chicago, Burlington & Quincey; Chicago, Rock Island & Pacific; Chicago, Milwaukee & St. Paul; and Chicago & Northwestern, railroads.

According to Dow’s calculation bull and bear primary trends lasted 4 year or more, and reactions from the primary trend afforded the most favourable opportunities for entry. Short term daily fluctuations he regarded as too erratic and brief for profit for all but short term traders.

Dow provided the rationale for still the most successful investment strategy, trend investment. For “long only” investment the objective was to hold quality stocks through the period of the bull market as defined by a study of the averages.

The decision to only diagnose the trend when both the Industrial average and the Railroad average confirmed each other was sensible since the Industrial Index reflected the health of the emerging manufacturing industry, whilst the Railroad index reflected the strength of the previously dominant agricultural economy.

We may think we now have more sophisticated investment tools, but it is hard to argue with the simplicity of investing in bull markets, and abstaining in bear markets. Not a formula for quick profits, but a rationale for sound investment returns.

Careful observers reflect the landscape of their day. The details will change, but the vision remains.

Indices are still a valuable guide to economic health, and a valid guide to investment timing for those who regard timing as important.

Categories: History of Technical Analysis


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