Dow Theory Theorems

One of the theorems of Dow Theory is that the ideal market picture consists of an uptrend, top, downtrend, and bottom, interspersed with retracements and consolidations. Figure 6.1 shows what this ideal market picture would look like. This market picture, of course, is never seen in its ideal form. Consider Hamilton’s quote, “A normal

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Secondary Trend The Minor Trend

1. The Secondary Trend …a secondary reaction is considered to be an important decline in a bull market or advance in a bear market, usually lasting from three weeks to as many months, during which intervals the price movement generally retraces from 33 percent to 66percent of the primary price change since the termination

Concept of Confirmation Importance of Volume

Dow always ignored a movement of one average which was not confirmed by the other, and experience since his death has shown the wisdom of that method of checking the reading of the averages. His theory was that a downward movement of secondary, and perhaps ultimately primary importance, was established when the new lows

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Criticisms of the Dow Theory

Although Dow Theory forms the building blocks for modern-day technical analysis, this theory is not without criticisms. One of the criticisms is that following the theory will result in an investor acting after rather than before or at market tops and bottoms. With Dow Theory, there is an inevitable lag between the actual turn

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What Is Sentiment?

Sentiment is defined as the net amount of any group of market players’ optimism or pessimism reflected in any asset or market price at a particular time. When a stock or commodity is trading at a price considerably above or below its intrinsic value, something we will not know until considerably later, the difference

Market Players and Sentiment

The appropriate corresponding timing strategy is to follow informed trader sentiment, act against positive feedback trader sentiment, and ignore liquidity trader sentiment. (Wang, 2000) Remember from Chapter 5, “An Overview of Markets,” that there are three types of players in any market: the informed, the uninformed, and the liquidity players. The estate that needed

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How Does Human Bias Affect Decision Making?

Remember, the Efficient Markets Hypothesis (EMH) suggests that enough investors are acting rationally at any particular point in time to make it impossible for a technical analyst to profit from security mispricing due to the emotions of the uninformed players. However, the field of behavioral finance has defined numerous ways in which investors act

Crowd Behavior and the Concept of Contrary Opinion

The art of contrary thinking may be stated simply: thrust your thoughts out of a rut. In a word, be a nonconformist when using your mind. Sameness of thinking is a natural attribute. So you must expect to practice a little to get into the habit of throwing your mind into directions that are

How Is Sentiment of Uninformed Players Measured?

A top in the market is the point of maximum optimism, and a bottom in the market is the point of maximum pessimism. (Davis, 2003, p. 9) Sentiment indicators are data series that give the technical analyst some feeling for how much prices are at an excessively emotional level. With that information, potential future

How Is the Sentiment of Informed Players Measured?

Thus far, we have focused mainly on the sentiment of the uninformed market players. Remember that these market participants often make incorrect market decisions, especially at market extremes. Therefore, the sentiment of the uninformed players is used in a contrarian strategy. Now we center our attention on the sentiment of informed players—those most likely

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Sentiment in Bonds

Given the subject matter of this book, our focus thus far in this chapter has been on the stock market. However, we complete our discussion of sentiment by presenting a few major measures of sentiment in other markets. 1. Treasury Bond Futures Put/Call Ratio The advent of an options market in futures has created

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Gold Sentiment

Mark Hulbert publishes a newsletter, the Hulbert Financial Digest, a subsidiary of MarketWatch, that follows the performance of other investment newsletters. He has been doing this since 1980. His methods are similar to those of Investors Intelligence. A number of these newsletters discuss the price of gold. Using this information, Hulbert calculates an index

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Chapter Objectives

By the end of this chapter, you should Understand the importance of measuring internal market strength Understand what is meant by market breadth Be familiar with how the advance-decline line measures market breadth Be familiar with how up and down volumes relate to market strength Be familiar with how new high and new low

Market Breadth

On any given day, a stock price can do one of three things: close higher, close lower, or remain unchanged from the previous day’s close. If a closing price is above its previous close, it is considered to be advancing, or an advance. Similarly, a stock that closes below the previous day’s close is

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Up and Down Volume Indicators

Breadth indicators assess market strength by counting the number of stocks that traded up or down on a particular day. An alternative way to gauge market internals is to measure the up volume and down volume. Up volume is the volume traded in all advancing stocks, and down volume is the total volume traded

Net New Highs and Net New Lows

When the stock market is rising, it is only reasonable to assume that individual stocks are making new highs. Conversely, stock market declines are associated with stocks making new lows. Generally, a stock is considered to reach a new high if the day’s price is higher than the price has been over the past

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Using Moving Averages

The indication of a trending stock usually is gauged by whether the stock price is above or below a moving average. The longer the moving average, the longer the trend the relationship represents. Looking at how many stocks are trending gives us a measure of market strength. 1. Coppock Curve In October 1965, a

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Very Short-Term Indicators

Although market sentiment indicators generally focus on spotting long-term trend reversals, the concept of sentiment can be used as a short-term contrarian indicator. Let’s look at a few ways in which following these indicators might provide clues to short-term trading opportunities. 1. Breadth and New Highs to New Lows Although breadth and new high-low

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Periods Longer Than Four Years in Technical Analysis

Let’s begin by looking at cycles occurring over a long period (over four years) of time. These cycles include Kondratieff waves, 34-year historical cycles, and decennial cycles. 1. Kondratieff Waves, or K-Waves Nicolas D. Kondratieff, an economist who lived in Communist Russia, studied historical commodity prices in the 1920s. He analyzed European agricultural prices

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Periods of Four Years or Less in Technical Analysis

A day is a definite period of time. A year, within small limits, is also definite. A month, however, may be lunar or solar; it may also be a number of other things. Hence 40 months of our present calendar must remain an approximation and certainly not an exact measure of the duration of