Stock Market will Go Up or Down, Know in 2 Mins | Theory In Technical Analysis of Stock Market

Stock Market will Go Up or Down, Know in 2 Mins | Theory In Technical Analysis of Stock Market

Stock Market will Go Up or Down, Know in 2 Mins | Theory In Technical Analysis of Stock Market

Do you know, what are the three most important pillars of your life for success? That is health wealth and relationships.

Dow Theory is the oldest and one of the most important concepts when applying technical analysis to stock markets. 

We use this theory friends freely when we recommend stocks to our clients it just increases our overall accuracy to a very large extent.  

It is very important for you, to be aware of this theory. 

So Dow theory was extracted from more than 250 Wall Street Journal, editorials by Charles H Dow from 1900 to 1902.  

After the death of Charles Dow, the other editors of the Wall Street Journal, namely William Peter Hamilton, Robert Rhea and II George Shaffer they organized the editorials by Charles is down expanded his work and formulated the Dow Theory.

So that was a brief intro, now why is Dow theory very important to you.  

First Dow Theory will help you as an investor to predict and understand the behavior and the overall direction of the market. 

Secondly, it will help you as an investor to spot hidden trends in the market and help you manage your open positions very efficiently. 

And thirdly, analyzing the market using doubt theory will help you know where the bigger players of the market are investing so that you can capitalize on it.  

Types of Technical analysis of the Stock Markets

So overall this topic will help you understand Dow theory in detail and you will learn to identify stock trends and market trends and then relate them with volumes to increase your stock selection accuracy.  

It will help you understand where the markets are currently, which will ensure that you never enter the markets at the wrong time especially when a bubble is created and you invest at the right stage.  

Dow Theory can be understood by studying its six principles:- The market moves in three trends. The Dow Theory defines the movement of the market in the form of trends. 

The trend in a stock or for that matter index represents the movement of the stock or the index in a particular direction over time. 

And trends can be bullish that is up trending or bearish that is down trending and move in a zig-zag fashion.  

So a trend is termed as an uptrend if it forms consecutive higher highs and higher lows.   

Consider the example of JSW steel limited between February 2016 and August 2016.

Stock Market will Go Up or Down, Know in 2 Mins | Theory In Technical Analysis
JSW steel was in an uptrend since every new high that it made was higher than the previous highs and every new Low made was higher than the previous low.  

Similarly, a trend is termed as a downtrend if it forms consecutive lower highs and lower lows. 

Let’s consider the example of Jet airways between Jan 2018 to August 2018.  

Technical analysis Vs fundamental Analysis

A jet airway was in a downtrend since every new high of the trend was lower than the previous high and every a new low of the trend was lower than the previous low.  

Now that we understand what trends are using these trending analyses the Dow Theory divided the market into three types of movements or trends.  

That is the primary trend, secondary trend, and minor trends.  

To understand this, let's consider an example of Nifty between October 2004 and June 2007.

Stock Market will Go Up or Down, Know in 2 Mins | Theory In Technical Analysis

It represents the three trends that we just talked about and the first one is the primary trend. 

This is the main underlying trend.  It could be bullish or bearish.  

It lasts from six months to several years.  It remains active until a trend reversal is confirmed.  

The second one is the secondary trend.  This occurs within the primary trend and is usually opposite to the primary trend.  

So here the red signals show us that the secondary trend is actually bearish.  

It’s a bearish correction to the bullish primary trend. It is treated as a correction to the primary trend of usually 10 to 35%.  

Its duration is smaller than the primary trend and we last from a few days to months.

Technical analysis for Beginners

The third one is a minor trend.  This occurs within the secondary trend and again it is usually opposite to the secondary trend.  

If you observe the trend is bullish to the bearish secondary line so this trend is treated as a correction to the secondary trend usually 10 to 15%. 

Its duration is against smaller than the secondary trend and may last for as short as say 10 days two maybe three months.  

So the Dow Theory states that the market will always show these three movements or trends at any given point in time. 

That ‘show the markets move and if you understand this you understand stock markets better than anybody else.  

Now let’s understand something important about the primary trend which will help you understand when exactly is a good time to enter into the stock markets.  

This is the second principle of Dow Theory so read carefully. The primary trend has three phases.  

That is the accumulation phase, the public participation phase and the third is the peak of the bubble.  

Technical Analysis of Stocks

Now let's try and understand these phases with the help of a Nifty chart between 2003 and 2009.  

Stock Market will Go Up or Down, Know in 2 Mins | Theory In Technical Analysis

Let's first talk about the accumulation phase. This way started in mid-2003 to 2004.  

During this phase, well-informed investors go on buying in huge numbers.  

This is just the start of the bull rally and it is very difficult to spot on. The valuations in this phase are very attractive.

The second phase is public participation.  This phase occurred between 2004 till mid-2007.

Stock Market will Go Up or Down, Know in 2 Mins | Theory In Technical Analysis of Stock Market

It occurs after the accumulation of the phase where the overall market sentiments and the whole economy look very good improved.  

Everyone including the retail investor they start participating and this is the longest phase where stocks move very fast and this phase is generally backed by trend followers and technical analysts and you would see a noticeable spike in the volumes here.  

The third phase is the peak bubble. This phase started in mid-2007 until January 2008.  

It is the last phase where the entire market scenario is extremely positive.  Every person starts talking about investing in stocks. 

Stocks are expensive but they appear to investors as if they are going to double in the next few days or months.

In reality, this is the last the phase of the primary trend after which a trend reversal will happen and the markets will fall, the bull rallies over. 

A lot of retail investors get trapped at this stage.  They lose a lot of money.  You can see the markets started falling from Jan 2008.

Stock Market will Go Up or Down, Know in 2 Mins | Theory In Technical Analysis

There are many people who entered the markets at the peak in 2008 and they lost all their wealth.  Even today they have not been able to recover their losses.  

So before entering the market at any point in time an investor should correctly estimate the market phase using this Dow Theory.

Technical analysis for Beginners

Now you know the trick, these three phases are applicable to individual stocks as well.  

Let’s consider the example of Jet Airways between October 2008 and September 2011.

Stock Market will Go Up or Down, Know in 2 Mins | Theory In Technical Analysis

In this example, Jet Airways was in the accumulation phase from October 2008 till May 2009.  

Then the market shifted to the public participation phase with a huge increase in volume. 

The beginning of the bubble or the peak started in August 2010 and lasted until the end of 2010.  This was the last phase of the primary uptrend after which the stock fell.

So now you know, when you should be entering into stock for maximum gains.  Now our third principle of the Dow Theory. The market discounts everything.  

This point in doubt remains that stock prices reflect the ultimate truth.  They represent all the necessary information pertaining to the past the present and the future.

Types of Technical analysis of the Stock Markets

This principle means, that the analysis of fundamentals such as economy, interest rates, your valuations your quarter numbers, your oil numbers, and your sentiments.  

They all are completely relevant as long as the chart is analyzed well.  The stock prices and the markets they have already accounted for everything under the sky that is the assumption.

The fourth principle is confirmation by indices.  This principle states that a major reversal of the primary trend.  

It cannot happen unless all the major indices of the market show a similar reversal of a trend.  For example, the banking sector plays a major role in the Indian markets.  

The banking sector also has a very higher weightage in the construction of the Nifty index.

So according to the principle of Dow Theory, any major reversal of the primary trending the Nifty index should be confirmed by a similar movement in the Bank Nifty index.  

Consider this chart of the Nifty index and Bank Nifty index over ten years between August 2008 to August 2018.  

Stock Market will Go Up or Down, Know in 2 Mins | Theory In Technical Analysis

If you observe all major reversals of the primary trend of nifty are confirmed by the reversal in the primary range of Bank nifty.  

That is when nifty Falls Bank nifty Falls too and when Bank nifty Rises the nifty also raises.  

Basically, the point is that the two indices must always go hand in hand and they must always be in the same direction to confirm a trend.  

So that’s, how you always confirmed trends from multiple angles. 

The fifth principle.  That is the principle of confirmation by volume.  Now as for this principle a trend with the support of higher volumes sustains for a longer period of time. 

This principle also indicates that the reversal in the trend would be successful only if it is supported by an increase in volume.

Now you consider this chart of Sun Pharmaceutical Limited between May 2017and September 2018.  

Stock Market will Go Up or Down, Know in 2 Mins | Theory In Technical Analysis

All major reversals in the primary trend as seen by these charts are supported by a sharp increase in the volume.  

This means that the trend change is successful. The last principle of Dow Theory.  Trends remain active until a clear signal of reversal is formed.  

As per this principle of the Dow Theory, the trend continues to persist until a clear and strong sign of reversal is observed. 

Let’s see this nifty chart between October 2015 and February 2016.

Stock Market will Go Up or Down, Know in 2 Mins | Theory In Technical Analysis

Here Nifty has a primary trend of a downtrend with lower high, lower low formations till February 2016. 

But the primary trend changed and the formation of lower high lower low stopped from March 2016 and confirmed reversal in the primary trend. 

This point teaches us the trend reversal can come anytime and we should have well-defined entry and exit points. 

So Use this Dow Theory effectively, it can be a game-changer. It just increases our accuracy to analyses the stocks. (Chart source

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