Charles Dow’s Theory Still Valid for the 21st Century
by Jack Schannep
Every day we hear about the Dow rising or falling, but we may not stop to think who Dow was, what the Dow averages are all about and what the implications might be.
I’ll start with who Charles Dow was and then how his theory, which has served so well for over 100 years, can still be used in the 21st century as a guide to timing the stock market and making money from it.
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Dow Theory Origins and Background
Charles Henry Dow was born in November 1851 on a farm in Sterling, Connecticut. At the early age of 18, he began his career as a reporter and developed an early interest in business. Subsequently, he and his friend Edward Jones formed Dow Jones & Company in 1882. They published the handwritten Customer’s Afternoon Letter, precursor of The Wall Street Journal, with Dow as its first editor. It was not until May 26, 1896, that the Dow Jones industrial average was born with 12 “smokestack” companies. A year later, a separate average began to keep track of the railroad stocks, which were the primary transportation mode of the day. Both averages have been expanded over time, with 30 stocks now in the industrial average, and the rail average (renamed the transportation average) expanded to include airline, air freight, delivery service, marine transport and trucking companies.
Dow saw the stock market and his idea, yet to be named by others as the “Dow Theory,” as a barometer of business activity. He recognized that if the stocks in his averages were going up, that pointed to future business being good, and vice versa. On January 31, 1901, Charles Dow compared the stock market to the tides of the ocean when he wrote in The Wall Street Journal: “A person watching the tide coming in and who wishes to know the exact spot which marks the high tide, sets a stick in the sand at the points reached by the incoming waves until the stick reaches a position where the waves do not come up to it, and finally recede enough to show that the tide has turned. This method holds good in watching and determining the flood tide of the stock market.”
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Discussion
The excessive headline driven volatility that investors have endured over the last 3 years has diminished the predictive power of the Dow Theory in my view.
I do agree though, that buy and hold has not worked for several years.
posted 6 months ago by Jim Braun from California
If the Dow Theory is properly applied, even with such simple means as appropriate moving averages, it can greatly exceed a Buy & Hold approach.
posted 6 months ago by Werner Emmerich from Pennsylvania
The corruption that nearly collapsed the world financial markets in 2008 has still not been called to account. The system within which any purported predictive theory operates will always be manipulated by that dark hand; thus, no prognosticating will ever be accurate...or reliable.
posted 6 months ago by Philip Faccenda from New Jersey
Have followed Richard Russell for years. Bought gold but still have not been able to benefit from stock market based on th Dow Thoery. Cashand Gold have been the bes position as Russell has said.
posted 6 months ago by David Disick from New York
In the sophisticated computer driven market of today's world volatility reigns supreme. Too Big to Fail investment firms with computerized algorithms can cause market disruptions and massive moves that destroy the basis for any theory, but this is a good lesson in how the market should work if an equal playing field existed (and it may work well - but for small & micro cap stocks if such a tracking system exists for them) Since transportation stocks are less likely to be manipulated, they might be more important to follow than the industrial's. And , in today's world, the service & tech sectors play a much bigger role in our economy than in the past. Their relationships to the Dow must also be taken into consideration when investing wisely. It is a much more complicated environment today than in the 1900s when manufacturing ruled the marketplace alone.
posted 6 months ago by David Heffelfinger from Pennsylvania
Are 19% and -16% the buy and sell signals, respectively?
posted 6 months ago by Fernando Robles from Florida
I use +19% and -16% attained by both the DJIA and S&P500 as the minimum levels to qualify as a Bull or Bear market for a number of reasons. In the article I mentioned they are reciprocal numbers, unlike the +/-20% traditionally used. In addition, when markets rise +19% they have gone on 93% of the time to at lease a +29% gain (one-half have risen over +80%). Conversely, when markets lose -16% they have gone on 81% of the time to at least a -24% drop and been followed 77% of the time by recessions. Therefore, IF a Dow Theory signal has not been completed by the time these levels are reached, I use that as a 'stop-point' to complete the signal. This is explained more fully in the free area of my website www.thedowtheory.com
Best to All,
Jack Schannep
posted 6 months ago by Jack Schannep from Arizona
Does anyone know what we are in now? Is the Dow theory saying buy, or sell?
posted 5 months ago by Edward Mueller from Illinois
Edward,
In Jack's latest newsletter, he still has a buy signal.
-Charles
posted 5 months ago by Charles Rotblut from Illinois
I was a little disappointed the article didn't discuss the interaction between the Dow Industrial and Dow Transport indexes, and what it means when they are converging and diverging. Anyone know of another article in AAII that might cover that? I've seen other authors mention that the interaction between the 2 indexes is a key market indicator.
posted 5 months ago by John from Illinois
