Technical analysis is a powerful tool for individual investors, and Dow Theory is the "Bible" of technical analysis. Dow Theory is the origin of all market technical research. Although it is often criticized for "reacting too late" and is sometimes ridiculed by those who refuse to trust its judgment (especially in the early stages of a bear market), anyone with even a modicum of experience with the stock market understands it. Hear. It is worth mentioning that the founder of this theory, Charles H. Dow, claimed that his theory was not used to predict the stock market, or even to guide investors, but was a barometer that reflected the overall trend of the market.

The Origin of Dow Theory

At first, Dow just wanted to know whether individual stocks were related to the overall trend of the market. To test his idea, he collected decades of economic data and calculated an average—the Dow Jones Index. After Dow's death, his successor, "Wall Street Journal" editor William P. Hamilton, inherited his theory and organized and summarized it into the Dow Theory we see today.

In the following days, the global investment market was verifying this theory. And in order to better track and record, the market has also innovated other recording methods. With the increasing number of indices, the verifications are also various, but now it seems that none of these have escaped Dow's theory. Along with the verification of this theory, a complete market research system has been gradually improved.

First, let’s talk about what research is. Marx gave a definition of research in the postscript to the second edition of Capital: Research must first fully possess the material, and then study the different development states of the material and understand their interrelationships. Only in this way can the current state of things be accurately described through induction and sorting. The purpose of futures market research is to accurately describe the current market status. For accurate description, one is to understand and judge the current risks; the other is to estimate the future.

The data statistics method pioneered by Dow Theory, after calculating the Dow Jones Index, was extended to the S&P Index, Nasdaq Index, etc. Every index that affects the world is the core of Dow. Moreover, this statistical method involves different species indexes, sector indexes and market indexes. In the process of development, Dow Theory has gradually become more complete and complete.

The cornerstone of technical analysis

Returning to the Dow Theory, what represents the overall market is an index, and the index is extracted from historical economic data. This involves the research object-whether historical economic data is valid and whether it can effectively reflect the market at that time.

First of all, we must admit that the data is valid, that economic data can represent the market itself, and that prices can represent all factors in the market at that time. This is the most important cornerstone of technical analysis. Whether it is fundamental analysis or technical analysis, the essence of price is the same.

After acknowledging the validity of the data, we begin the following discussion. What does the entire market have to do with individual stocks? This requires us to run statistics and analysis on the data. The difference between technical analysis and fundamental analysis lies in the source of data, and there should not be any difference in other aspects.

During the research process, Dow found that the data of the entire market and the trends of most individual stocks have convergence: first, the prices of individual stocks and the prices of the overall market have certain group tendencies from a historical perspective; second, There is also a tendency for convergence between different markets and between different individual stocks.

The conclusion drawn from this is obvious that the market is evolving in a trend.

During the research process, we must ignore countless prices and choose one of them as the research object. This is an inevitable process, and it requires constant abstraction and induction. It only needs to ensure that the sample data and operation cycle have a certain accuracy range.

How to select data and how to get closer to the market itself leads to different recording methods. The recording methods of economic data are constantly being innovated, and statistical methods are constantly being improved. This process is through the continuous verification of data and facts, and retroactively nourishes the continuous improvement of Dow Theory. When we study the relationship between prices and history, especially the vertical historical changes, we will find that the market itself has a cyclical movement, that is to say, history is constantly re-interpreted and follows a certain law.

History will repeat itself because for thousands of years, people have not made any qualitative breakthrough on the psychological level and have always moved on a flat level, so there is a certain regularity. The first is to demonstrate from the effectiveness of market prices, the second is to demonstrate from the regularity of the distribution of market prices themselves, and the third is to demonstrate from the regularity of group behavior participating in the market. These are the three cornerstones of technical analysis.

Theoretical extension

Whether it is wave theory or Gann test, they have their own standards. This judgment standard is the basis of everything. Now that we know the standard, all we have to do is verify it and trust it. The statistical method is very primitive, but very effective. It follows the principle that the longer the time, the greater the reliability and security; the more sample data, the closer your calculated standard is to the real standard. As time and prices change, market risks are constantly changing. Therefore, in actual application, we must accept and understand changes, and at the same time, we must know how to take advantage of changes and always stay within the accuracy of the market itself.

The main trends are divided into three directions: up, down and sideways. This is Dow Theory's interpretation of market structure. For specific judgment criteria, we will learn more details and methods from John Murphy's "Technical Analysis of Futures Markets" later. For auxiliary confirmation of volume, energy and form, we will learn from John Magee's "Technical Analysis of Stock Market Trends" We can get more help; and in terms of grasping the overall market, such as cycles and market breadth (that is, the mutual verification in Dow Theory), we will make great progress from Martin Pringle's "Technical Analysis". Of course, the root of all this is the Dow Theory, which means that the cornerstone never moves.

Dow Theory’s definition of trend has led to many methods of judging trends. This is also the first introductory test that all subsequent technical analysis must face. When it comes to practical operations, Victor Sporandi's "Principles of Professional Speculation" can be regarded as a thread that connects all the skills. Of course, if possible, we will re-read these classics one by one, analyze their development context and their respective connections, and how to coordinate and improve them in practical application. For example, we feel that Elliott Wave Theory is more suitable to judge which stage of the trend the current market price is in, and Gann Theory is more suitable to judge whether the current market state is normal or extreme. These can naturally be based on Dow Theory, but they were limited to the conditions at the time and could not mature.

Regarding trend classification, the essence is still a relatively accurate grasp of time and price. This is also the main factor that we need to pay attention to when analyzing the market. Only in time and space can people understand and evaluate the risks they face, and thereby manage risks.

We believe that the framework of Dow Theory is to observe price (space) changes in longitudinal and cross-sections of time, so as to find opportunities to understand and evaluate market risks, and his research method is to set standards, Use the average to determine whether the market status is consistent with our understanding.