Stock Market Masters – 21st Century Use of the Charles Dow Theory, Component 4

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In Component 3 of this sequence, we targeted on the 2nd tenet of Dow Theory: the marketplace has three trends. In Part 4 we are going to zero in on the trend a bit more and concentrate on the 3rd tenet: major trends have 3 phases.

As a fast refresher, the 6 tenets of Dow Concept are:

The price discounts every thing.
The marketplace has 3 developments.
Main trends have 3 phases.
The averages must verify every other.
Quantity must verify the trend.
A trend is assumed to be in effect until it provides definite signals that it has reversed.

Major Developments Have 3 Phases

Way back again in the late 1800s when Charles Dow initial wrote his observations in the Wall Street Journal extremely couple of people had taken the time to really evaluate the moves of a stock, a lot much less the whole market. The tools of technical analysis were years from being developed, and in numerous methods individuals considered the speculation of investing/investing in the stock marketplace absolutely nothing short of gambling. But in his research of marketplace behavior, Charles Dow made some fascinating discoveries. One of these discoveries is the buy in which individuals enter the marketplace. And this buy is summed up in the third tenet of Dow Concept: main trends have 3 phases.

1. Accumulation

The first phase of a trend is what Dow termed the Accumulation Stage. During the accumulation phase Dow theorized that some investors, for what ever reason, had been able to foresee the long term cost of a safety and managed to purchase at, or close to, the low of the stock’s price swing. Dow stated these individuals do not in and of themselves hold sufficient buying energy to transfer the marketplace, but they begin to purchase up stock and “accumulate” their positions in anticipation of the next big transfer. As costs stabilize throughout the accumulation stage, the public starts to believe in the market a small much more. Eventually the public begins to place their money into the market, and the accumulation phase completes as we move into the 2nd stage.

2. Manifeste Participation

The Public Participation Stage is where the bulk of the cost movement occurs. Throughout this time the public’s confidence in the stock begins to rise, and more and much more individuals begin to location their money in the trade. As the purchasing pressure grows, so does the price of the stock, thus driving the cost even greater. As the cost carries on to rise, public self-confidence rises even much more, attracting more money and driving the price even greater. Eventually the optimism that drove the stock to its new highs spreads like a virus and most of the available money of the general investor is placed in the trade. This overexposure prospects to a absence of purchasers and consequently leads us to the 3rd phase of the pattern.

3. Distribution

In the Distribution Stage the extremely traders who began the move by accumulating their positions are the first to exit the move and “distribute” their positions. These much more insightful traders, who in Dow’s mind by some means foresaw the upcoming move, are also insightful sufficient to realize the marketplace has moved as way as it will move and the time has arrive to exit their position. Dow also factors out that while these insightful investors appear to have an inherent understanding of the price move of the stock and near their positions, the public’s optimism is at its greatest and begins to attract the latecomers who start to think this stock should certainly continue higher. It is during this time that the main news shops also start to print the most optimistic information tales, which bolsters the public’s sentiment that things must continue higher. This good press builds the optimism and sets the public at ease.

As the distribution phase gets beneath way and the authentic money that began the move in the accumulation phase is removed from the marketplace, the manifeste has fully vested their positions and sits anxiously in anticipation of a continuing greater move. However, because the availability of refreshing money has dried up and ceased, the continuing rise in price has also ceased. With the original money now gone from the market, prices start to fall, and the manifeste-who so eagerly assisted to generate the market up in a frenzy with the assist of the optimistic news media-now begins to doubt their positions. This doubt leads to an equal and opposite selling frenzy, which drives the market back down-frequently to the exact same location it began the transfer. As soon as the stock has been driven back again to the lows, the very people who began the accumulation stage and participated in the distribution stage once again enter the marketplace, accumulating new positions in anticipation of the subsequent cycle of increasing prices.

For the uneducated investor, this scenario appears like market manipulation. Nevertheless, manipulation is not what is occurring-it is insightful market observation. This tenet is one of Charles Dow’s greatest contributions to the globe of market analysis as it provides insight into the cycles of market behavior. When you comprehend how market cycles have a tendency to behave, you can learn to enter the markets during the accumulation phase, when most individuals believe the stock is doomed forever. And when most think about the stock to be increasing to the heavens with no end in sight, you can be insightful sufficient to know when to close and distribute your positions. This will make you an exponentially much more profitable trader.

It is really worth noting that this specific tenet of Dow Concept eventually led to a further study of market conduct, one that focuses entirely on the place of contrary viewpoint. Investing as a contrarian can be a very profitable position if and when you comprehend how to use it. This subject will be covered in much more detail in an approaching article series.