Charles Dow transformed the world of investing more than just about anyone in history. His ideas on market trend have been taught in millions of classrooms, forums, seminars, and trading floors all over the world.
Dow was born in 1851 on a rural farm. From the age of six he started working odd jobs to help support his family after his farther died. He wasn’t “learned” in Harvard and had no outstanding formal education. What he did have, which survives him today, was the ability to see trends in what was considered a sea of financial confusion.
Shortly after moving to New York in 1882 and starting Dow Jones & Co., Dow created the Dow Jones Industrial Average. An averaging of 11 major stocks listed on the exchange. Later, he also created the 20 stock Railroad Average (now the Transport Average). Dow never referred to his theories as the Dow Theory, and in fact, never took credit for it.
Dow’s theories of trend movement apply to nearly every market on Earth where traders respond to any type of movement with emotion.
The Dow Theory defines the (stock) market as moving within three movements. Each movement is defined as a time frame in which the market fluctuates in major and minor trends.
Dow stated these movements as being the Major Movements (trends), Secondary Movements, and the Intra-day Cycles. Within these movements are known as the Bull Markets, Bear Markets, and Ranging Markets.
We won’t cover all the particulars, just the points you need to know.
Bull markets are broad upward movements of the market that may last several years, interrupted by secondary reactions. Bear markets are long declines interrupted by secondary rallies. These movements are referred to as the primary trend.
From the above below, we can see clear defined paths indicating Bullish and Bearish market conditions. At the same time, we also see an excellent example of “Trending” market conditions. The market is moving in a defined upward or downward movement.
Periods between major trends are referred to as the “Bottom” and typically define “Ranging” market conditions. Prices move within a narrow band and “whipsaw” back and forth. Ranging market conditions are normally followed by a break out in either direction.
Within the Major Trends can be several Minor Trends referred to as Secondary Trends or Secondary Movements.
Secondary movements normally retrace from one third to two thirds of the primary trend since the previous secondary movement
Often if a Secondary Trend is severe in nature, it’s referred to as a “Correction”.
To help identify trends, here are the basic rules of the market:
A Bull Market is defined as having Higher Highs and Higher Lows.
A Bear Market is defined as having Lower Highs and Lower Lows.
Defining the exact start and ending of market conditions is normally irrelevant to daily trading, but you’re gonna find out anyway.
The start of an up trend is signaled when price makes a higher low, followed by a rally above the previous high:
Start = higher Low + break above previous High
The end is signaled by a lower high, followed by a decline below the previous low:
End = lower High + break below previous Low
There are those that argue that a major correction in the opposite direction of the trend indicates an end to the trend. But again, it’s irrelevant to daily trading. We just need to identify the major trend.
By definition, the Bullish trend cycle ends when the next two closes result in Lower Highs and Lower Lows. This is referred to as the “Reversal”
For practical purposes, only accept large corrections as trend changes in the primary trend.
Okay, I’ve covered the Dow Theory and now you can identify Major and Minor trends within a time frame.
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In the early part of the 20th century, Jesse Livermore was the most successful (and most feared) stock trader on Wall Street. He called the stock market crash of 1907 and once made $3 million in a single day. In 1929, Livermore went short several stocks and made $100 million. He was blamed for the stock market crash that year, and solidified his nickname, "The Boy Plunger." Livermore was also a successful commodities trader.
I think the most valuable knowledge one can gain regarding trading and markets comes from studying market history, and studying the methods of successful traders of the past. Jesse Livermore and Richard Wyckoff are two of the most famous and successful traders of the first half of the 20th century. Many of the most successful traders of today have patterned their trading styles after those of the great traders of the past.
Here are some valuable nuggets I have gleaned from the book, "How to Trade Stocks," by Jesse Livermore, with added material from Richard Smitten. It's published by Traders Press and is available at Amazon.com. Most of the nuggets below are direct quotes from Livermore, himself.
* "All through time, people have basically acted and reacted the same way in the market as a result of: greed, fear, ignorance, and hope. That is why the numerical (technical) formations and patterns recur on a constant basis."
* "The game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the person of inferior emotional balance, or the get-rich-quick adventurer. They will die poor."
* Don't take action with a trade until the market, itself, confirms your opinion. Being a little late in a trade is insurance that your opinion is correct. In other words, don't be an impatient trader.
* Livermore's money made in speculation came from "commitments in a stock or commodity showing a profit right from the start." Don't hang on to a losing position for very long."It is foolhardy to make a second trade, if your first trade shows you a loss. Never average losses. Let this thought be written indelibly upon your mind."
* "Remember this: When you are doing nothing, those speculators who feel they must trade day in and day out, are laying the foundation for your next venture. You will reap benefits from their mistakes."
* "When a margin call reaches you, close your account. Never meet a margin call. You are on the wrong side of a market. Why send good money after bad? Keep that good money for another day."
* Livermore coined what he called "Pivotal Points" in a market or a stock. Basically, they were: (1) Price levels at which the stock or market reversed course previously--in other words, previous major tops or bottoms; and (2) psychological price levels such as 50 or 100, 200, etc. He would buy a stock or commodity that saw a price breakout above the Pivotal Point, and sell a stock or commodity that saw a price breakout below a Pivotal Point.
* "Successful traders always follow the line of least resistance. Follow the trend. The trend is your friend."
* A prudent speculator never argues with the tape. Markets are never wrong-- opinions often are.
* Few people succeed in the market because they have no patience. They have a strong desire to get rich quickly.
* "I absolutely believe that price movement patterns are being repeated. They are recurring patterns that appear over and over, with slight variations. This is because markets are driven by humans -- and human nature never changes."
* When you make a trade, "you should have a clear target where to sell if the market moves against you. And you must obey your rules! Never sustain a loss of more than 10% of your capital. Losses are twice as expensive to make up. I always established a stop before making a trade."
* "I am fully aware that of the millions of people who speculate in the markets, few people spend full time involved in the art of speculation. Yet, as far as I'm concerned it is a full-time job -- perhaps even more than a job. Perhaps it is a vocation, where many are called but few are singled out for success."
* "The big money is made by the sittin' and the waitin' -- not the thinking. Wait until all the factors are in your favor before making the trade."
An important point I want to make is that Jesse Livermore's trading success came not because of any "inside" information or some huge store of knowledge he had about each and every stock or commodities market he traded. Livermore's trading success was derived from his understanding of human behavior. He realized early on that markets and stocks can and do change -- but people and their behaviors do not. Therein lay his formula for trading success. That formula for trading success has not changed since Livermore's hey day in the stock and commodities markets almost a century ago.
A final note: Jesse Livermore may have been called the greatest stock market trader of the 20th century, but I question that notion. Certainly, no one can disagree that his profits were immense and his trading prowess was unmatched. But his life was not in balance. He was a "workaholic" who paid too little attention to his family. Livermore put a gun to his head and pulled the trigger in 1940. He"crashed and burned." You must have balance in your life to achieve lasting success at any endeavor. Trading markets is no exception.
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Bob Prechter: Bear Market Rally Is Over, Stocks Headed For New Lows
With the Dow Jones Industrial Average once again marching closer to 10,000, many investors, especially those who missed the rally since March, must be asking themselves: Is now the time to finally pull the trigger?
Robert Prechter, founder of Elliott Wave International, implores retail investors stay away… for now. Prechter, who was bullish near the lows in March, now says the stock market "is in a topping area."
- Slowdown in upside momentum. Recent intraday rallies are petering out before the close.
- Bullish Sentiment. Investors who were bearish near the lows, are now just as bullish after a 60% run in the S&P 500. To Prechter, "that's a dangerous place to be."
- General overvaluation of stocks.
Prechter, the author of Conquer the Crash, says this is akin to the market in 1966-74 or 1929-32, where massive bear rallies gave way to another "big leg down."
He's predicting another crash in 2010 that will bring stocks below this year's low. His word to the wise, "be patient, don't rush it" keep your money in cash and cash equivalents for now and wait out this bear market.
He thinks it'll be another 5 or so years before we turn the corner but the good news is when we do, it'll be the buying opportunity of a lifetime.
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