The Handbook of Technical Analysis + Test Bank_ The Practitioner\'s Comprehensive Guide to Technical Analysis ( PDFDrive )

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Introduction to Dow Theory


the trade. Furthermore, the capital risk would be astronomically high if the
trader is expected to place a stop loss order based on the motion of the pri-
mary trend.


  1. The primary trend is susceptible to manipulation: Monetary policy such as
    near‐zero interest rates set by central banks over extended periods combined
    with colossal stimulus packages and quantitative‐easing (QE)‐to‐infinity‐type
    operations impact the longer‐term action of the markets by creating an artifi-
    cially super bullish environment where even its participants have little or no
    fear of anything untoward happening to the markets. Collective energy mar-
    ket rigging and the latest Libor scandal are further evidence that markets have
    and will always be susceptible to manipulation. Hence, Dow’s main reason for
    trading the primary trend is questionable in today’s highly impacted markets.

  2. The averages are not a true reflection and barometer of the market environ-
    ment: Unfortunately, in today’s markets, the majority of indices are themselves
    tradable and are therefore open to manipulation. For example, the VIX was
    meant to reflect the level of fear in the markets. It main objective is somewhat
    thwarted by the large amount of speculative trading impacting the VIX. Physi-
    cal gold prices are also at the mercy of heavy shorting in its corresponding
    ETFs, like the GLD, or via its futures and options contracts. Such products
    never existed in Dow’s time.

  3. Only closing prices are recognized: Recognizing only the closing price ig-
    nores potentially large intraday ranges that may occur during the day’s trad-
    ing session. These important price rejection levels are totally disregarded.
    Furthermore, there seems to be some conceptual conflict between recognizing
    the smallest amount required to close higher or lower while at the same time
    discounting potentially large and significant day to day fluctuations, regarding
    them as merely noise.

  4. The buy and sell signals based on the primary trend are safer: This may or
    may not be true, but detractors of Dow Theory argue that such signals usually
    occur late in the trend and miss a large part of it.

  5. The identification of a new primary trend: Due to the difficulty in establish-
    ing whether a retracement is part of a secondary reaction or the inception of
    a new primary trend in the opposite direction, investments based on the belief
    that the retracement is merely a secondary reaction will run a higher risk of
    losing capital should the market unfold contrary to what was expected.

  6. The averages must confirm each other: The rationale behind this logic is that
    in a healthy economy, the goods produced by industry are in great demand
    and this is evidenced by the amount of transport activity generated in trying to
    ship these goods to the consumers. Therefore, underperformance in either the
    industrial or transportation averages leading to non‐confirmation would logi-
    cally signal potential trouble in the economy. Unfortunately, the Dow Jones
    Industrial Average today is composed of many stocks that do not produce
    any physical product that requires shipping or transport, in general. Many of
    today’s companies are more involved in financial products, telecommunica-
    tions, and insurance. This severely diminishes the effectiveness of confirmation
    between the industrials and the transports. Many practitioners today prefer

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