Technical analysts,orchartistsas they are sometimes called, stand in
sharp contrast to fundamental analystswho use such variables as divi-
dends, earnings, and book values to forecast stock returns. Chartists ig-
nore these fundamental variables, maintaining that useful information
may be gleaned by analyzing past price patterns. These patterns tend to
repeat themselves and are the result of market psychology or unusual
price movements caused by informed traders. If these patterns are read
properly, chartists maintain, investors can use them to outperform the
market or share in the gains of those who are more knowledgeable about
a stock’s prospects.
CHARLES DOW, TECHNICAL ANALYST
The first well-publicized technical analyst was Charles Dow, the creator
of the Dow Jones Industrial Average. But Charles Dow did not analyze
only charts. In conjunction with his interest in market movements, Dow
founded the Wall Street Journaland published his strategy in editorials in
the early part of this century. Dow’s successor, William Hamilton, ex-
tended Dow’s technical approach and published theStock Market Barom-
eterin 1922. Ten years later, Charles Rhea formalized Dow’s concepts in
a book entitled Dow Theory.
Charles Dow likened the ebb and flow of stock prices to waves in
an ocean. He claimed that there was a primary wave, which, like the tide,
determined the overall trend. Upon this trend were superimposed sec-
ondary waves and minor ripples. He also claimed you could identify
which trend the market was in by analyzing a chart of the Dow Jones In-
dustrial Average, the volume in the market, and the Dow Jones Rail
(now called the Transportation) Average.
Those that follow the Dow theory acknowledged that the strategy
would have gotten an investor out of the stock market before the Octo-
ber 1929 stock crash. Martin J. Pring, a noted technical analyst, argues
that, starting in 1897, investors who purchased stock in the Dow Jones
Industrial Average and followed each Dow theory buy-and-sell signal
would have seen an original investment of $100 reach $116,508 by Janu-
ary 1990, as opposed to $5,682 with a buy-and hold strategy (these cal-
culations exclude reinvested dividends).^2 But confirming profits that
come from trading based on the Dow theory is difficult because the buy-
290 PART 4 Stock Fluctuations in the Short Run
(^2) Martin Pring, Technical Analysis Explained, 3rd ed., New York: McGraw-Hill, 1991, p. 31. Also see
David Glickstein and Rolf Wubbels, “Dow Theory Is Alive and Well!”Journal of Portfolio Manage-
ment, April 1983, pp. 28–32.