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Of course, primary trend in the stock mar- Iny that publishes The Wall Street no one ever knows in advance ket is driven by forces much big- Journal, Charles Dow (1851–1902) how long trends will last (that’s a ger than any single individual, also lent his name to one of the most key principle of the Dow theory). cartel, breaking news, or rumor. popular U.S. stock market indexes And since market prices fluctuate • The stock indexes reflect all (the Dow Jones Industrial Average) from day to day, it’s dangerous to available information. The Dow and created a theory regarding make too much out of a single theory believes that everything major shifts in stock market trends. day’s movement. there is to know about a stock While neither Dow nor those who • Primary trends can’t be manipu- and the economy at a given mo- refined the Dow theory after him lated. While it may be possible ment is factored into the prices of believed they were creating a sure- for private interests to manipu- stocks. This include hopes, fears, fire way to beat the market, they did late the price of one security for a and expectations of such factors believe that following its principles relatively short period of time, as interest rates, earnings, could at least avoid the mistakes as- the Dow theory holds that the Continued on page 2 sociated with greed and fear. Three Assumptions When Should You Sell? Behind the Dow theory is a set of assumptions about how the stock ost information about stock in- lost all the profit, plus some of the market works: Mvesting seems to discuss buy- initial investment. • The stock market moves in ing, but to actually profit from a If selling is dictated by emotion broad cyclical trends. According stock investment, it must be sold. rather than a well-thought-out plan, to Dow, there are primary trends, For many investors, selling a stock is it is very likely to play out as de- which are long lasting (from the most difficult decision. scribed in the example above. A months to years), and minor The reason selling is difficult for good selling decision may leave trends, which don’t last long and some investors is the fear of missing some profit on the table, but it run in the opposite direction of out on future profits. Let’s say an in- should be determined by a rational the primary trend. Primary up vestor purchases a stock at $30 per analysis of valuation and price. The trends are bull markets and pri- share and decides to sell when the most successful investors do not mary down trends are bear mar- stock reaches $35 per share. But focus on market timing by trying to kets — these are marked by when the stock reaches $35, the in- sell at the highest price; instead, peaks and troughs in price charts. vestor thinks it is doing so well that they focus on buying at one price Within these broader trends, it will surely rise more. The stock and selling at a higher price. there are secondary (minor) then drops to $31 and the investor If you have a difficult time with countertrends called corrections, decides to wait until it reaches $35 selling, you should consider using a which can retrace anywhere from again. Then the stock takes another limit order. This type of order will tumble to $24 and the investor just 33% to 67% percent of the prima- Continued on page 3 Copyright © Integrated Concepts 2019. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party as- sumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material. FR2019-0522-0102 2 Dow Theory Learning Lessons from the Stock Market Continued from page 1 f you pay attention to the stock he/she made a mistake, which is revenue, and product initiatives. Imarket, you can learn some psychologically difficult to do. Unexpected events can occur, but valuable lessons: When evaluating your stock in- usually they affect the short-term • The market tends to revert to vestments, objectively review the trend, creating what are called re- the mean. When the stock mar- prospects of each one, making action rallies. These soon lose ket has an extended period of decisions to hold or sell on that steam and the primary trend re- above or below average re- basis. sumes. turns, it has a tendency to re- • Make sure an investment will Three Primary Trend Phases vert back to the average return. add diversification benefits to According to the Dow theory, • Don’t chase performance. In- your portfolio. It’s common for major trends consist of three phases vestors often move out of sec- of varying length: investors to keep adding invest- Stage 1: Accumulation or distri- tors that are not performing ments that are similar in nature. bution. In this phase, the smart well, moving money to invest- This does not add much in the money — typically large institution- ments that are currently high way of diversification, while al investors like investment banks, performers. But the market is making the portfolio more diffi- pension funds, and mutual funds — cyclical, and often those high cult to monitor. start major buying or selling pro- performers are poised to under- • Check your portfolio’s perfor- grams. Initially, this looks like a sec- perform, while the sectors just mance periodically. Compare ondary countertrend, but trading sold are ready to outperform. your actual return to your target- volume on the major exchanges no- A classic example is technology ed return. Now honestly assess ticeably increases on up days, while stocks in early 2000. how well your portfolio is per- volume tends to be lighter on down • Avoid strategies designed to forming. Are major changes days. In a bull market, stocks are get rich quick. The stock mar- needed? cheap, but no one other than value ket is a place for investment, • No one knows where the mar- investors seems to buy them. In a not speculation. When your ex- ket is headed. So don’t pay at- bear market, there’s a high level of pectations are too high, you tention to gloomy or optimistic enthusiasm for stocks, and few peo- have a tendency to chase after predictions. Instead, approach ple believe the bull market is over. high-risk investments. investing with a formal plan so Stage 2: The big move. In this • Don’t avoid selling a stock be- you can make informed deci- phase, there are many more days in cause you have a loss. When sions with confidence. zxxx which the indexes move in the di- selling a stock with a loss, an rection of the primary trend than in investor has to admit that the opposite direction. In bull mar- kets, there are strings of up days, one is concerned about safety of firms would show up in business for followed by shorter strings of down principal, while those who bought the companies that move the goods days, reflecting the spread of enthu- stocks at high prices have finally they make. siasm for stocks. In bear markets, given up and sold at a loss. For the second index to confirm the opposite occurs, as anxiety and The Indexes Confirm the the first, the Dow theory looks for pessimism mounts. The result is a New Trend both averages to be moving in the significant, long-term increase (bull For Charles Dow, the primary same direction. New highs or lows markets) or decrease (bear markets) trend was reflected in the Dow Jones in one index are accompanied by in the market averages. Industrial Average, which today highs or lows at the same time or Stage 3: Excess. The final phase comprises 30 stocks. But Dow also shortly thereafter in the other. of a primary trend is marked by ex- looked to another index to confirm The Dow theory isn’t intended tremely high levels of emotion — the emergence of a new trend. In his to help short-term traders. What it’s enthusiasm in bull markets and pes- day, that was the Dow Railroad designed to do is tip off long-term simism in bear markets — which are Index. Today, it’s the Dow Trans- investors to changes in the trend, so signs that the primary trend is about portation Index of 20 companies they can shift their money from to change. These extremes can be engaged in the shipping and trans- stocks to another asset class, like seen in the behavior of individual portation of manufactured goods, bonds or cash, during a full business investors: in bull markets, even the including marine transport, rail- cycle. most conservative investors are buy- roads, and trucking. The idea was a Please call if you’d like to dis- ing stocks.