Course Theory

Welcome to our site!

We hope you find the information on Course Theory that you are looking for.

Check out the following products on eBay. It has an enormous inventory of just about anything you could want!

You can also check out Amazon for information on Course Theory.

« Previous12345...399400Next »

An Article On Application Of "the Dow Theory" On The Nse Nifty

AN ARTICLE ON

APPLICATION OF "THE DOW THEORY"

ON THE NSE NIFTY

BY: HARDIK P. BAXI

Fulltime faculty of finance at Swami Sahajanand College of Comm. & Mgt. Bhavnagar, Gujarat, India.

Visiting faculty of finance at ICFAI, Sahajanand Institute of Mgt., Vision International Institute of Mgt. Bhavnagar, Gujarat, India.

hardikbaxi@gmail.com

INDEX

Abstract

The Dow Theory

Construction of HARTRANX

Application of the theory on NIFTY

Conclusions

ABSTRACT

The research paper deals with the application of The Dow theory on the NSE NIFTY. I have gone through the tenants of the Dow Theory as propounded by Charles Dow. All the tenants of the Dow Theory after studying precisely have been used to create a transport index which is not available in the Indian stock markets.

The Dow Theory has its basics in the 1897 when Charles Dow developed the Widely known Dow Jones Industrial Average and the Dow Jones Transport Average comprising of 50 railroad companies.

The Theory has attracted many financial analysts specifically the technical analysts. However, what I feel is, the theory can also be helpful to the economists who would like to forecast the reversal of economic cycles.

Using the SIX MAIN TENANTS OF DOW THEORY, I have constructed a transport index for the study purpose. I have named the transport index as HARTRANX or the Hardik Transport Index. For constructing the index, I have taken the period from 03-01-2000 to 26-02-2010. I have used 8 companies for the said purpose. Details of index construction are in the following chapters.

The findings as was expected; are affirmative and prove the application of Dow Theory on our markets. I am sure that this article will be of great help to all the technical analysts and the people who wish to apply the Dow Theory on Indian stock markets.

THE DOW THEORY

The Dow Theory is the granddaddy of all technical market studies. Although it is frequently criticized for being "too late," and occasionally derided (particularly in the early stages of a Bear Market) by those who rebel at accepting its verdicts, it is known by name to nearly everyone who has had any association with the stock market, and respected by most. Many who heed it in greater or lesser degree in determining their investment policies never realize that it is purely and simply "technical." It is built upon and concerned with nothing but the action of the stock market itself (as expressed in certain "averages"), deriving nothing from the business statistics on which the fundamentalists depend.

There is much in the writings of its original promulgator, Charles H. Dow, to suggest that he did not think of his "theory" as a device for forecasting the stock market, or even as a guide for investors, but rather as a barometer of general business trends. Dow founded the Dow–Jones Financial News Service and is credited with the invention of stock market averages. The basic principles of the theory, which was later named after him, were outlined by him in editorials he wrote for The Wall Street Journal. Upon his death in 1902 his successor, as editor of the Journal, William P. Hamilton, took up Dow's principles and, in the course of 27 years of writing on the stock market, organized them and formulated them into the Dow Theory as we know it today.

Before proceeding to an explanation of the theory itself, it will be necessary to examine the stock averages which it employs.

Long before the time of Dow, the fact was familiar to bankers and businessmen that the securities of most established companies tended to go up or down in price together. Exceptions — stocks that moved against the general nancial tide — were rare, nor did they as a rule persevere in that contrary course for more than a few days or weeks at a time. It is true that when a boom was on, the prices of some issues rose faster and farther than others, and when the trend was toward depression, some stocks declined rapidly while others would put up considerable resistance to the forces that were dragging the market down, but the fact remained that most securities tended to swing together. (They still do, needless to say, and always will.)

This fact, as we have said, has long been commonly known and accepted — so completely taken for granted that its importance is usually overlooked. For, it is important — tremendously important from many angles in addition to those which come within the province of this volume. One of the best of all reasons for a student of market techniques to start with the Dow Theory is because that theory stresses the general market trend.

Charles Dow is believed to have been the first to make a thorough effort to express the general trend (or, more correctly, level) of the securities market in terms of the average price of a selected few representative stocks. As finally set up in January of 1897, in the form which has continued to date, and used by Dow in his studies of market trends, there were two Dow–Jones Averages. One was composed of the stocks of 20 railroad companies only, for the railroads were the dominant corporate enterprises of his day. The other, called the Industrial Average, represented all other types of business, and was made up, of only 12 issues. This number was increased to 20 in 1916 and to 30 on October 1, 1928.

The stocks included in these two Averages have been changed from time to time in order to keep the lists up to date and as nearly representative as possible of their respective groups. Only General Electric, of the present 30 industrial stocks, was included in the original Industrial Average, and that was dropped at one time (in 1898) and subsequently reinserted. In 1929, all stocks of public utility companies were dropped from the Industrial Average and a new Utility Average of 20 issues was set up; in 1938 its number was reduced to 15. The 20 rail, 30 industrial, and 15 utility stocks are now averaged together to make what is known as the Dow Jones Stock Composite.

The basic tenants of the Dow Theory are as under

The Dow Theory comprises six assumptions:

1. The Averages Discount Everything.

An individual stock's price reflects everything that is known about the security. As new information arrives, market participants quickly disseminate the information and the price adjusts accordingly. Likewise, the market averages discount and reflect everything known by all stock market participants.

2. The Market Is Comprised of Three Trends.

At any given time in the stock market, three forces are in effect: the Primary trend, Secondary trends, and Minor trends.

The Primary trend can either be a bullish (rising) market or a bearish (falling) market. The Primary trend usually lasts more than one year and may last for several years. If the market is making successive higher-highs and higher-lows the primary trend is up. If the market is making successive lower-highs and lower-lows, the primary trend is down.

Secondary trends are intermediate, corrective reactions to the Primary trend. These reactions typically last from one to three months and retrace from one-third to two-thirds of the previous Secondary trend.

Minor trends are short-term movements lasting from one day to three weeks. Secondary trends are typically comprised of a number of Minor trends. The Dow Theory holds that, since stock prices over the short-term are subject to some degree of manipulation (Primary and Secondary trends are not), Minor trends are unimportant and can be misleading.

3. Primary Trends Have Three Phases.

The Dow Theory says that the First phase is made up of aggressive buying by informed investors in anticipation of economic recovery and long-term growth. The general feeling among most investors during this phase is one of "gloom and doom" and "disgust." The informed investors, realizing that a turnaround is inevitable, aggressively buy from these distressed sellers.

The Second phase is characterized by increasing corporate earnings and improved economic conditions. Investors will begin to accumulate stock as conditions improve.

The Third phase is characterized by record corporate earnings and peak economic conditions. The general public (having had enough time to forget about their last "scathing") now feels comfortable participating in the stock market--fully convinced that the stock market is headed for the moon. They now buy even more stock, creating a buying frenzy. It is during this phase that those few investors who did the aggressive buying during the First phase begin to liquidate their holdings in anticipation of a downturn.

4. The Averages Must Confirm Each Other.

The Industrials and Transports must confirm each other in order for a valid change of trend to occur. Both averages must extend beyond their previous secondary peak (or trough) in order for a change of trend to be confirmed.

5. The Volume Confirms the Trend.

The Dow Theory focuses primarily on price action. Volume is only used to confirm uncertain situations.

Volume should expand in the direction of the primary trend. If the primary trend is down, volume should increase during market declines. If the primary trend is up, volume should increase during market advances.

6. A Trend Remains Intact Until It Gives a Definite Reversal Signal.

An up-trend is defined by a series of higher-highs and higher-lows. In order for an up-trend to reverse, prices must have at least one lower high and one lower low (the reverse is true of a downtrend).

When a reversal in the primary trend is signaled by both the Industrials and Transports, the odds of the new trend continuing are at their greatest. However, the longer a trend continues, the odds of the trend remaining intact become progressively smaller.

In a nutshell:-

An early key observation by Charles Dow was the interconnectedness of production and distribution in the economy, as reflected by his Industrial and Transportation averages. Both economic aspects had to be healthy for the overall market to go up—if this was the case, the averages would move in tandem or confirm each other's trend. If this was not the case there was a lack of confirmation or divergence between the two averages, signaling an upcoming downturn in the economy and in stock market prices, which reflect the economy. From this concept, other ideas emerged later that tied confirmation and divergence not only to each other but to various technical indicators, a key concept of technical analysis today.

Dow also was one of the first to describe the cyclical nature of market cycles, with their reoccurring patterns of accumulation and distribution of stocks, which was in turn associated to varying degrees of public enthusiasm or avoidance of stocks. He saw these patterns repeating over and over, which is a foundation of technical analysis and its rationale.

Dow was one of the first to describe the workings of human psychology and behavior as it applied to the stock market. As a student of human nature Dow always allowed for surprises, and history has borne him out. A reversal in the market's trend can occur any time after that trend has been confirmed by the other average. Even if you are concerned only with the major or primary trend and take an attitude that you are in the market for the long haul, it's also true that a major bull market can deteriorate or end relatively suddenly and shake up this thinking. Therefore, Dow's practical and hardheaded advice is not to get complacent and to continue to monitor and pay attention to how the averages are behaving. This advice is as valuable in 2010 as it was in 1900.

Dow made use only of closing prices as the only price history he considered important to study and keep—of course, daily price fluctuations were generally narrow during this era.

CONSTRUCTION OF THE HARTRANX

There are many methods of computing index, but to keep the study simple I have used the weighted index construction. The weights are assigned on the basis of market capitalization of the companies. The number of shares have been updated for ESOPS, bonus, private placements and all the other modes of raising equity which would raise the issued capital.

As we know, in India, we do not have a transport average, so for the study purpose, I have selected the leading listed companies engaged in transport and allied activities i.e. production of commercial vehicles as the growth of such companies depends on growth of transport companies.

Companies selected for construction of HARTRANX

1. Container Corporation Ltd.
2. All Cargo Ltd.
3. Gateway Distriparks Ltd.
4. TATA Motors Ltd.
5. EICHER Ltd.
6. Ashok Leyland Ltd.
7. Balmer Lawrie Ltd.
8. Mahindra & Mahindra Ltd.

The companies as and when listed (All Cargo and Gateway are newer companies) have been included in the index. For e.g. Gateway Distriparks Ltd. Got listed in 2005 and similarly All Cargo in 2006.

The weights of the companies are purely based on their market capitalizations which is arrived at by multiplying the closing price with the number of shares outstanding. I have used the closing prices because it is what was used by Charles Dow for his studies even.

The base value of index is 1000.

The index performance over past 10 years can be seen from the below chart

APPLICATION OF THE HARTRANX ON NIFTY

THE BEAR MARKET

From the above chart, we can see that, the HARTRANX had hit the highest level of 6009 while NIFTY was at 3850 levels on 11-12-2006 after which HARTRANX has constantly fallen whereas the NIFTY has constantly risen.

This indicated that the averages were diverging with each other. The HARTRANX was falling and market was moving up; which had signaled a turn in market trend. However, the market kept rising for next year to a high of 6357 on 08-01-2008.

The real sell signal came when the HARTRANX made a triple top between 5300 to 5240 levels.

TOP              Date                  HARTRANX Value

1             18-06-2007                        5273

2             06-09-2007                        5300

3             27-11-2007                        5247

Thus we can see that the divergence between the indices gave a valid signal. However, the main difficulty over here is, it is not possible to time and quantify the reversal.

After this, the markets collapsed to multiyear lows.

THE NEXT BULL MARKET?

From the above chart we can see that, the HARTRANX had started making higher bottoms from the final sell-off on 27-10-2008. The market closed at the low level of about 2585 on 27-10-2008 while the HARTRANX closed at 1930 which was 272 points higher than its low of 1658 as on 21-10-2008. Since then, the market kept languishing in the range of 3100 to 2600 while the HARTRANX kept moving northwards to 3040 as on 01-04-2009 where the market gave a breakout above the downward trend line. This confirmed the reversal in HARTRANX was valid and the accuracy of proof is shown by the market movement and the high on which it is today as compared to those 3100 levels.

At present, the HARTRANX after budget, is suggesting a gradual rise in the stock market index.

Thus we can see that, Dow Theory, which has its roots in 1900, is even today very useful for predicting the reversal of major trends in the stock markets.

About the Author

Thanks for visiting!