in the history of capital markets You have learned that the capital market, also known as the stock market, has existed in the world for hundreds of years. It is therefore not surprising that the theory of capital markets has been around for a long time. One of them is the star theory.
Understanding the Dow Theory
The Dow Theory is a collection of capital market theories coined by Charles H. Dow in his 255 writings in the Wall Street Journal from 1851-1902. During his lifetime, Charles H. Dow was the founder of the newspaper and Founder of Dow Jones & Company, Inc. and the Dow Jones Indices (DJIA).
Although his writings are over 100 years old, this theory is still being studied today. The reason is that Charles H. Dow’s writings were still developed by scientists after him, especially William P. Hamilton, Robert. Rhea, E. George Schaefer and Richard Russell.
This theory has become one of the basic theories a trader must learn if he wants to apply technical analysis in the stock market. This theory is becoming more and more important. This is because technical analysis is currently used not only in the capital markets, but also in forex and cryptocurrencies.
The six principles of the star theory
Here are the 6 principles of the Dow Theory Strategy, identified by the scientists who developed the above theory:
1. The capital market is efficient.
First of all, the Dow principle is that capital markets are efficient.stock market price all newsEfficiency here means that the capital market supports all data as soon as the data is reported (complete information).
This is indirectly demonstrated by Charles H. Dow’s belief that stock price movements directly describe the state of a country’s economy. Because if there is bad information about the country’s economy. The share price in that country will immediately fall. and vice versa
There are several criticisms of this principle:
- Capital markets do not support news completely and quickly. It is not uncommon for a new company’s share price to go up a day or two after bad news about the company is released.
- This assumption goes against the human personality factor (behavioral economics). Not all people respond to economic news and have the same strategy. This makes the capital market conditions in Indonesia different from the United States in terms of response to changes in interest rates.
In addition to the above criticisms Market performance assumptions lead experts to formulate risk management and interest rate formulas on investments, such as calculating net present value (NPV). Weighted Average Cost of Capital (WACC) and many others.
2. Market trends can be divided into 3 types.
The first type is a long-term trend (main trend) at 1-3 years old, medium-term trend. (Medium swing/minor movement) lasting 3 weeks to 3 months, and minor trends up to 3 weeks.
Medium-term price movements can be in the same direction or opposite to the long-term price trend. (main trend) Likewise The price action in the minor trend can be in the same direction or opposite to the middle and main trend swings.
3. The trend of price movements in the market is divided into 3 phases.
Dow believes that the trend of price movements in the stock market can be divided into 3 phases:
- collection processThe cumulative phase is the phase at which investors begin to buy stocks and begin to receive the cumulative share price increase. The price increase is not large because the investors who buy these stocks are still a minority. (The number is not large)
- public participation platformAs stock prices began to rise, more and more early non-investors were now buying more and more stocks.
- beyond the range. At this stage, the share price will continue to rise. A smart investor who knows this condition will start selling shares to the public and making a profit.
- Distribution process. At this stage, profitable investors begin to sell their shares to the public. As a result, the supply of these financial instruments increased. If the number of requests is not enough from now on price will be pushed down
- public participation platform. Seeing the price starting to drop due to investors making profits Other investors began to follow suit. Either take profits or cut losses. As a result, selling pressure has increased and the associated share price has decreased.
- panic stageAt this stage, there are investors who cut losses more than those who take profits for fear that the associated share price will fall further.
4. Stock indices are correlated.
To understand the principles of the Dow theory in this regard. You need to know the type of product in relation to other products. Types of goods according to their relationship with other goods are divided into two categories: substitute goods (substitute) and supplementary goods (additional goods).
The demand for substitutes will increase if the price of major commodities increases. For example, rice and corn are ingredients of human food. If the price of rice increases The demand for corn will also increase. An increase in the price of ancillary goods will lead to a decrease in demand for the main product. For example, fuel and motor vehicles. If the price of oil rises The demand for motor vehicles will decrease.
already? How does this relate to stock indices? Simply put, a change in the price of one stock index affects another. If both indexes consist of companies producing related products
For example, fuel produced by companies at IDXEnergy and vehicles produced by IDX Transportation. If oil prices rise, the value of IDXEnergy may increase due to the increased revenue and the value of IDX Transportation. will decrease due to lower sales
5. The trading volume confirms the trend.
share price trend driven by demand and supply Trading volume is a variable that shows how much supply and demand there is. The greater the number of demand and supply The stronger the trend (the stronger the volume), the stronger the trend is.
An application of this principle is breakout theory. breakout What happens to an asset is true and becomes a pattern of continuation of the trend if supported by sufficient trading volume. It is possible to signal a reversal if there is not enough trading volume.
6. The trend will continue until there is a clear reversal signal.
In the discussion of the second paragraph above You can see that trends fall into three categories: long-term trends. medium term trend and short-term trends Medium-term trend movements will not affect long-term trend movements without clear reversal signals. in the same way Short-term trend movements will not affect the medium-term trend without a clear reversal signal either.