Smiling proudly at the stock futures exchange, smashing Wall Street! Hello everyone, welcome to the Technology Paradise, I am Lao Zou, the owner of the park. In the last class, we described the six principles of Dow Theory; by now, everyone should have a clearer understanding of Dow Theory, and know the magic of this theory, right? But in fact, there are different voices on the Dow Theory in the market, so why?
For those who believe in Dow theory or "follow the trend", the most difficult thing is to have the ability to clearly distinguish the minor adjustments that are common in the general trend from the first round of the new trend that turns around and reverses. Regarding what kind of situation is the real reversal signal, this point is still controversial among the trend-followers. The left and right of Figure 1 are exhaustion patterns, showing two patterns. In the left panel of Figure 1, we notice that the rise at point c failed to reach the height of the adjacent previous peak at point A, after which the price turned around and fell below the level of the previous trough at point B. In this case, there are two successively descending peaks and two successively descending troughs, indicating that point s is a clear sell signal when the previous low, B, is broken. This reversal pattern is often referred to as a "burnout".
Figure 1: The graphs of "destroyed after a setback" and "extremely reversed"
In the right panel of Figure 1, we notice that the high point reached by this round of upswing has broken the previous peak point A, and then the price slipped through the previous low point B. Although at s1 the support at price B has clearly broken down, some Dowists do not consider this a good signal to sell on the grounds that there are only successively lower lows but no successively lower highs. They would rather see that the price returns to point E again and is unable to reach the height of point c, and then after the subsequent jump below point D, they think that point s2 at this time is a real sell signal. Because there are both successively descending peaks and successively descending valleys here. The reversal pattern shown in the right diagram of Figure 1 is called "extreme opposite". The "sluggish" pattern shown on the left is much weaker than the "extremely reversed" pattern.
In fact, the Dow Theory has been successful in identifying major bull and bear markets for many years. But even so, it can hardly escape the rigor of perfection. Probably the most common criticism is that the signal comes too late. Usually a Dow Theory buy signal occurs during the second phase of an uptrend, when the market breaks above the first peak off the bottom. Generally, we miss about 20% to 25% of the total price change in the new trend before the signal occurs. By the way, most trend-following technical systems also confirm and invest in new trends at this time.
This criticism is probably familiar to those who follow the trend. Remember, the Dow Theory is never an attempt to get ahead of trends, but rather to reveal the arrival of a major bull or bear market in time. Based on the existing record, its performance in this area should be said to be quite good. According to Barron's statistics, from 1920 to 1975, Dow Theory successfully revealed 68% of all large movements in the industrial and transportation stock indexes and 67% of the large movements in the S & P 500 index.
As in the spirit of most trend-following system designs, the Dow Theory aims to capture the greatest intermediate stages of important market movements. In this sense, the above criticism is untenable. On the other hand, this censure itself shows a lack of understanding of trend-following theory by its critics. In essence, there is no trend-following system trying to catch bottoms or tops, because those who want to buy bottoms or tops rarely get their way.
There is also the age-old accusation that no one can really buy or sell averages, and that Dow Theory says nothing about which stocks to buy or which to sell. But now that the stock index futures have already been listed, investors can indeed "buy and sell the index" wholeheartedly without caring about individual stocks; with the increasing popularity of the stock index, perhaps the Dow Theory can serve as a more powerful tool for the technical analysis of foreign exchange futures in the future tool.
Dow Theory is certainly not infallible. Sure, it had its bad days of false signals; however, any good signaling system in this world has its flaws and deficiencies. You know, Dow didn't even intend to use his theory to predict the direction of the stock market. Its real value, he felt, lay in using the direction of the stock market as a barometer of general business activity. Dow's insight was amazing. Not only did he lay the foundation for the forecasting methods we use everywhere today, but he even realized at that time that the stock price index is a good leading indicator of the economy.
Well, so far we have briefly outlined the more important aspects of Dow Theory. As you progress through this course, you will fully appreciate that an understanding and acceptance of Dow Theory can provide a solid foundation for studying technical analysis. At the same time, it will become increasingly clear to you that the content explained in the following chapters represents various developments in Dow Theory, such as the standard definition of the concept of trend, the division of three types of trends and three stages of trends, the principle of mutual verification and mutual divergence The principles, interpretation of trading volume, and usage of percentage retracement are all derived from Dow Theory.
Before concluding the discussion of Dow Theory, we must also point out that although most of the content of Dow Theory has certain applications in the foreign exchange futures market, there are also some important differences. For example, Dow believes that most investors only focus on major trends, while medium adjustments are used as timing choices for entering the market, and short-term trends are ignored. Obviously, this is not the case in the foreign exchange futures market.
The vast majority of foreign exchange futures traders are chasing intermediate trends rather than major trends. Small price fluctuations are extremely important for timing. That said, in a moderate uptrend expected to last several months, trend followers take advantage of brief dips in price to buy. And in a moderate downtrend, brief price rallies are good opportunities to sell. In this way, short-term trends are extremely important in foreign exchange futures trading. Many short-term investors open and close positions in a very short period of time, and they are more committed to grasping intraday price changes.
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