Dow theory

The Dow theory on stock price movement is a form of technical analysis that includes some aspects of sector rotation. The theory was derived from 255 Wall Street Journal editorials written by Charles H. Dow (1851–1902), journalist, founder and first editor of The Wall Street Journal and co-founder of Dow Jones and Company. Following Dow's death, William Peter Hamilton, Robert Rhea and E. George Schaefer organized and collectively represented Dow theory, based on Dow's editorials. Dow himself never used the term Dow theory nor presented it as a trading system.

The six basic tenets of Dow theory as summarized by Hamilton, Rhea, and Schaefer are described below.

Alfred Cowles in a study in Econometrica in 1934 showed that trading based upon the editorial advice would have resulted in earning less than a buy-and-hold strategy using a well diversified portfolio. Cowles concluded that a buy-and-hold strategy produced 15.5% annualized returns from 1902–1929 while the Dow theory strategy produced annualized returns of 12%.

After numerous studies supported Cowles over the following years, many academics stopped studying Dow theory believing Cowles's results were conclusive. In recent years however, Cowles' conclusions have been revisited. William Goetzmann, Stephen Brown, and Alok Kumar believe that Cowles' study was incomplete and that W.P. Hamilton's application of the Dow theory from 1902 to 1929 produced excess risk-adjusted returns . Specifically, the return of a buy-and-hold strategy was higher than that of a Dow theory portfolio by 2%, but the riskiness and volatility of the Dow theory portfolio was lower, so that the Dow theory portfolio produced higher risk-adjusted returns according to their study.

On the 160th anniversary of Charles Dow's Birthday, Jack Schannep of TheDowTheory.com, delivered a speech to the Market Technicians Association, describing recent contributions to the Evolution of the Dow Theory and showed that traditional Dow Theory gives a total annualized return, from 1953 until 2011, about 1.5% per year greater than Buy and Hold.

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