Dow Theory – Averages must confirm each other!
Finishing series of articles devoted to the Dow Theory, the last topic of this cycle will be an important theme of technical analysis – “Averages must confirm each other.” Earlier we considered such topics: The trend has three phases, The price discount everything and The trend is confirmed by volume.
Charles Dow based in his works mostly on his own index: industrial and transport, which later became DOW 30. He argued that the Dow Jones averages are consistent and the trend change must be confirmed by both averages. At the same time, the possibility of a single average to respond faster to a trend change was not excluded.
Nowadays, this theory is noticeably outdated, even with the importance of the DOW 30 index. At the same time, the very essence of the Dow theory remains relevant, especially if the indices (averages) are grouped according to some parameters and features. Thus, the indices of one sector of the economy are closely intertwined with each other and this does not require any evidence. Depending on the layout, they may be either more sensitive to various factors or less.
But it should be noted that the indices from different sectors of the economy are also coordinated. It is well seen in crises and recovery. Thus, the collapse of one sector of the economy will inevitably pull along itself and others that might seem very independent, which ultimately confirms the statement of the Dow Theory – averages must confirm each other. Even on a more general level, as it was described by Charles Dow.
For example, consider the dynamics of national stock indices in different countries, which include the value of shares of key companies in different countries and, moreover, these indices are traded alternately, responding to the time frame of the trading session.
The graph above shows an example of the unidirectional movement of such indices DOW 30 – the blue line, EuroStoxx 50 – the red line and the Nikkei 225 – the green line.
It demonstrate an unidirectional dynamics despite the difference in the number of included shares, geography and time frame. The difference is in a small movement, which can serve as a leading factor, as well as the influence of local factors.
General picture confirms the statement that averages must confirm each other. And the collapse or growth of one of the significant indices inevitably affects the entire market.
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