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Charles Dow and his partner Edward Jones founded Dow Jones & Company in 1882. Most technicians and students of the markets concur that much of what we call technical analysis today has its origins in theories first proposed by Dow around the turn of the century. Dow published his ideas in a series of editorials he wrote for the Wall Street Journal. Most technicians today recognize and assimilate Dow's basic ideas, whether or not they recognize the source. Dow Theory still forms the cornerstone of the study of technical analysis, even in the face of today's sophisticated computer technology, and the proliferation of newer and supposedly better technical indicators.
On July 3, 1884, Dow published the first stock market average composed of the closing prices of eleven stocks: nine railroad companies and two manufacturing firms. Dow felt that these eleven stocks provided a good indication of the economic health of the country. In 1897, Dow determined that two separate indices would better represent that health, and created a 12 stock industrial index and a 20 stock rail index. By 1928 the industrial index had grown to include 30 stocks, the number at which it stands today. The editors of The Wall Street Journal have updated the list numerous times in the ensuing years, adding a utility index in 1929. In 1984, the year that marked the one hundredth anniversary of Dow's first publication, the Market Technicians Association presented a Gorham-silver bowl to Dow Jones & Co. According to the MTA, the award recognized“the lasting contribution that Charles Dow made to the field of investment analysis. His index, the forerunner of what today is regarded as the leading barometer of stock market activity, remains a vital tool for market technicians 80 years after his death.”
Unfortunately for us, Dow never wrote a book on his theory. Instead, he set down his ideas of stock market behavior in a series of editorials that The Wall Street Journal published around the turn of the century. In 1903, the year after Dow's death, S.A. Nelson compiled these essays into a book entitled The ABC of Stock Speculation. In that work, Nelson first coined the term“Dow's Theory.”Richard Russell, who wrote the introduction to a 1978 reprint, compared Dow's contribution to stock market theory with Freud's contribution to psychiatry. In 1922, William Peter Hamilton (Dow's associate and successor at the Journal) categorized and published Dow's tenets in a book entitled The Stock Market Barometer. Robert Rhea developed the theory even further in the Dow Theory (New York: Barron's), published in 1932.
Dow applied his theoretical work to the stock market averages that he created; namely the Industrials and the Rails. However, most of his analytical ideas apply equally well to all market averages. This chapter will describe the six basic tenets of Dow Theory and will discuss how these ideas fit into a modern study of technical analysis. We will discuss the ramifications of these ideas in the chapters that follow.