Spotting the 2007 Financial Crisis Crash & Recovery Using Dow Theory
Using a mix of Dow Theory and the right indicators it is possible to understand the current character of the market. On TV and in newspapers stock market pundits and supposed “gurus” are always looking to give you their opinion. But who should you believe.? I think you should form your own opinion.
This article will show you one of the ways to form a hypothesis about the market based on solid Technical Analysis.
Dow Theory Has 5 Tenets To Assess The Market.
Tenet 1. The market discounts everything.
As soon as news is made available to the market it should discount (or appreciate) the prices accordingly.
Tenet 2. The market has 3 trends
- Primary Trend – Lasts from months to years
- Secondary Trend – Lasts from weeks to months
- Minor Trend – Lasts from days to weeks – Charles Dow holds that minor trends can be random but the other 2 trends are parts of a cyclical trend.
Tenet 3. The Primary trend has 3 phases
- Phase 1 – Accumulation. The far-sighted investors who have seen a potential recovery
- Phase 2 – Public Participation. Company earnings are proving good and the general public starts to participate
- Phase 3 – Distribution. Far-sighted investor start to sell as they see Stock Price growth is unsustainable in comparison to company earnings or economic climate.
Tenet 4. The averages must confirm.
Using the Dow Jones Industrial Average and the Dow Jones Transports, both must be in sync to have a solid trend. When both head down this is the start of a bear market for example.
Tenet 5. Market Action.
Volume is important and a market moving up on increasing volume is healthy. A market moving down on increasing volume is a warning sign.
The Chart below (a historical example) shows the Dow Jones 30, the Dow Jones Transports and the S&P500, side by side in a line chart.
Also, I have included Chaikin Money Flow, Volume, and the DMI ADX indicator. Important indicators for us to form our opinion.
Forming Your Opinion on Market Direction.
Take some time to evaluate the chart, form your opinion and then read the explanation of what is happening.
Price. In the upper part of the chart, we can see that all three indexes were confirming each other in a downtrend in 2007. From October 2007 the DJ-20 tried to drive a rally but the S&P 500 and DJ-30 continued to fall. This should have made you suspicious of the rally.
The Transports DJ-20 (Blue Line) then fell the hardest in mid-2008.
The recovery started to take shape in 2009 and we got confirmation of this in November 2009 when all 3 indices were confirming the move up through the line of resistance.
Volume. Since the market bottom in March 2009 stocks have recovered but volume has been decreasing. this trend continued for the next 6 years as my independent investors refused to re-enter the market after being burned so badly in this crash.
Money Flow. Chaikin Money Flow is a great indicator as it utilizes both price and volume. It has an excellent ability to contradict price and give early warning signals. Watch this closely. It took a significant hit in the last 4 weeks but is showing signs of a recovery. If this continues down when the price is increasing on lower volume this is a warning sign.
ADX Average Directional Index. ADX between 20 and Zero suggests that a trend (either up or down) is stalling and there may be a sideways consolidation or a change in direction. Here we see ADX registering at 28 which signifies a weaker trend however it is still an uptrend.
The market has made a magnificent recovery since 2009. The market has already undergone the accumulation phase of the new Bull Market
Now in 2018, we are seeing the public participation phase occurring contributing to a great Bull Market.
The only question left is when will the next distribution phase occur?
See the article on Stock screening to help you find those stocks.
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