https://marketrealist.com/2014/12/whats-dow-theory A guide to technical indicators, Dow Theory, and Elliott Wave Theory By Gordon Kristopher Dec 03, 2014. 07:55 PM Technical analysis - technical indicators, Dow Theory, and Elliott Wave Theory Introduction In an earlier series, we discussed some concepts of technical analysis. These concepts included chart types, support and resistance, trends, and patterns. We saw how technical analysis concepts are important and how market participants use these concepts for trading and investing. In this series, we’ll discuss simple moving averages, technical indicators, the Dow Theory, and the Elliott Wave Theory. We’ll also look at technical indicators like the Moving Average Convergence Divergence (or MACD), the Relative Strength Index (or RSI), the stochastic process, and Bollinger Bands. We’ll discuss the importance and use of these technical indicators. These indicators are useful in determining trends and making informed decisions. Some traders combine two or more technical indicators along with patterns and moving averages for trend identification. This is also used for entry and exit points. Applying technical indicators
https://marketrealist.com/2014/12/whats-dow-theory You can apply these indicators and concepts to auto stocks like Ford Motors (F), General Motors (GM), Tesla Motors (TSLA), and Goodyear Tire (GT). These companies are part of exchange-traded funds (or ETFs) like the Consumer Discretionary Select Sector SPDR Fund (XLY). Understanding the simple moving average in technical analysis Simple moving average In technical analysis, the simple moving average (or SMA) is an average of the closing price of a stock over a specified number of periods. When the stock price changes, the moving average changes accordingly. The above chart shows the moving averages for Apple’s (AAPL) stock. For example, the stock’s five-day moving average is the average of the stock’s closing price for the last five days. As the moving average progresses, it drops the old data. The moving average smooths the short-term fluctuations in the stock prices. It allows us to identify a clear market trend. When the stock price increases, the short-term moving average crosses over the long-term moving average. When the stock price decreases, the long-term moving average crosses over the short-term moving average. This crossover indicates the change in the price trends. A simple moving average is also used as a stock’s support and resistance level. When a moving average is below the stock’s current market price, it can be used as a support level. When the moving average is above the stock’s current market price, it can be used as a resistance level. The crossover of two moving averages—like five-day and ten-day moving averages—is used by some traders as entry and exit points. When the five-day SMA crosses over the ten-day SMA, it’s
https://marketrealist.com/2014/12/whats-dow-theory used as an entry signal. When the ten-day SMA crosses over the five-day SMA, it’s used as an exit signal in an uptrend and vice versa in a downtrend. Applying SMA concepts SMA concepts can be applied to stocks like Anadarko Petroleum (APC), Apache Corp. (APA), Conoco Phillips (COP), and Chevron Corp. (CVX). All of these companies are part of the Energy Select Sector SPDR ETF (XLE). For more information on the companies mentioned above, visit the Market Realist Energy Commodities page. Interpreting volume in technical analysis Volume in the stock market In technical analysis, volume measures the number of a stock’s shares that are traded on a stock exchange in a day or a period of time. Volume is important because it confirms trend directions. The above chart shows the volume and stock price movement for Chevron’s (CVX) stock. When the stock price and volume increase, it shows that some fundamental or psychological factors are driving the stock price. An example of a fundamental factor is earnings news. The expectation of an increase in a stock’s price is an example of a psychological factor. When a stock’s price and volume increase, it indicates the buying interest in the stock. It shows the stock’s uptrend. When the stock price increases and volume decreases, it indicates traders’ indecision to buy the
https://marketrealist.com/2014/12/whats-dow-theory stock. The indecision arises when there aren’t any fundamental or psychological factors influencing the larger market participants. This means there’s a chance that the trend could change. When the stock price decreases and volume increases, it shows that some fundamental or psychological factors are driving the stock price. This indicates the selling interest in the stock. This also means that there could be a downtrend for the stock. When the stock price and volume decrease, it indicates traders’ indecision to sell the stock. The indecision arises when there aren’t any fundamental or psychological factors influencing more market participants. This implies there’s a chance that the trend could change. Volume and pattern are combined to identify the trend direction. Some traders use this combination for entry and exit signals. Applying volume concepts This volume concept can be applied to stocks like Ford Motors (F), General Motors (GM), Tesla Motors (TSLA), and Goodyear Tire (GT). These companies are part of exchange-traded funds (or ETFs) like the Consumer Discretionary Select Sector SPDR Fund (XLY). Technical indicators and the Relative Strength Index Introduction Technical indicators are useful for predicting stock trends’ direction. These indicators are derived by applying a formula to the stock price. The commonly used technical indicators are the Relative Strength Index (or RSI), stochastics, the Moving Average Convergence Divergence (or MACD), and Bollinger Bands. Relative Strength Index The RSI is a measure of a stock’s overbought and oversold position. The commonly used RSI is a 14-day RSI. It refers to the 14-day stock price that’s used to calculate the RSI. The number of days used to calculate the RSI can vary.
https://marketrealist.com/2014/12/whats-dow-theory The above chart shows the RSI and stock price movement for General Motors’ (GM) stock. The RSI calculation is shown below. RSI = 100-100/(1+RS*) *RS = Average gains/average losses For a 14-day RSI, the stock’s 14-day price movement is used to calculate average gain and loss. If the stock’s price increased for the first ten days and decreased for next four days, the stock’s price decreased. Average gain = sum of absolute gain in ten days/14 Average loss = sum of absolute gain in four days/14 The RSI moves between zero to 100 levels. It’s normalized using the formula RSI = 100- 100/(1+RS*). When the stock’s price decreases for 14 days in a row, the RSI will show zero values. It indicates that the stock is oversold. When the stock’s price increases for 14 days in a row, the RSI will show 100 values. It indicates that the stock is overbought. The level of 30 is considered oversold. The level of 70 is considered overbought. When the stock is oversold and at the support level, it could be used as an entry point. When the stock is overbought and at the resistance level, it could be used as an exit point. It isn’t recommended to use the RSI indicator alone for an entry and exit strategy. It’s advisable to use a combination of indicators and patterns for entry and exit signals.
https://marketrealist.com/2014/12/whats-dow-theory Applying RSI concepts RSI concepts can be applied to stocks like EOG Resources (EOG), Cabot Oil and Gas (COG), Devon Energy (DVN), and Chesapeake Energy (CHK). Most of these companies are part of the SPDR S&P Oil & Gas Exploration & Production ETF (XOP). Importance of the stochastic indicator in technical analysis Stochastic indicator The stochastic indicator compares the stock’s closing price with the stock’s price over a certain time period. In an uptrend, the stock price tends to close near its high. In a downtrend, the stock price tends to close near its low. The above chart shows the stochastic indicator for General Motors’ (GM) stock. Stochastic calculation The stochastic indicator moves between zero and 100 levels. A 14-day time period is commonly used. However, the number of days can be customized. The indicator has two lines—the %K line and the %D line. The %K line is the faster line. The %D is the slower line. %K = 100 (closing price – lowest price in the last 14 days)/(highest price in the last 14 days – lowest price in the last 14 days) and %D = average of the last three %K values calculated daily
https://marketrealist.com/2014/12/whats-dow-theory For the stochastic indicator, the level of 20 is considered oversold. The level of 80 is considered overbought. When the stock is oversold and at the support level, it could be used as an entry point. When the stock is overbought and at the resistance level, it could be used as an exit point. The stochastic indicator uses the stock’s relative closing prices to calculate the oversold and overbought levels. The Relative Strength Index (or RSI) uses the ratio of average gain and loss to calculate the overbought and oversold levels. An oversold level is 30 in RSI and 20 in stochastic. The overbought level is 70 in RSI and 80 in stochastic. Both indicators have minor differences. However, their functions are the same. They determine the stock’s strength. It isn’t recommended to use the stochastic indicator alone for an entry and exit strategy. It’s advisable to use a combination of indicators and patterns for entry and exit signals. Applying stochastic concepts In technical analysis, stochastic concepts can be applied to stocks like Duke Energy (DUK), Southern Company (SO), and American Electric Power Company (AEP). These companies are part of the Utilities Select Sector SPDR (XLU). XLU is a key exchange-traded fund (or ETF) in the power utilities industry. What's the Moving Average Convergence Divergence? What’s the Moving Average Convergence Divergence? The Moving Average Convergence Divergence (or MACD) was developed by Gerald Appel in the 1970s. The MACD is the difference between two moving averages. Calculating MACD The MACD consists of two lines—the fast line and the slow line. The fast line, or MACD line, is the (12-day exponential moving average) – (26-day exponential moving average). It’s important to note that an exponentially weighted average of a moving average is called an exponential moving average. The slow line is a nine-day exponential moving average. The slow line is also called the signal line.
https://marketrealist.com/2014/12/whats-dow-theory The above chart shows the MACD indicator for General Motors’ (GM) stock. MACD lines are plotted between the ranges of -1, zero, and one. The center line between -1 and one is called the zero line. When the MACD line crosses over the signal line and rises above the zero line, this indicates that the trend could change. When the signal line crosses over the MACD line and falls below the zero line, this indicates that the trend could change. When the MACD line crosses over a signal line, it’s an entry signal. When the signal line crosses over the MACD line, it’s an exit signal. When the stock price is making higher highs in an uptrend and the MACD line is making lower highs, it’s called bearish divergence. This suggests that the trend could change. When the stock is in a downtrend and making lower highs and the MACD line is making higher highs, it’s called bullish divergence. This means that the trend could change. Applying MACD concepts In technical analysis, MACD concepts can be applied to stocks like Murphy Oil (MUR), Whiting Petroleum (WLL), Continental Resources (CLR), and Pioneer Resources (PXD). All of these companies are part of the SPDR S&P Oil & Gas Exploration & Production ETF (XOP). In technical analysis, what are Bollinger Bands? Bollinger Bands Bollinger Bands are a channel of moving averages over stock prices. Bollinger Bands consist of three lines: 1. center line
https://marketrealist.com/2014/12/whats-dow-theory 2. upper line 3. lower line The upper line moves above the stock price. The lower line moves below the stock price. The center line moves between the two lines. The above chart shows the Bollinger Bands for General Motors’ (GM) stock. Calculating Bollinger Bands Center line = 20-day simple moving average (or SMA) Upper line = 20-day SMA + (20-day standard deviation of price multiplied by two) It’s important to note that standard deviation is a measure of volatility. Lower line = 20-day SMA – (20-day standard deviation of price multiplied by two) Bollinger Bands are combination of a stock’s moving averages. When a stock’s volatility increases, the moving average channel expands. When volatility decreases, the channel tightens. The expanding and tightening indicate a trend change. When the stock’s price falls to the lower channel of the Bollinger Band and trades at the support level, it could be used as an entry point. When the stock’s price reaches the upper channel of the Bollinger Band and trades near the resistance level, it could be used as an exit point. When the stock’s price trades near the upper or lower channel of the Bollinger Bands, this
https://marketrealist.com/2014/12/whats-dow-theory indicates that the stock is overbought and oversold. Bollinger Bands shouldn’t be used as a single indicator for determining the trade. Bollinger Bands, combined with other indicators and patterns, are useful for entry and exit points. Applying Bollinger Bands’ concepts Bollinger Bands’ concepts can be applied to stocks like Ford Motors (F), General Motors (GM), Tesla Motors (TSLA), and Goodyear Tire (GT). These companies are all part of exchange-traded funds (or ETFs) like the Consumer Discretionary Select Sector SPDR Fund (XLY). What's the Dow Theory? The Dow Theory The Dow Theory was developed by Charles Dow. It identifies and signals the change in stock market trends. It’s useful for trading and investing. The Dow Theory has six components: 1. The markets have three basic movements. 2. The market trends have three phases. 3. Stock prices reflect all news. 4. Financial market indexes should agree with each other. 5. Market trends should be confirmed by volume. 6. Market trends reverse after giving strong signals. The markets have three basic movements. The movements include: 1. Primary trend 2. Secondary trend 3. Minor trend The major market movement is called as the primary trend. The medium movement is called the secondary trend. The smallest movements are called the minor trend. The primary trend can last from many months to many years. The secondary trend ranges from ten days to three months. The minor trend ranges from a few hours to one month. The market trends have three phases. The phases are: 1. Accumulation phase 2. Public participation phase 3. Distribution or panic phase All of these phases occur in the uptrend and downtrend.
https://marketrealist.com/2014/12/whats-dow-theory The above chart shows the three phases of the market trend for Goldman Sachs’ (GS) stock. In the accumulation phase, investors buy or sell stocks. This accumulation happens during the beginning of an uptrend or downtrend. In the public participation phase, the fundamental news starts to impact the stock prices. In this phase, more investors participate. They drive the stock price higher in an uptrend and lower in a downtrend. In this phase, there’s volatility in the stock prices. This phase happens in the middle of an uptrend or downtrend. In the distribution phase, all of the prices have peaked or bottomed. During this phase, more investors sell in an uptrend and buy in a downtrend. There’s consensus in the market that the stock price is trading above or below its fundamental valuation. The Dow Theory’s concepts will be discussed in the next part of this series. Applying the Dow Theory The Dow Theory can be applied to stocks like Chesapeake Energy Corporation (CHK), Cabot Oil & Gas Corporation (COG), Devon Energy Corporation (DVN), and Southwestern Energy (SWN). Many of these stocks are part of energy exchange-traded funds (or ETFs) like the Energy Select SPDR ETF (XLE). Why it's important to understand the Dow Theory Why the Dow Theory is important One of the components in the Dow Theory is that stock prices reflect all news. The stock market
https://marketrealist.com/2014/12/whats-dow-theory reacts to the fundamental news. As soon as the information is available in the market, the information is reflected in the share prices. The Dow Theory assumes that when a stock market is entering an uptrend or downtrend, the financial markets should agree with each other. The average of the indexes—like the industrial average or railroads’ average—should confirm each other in the same direction. It means when the economy is improving, the industry’s profit will increase because of the increased consumption. So, rail transportation would also increase because of the increased consumption. Both of the index averages would be in the same direction. As a result, the stock indexes confirm the trend direction. The above chart shows volume and stock price movement for Chevron’s (CVX) stock. When a stock is entering an uptrend or downtrend it should be confirmed by the rise in the stock’s volume. If the stock’s volume is low, the direction of the stock trend can’t be confirmed. When the volume and stock price increase, this indicates more investors are driven by fundamental or psychological factors. It shows that the stock price will increase. This confirms the trend directions. When market trends reverse after giving strong signals, the stocks will continue to be in an uptrend or downtrend. The stock prices will have a minor correction. The correction doesn’t mean that the trend changed. The stock price declined enough to confirm that the trend changed. Conclusion The Dow Theory is useful for understanding technical analysis. It’s also useful for trading strategy. The economy and indexes changed compared to the Dow Theory’s period. The Dow Theory is useful for trend identification. It’s also useful for entry and exit signals.
https://marketrealist.com/2014/12/whats-dow-theory Applying the Dow Theory The Dow Theory can be applied to stocks like Ford Motors (F), General Motors (GM), Tesla Motors (TSLA), and Goodyear Tire (GT). These companies are all major parts of exchange-traded funds (or ETFs) like the Consumer Discretionary Select Sector SPDR Fund (XLY). What's the Elliott Wave Theory? Introduction to the Elliott Wave Theory The Elliott Wave Theory was developed by R.N. Elliott in the 1930s. The theory proposed that market trends moves in repeated cycles. The cycles are classified based on how long they last. The cycles include: Grand Super cycle – This is the longest wave. It takes place over many centuries. Super cycle – This wave lasts for many decades. It lasts ~40–70 years. Cycle – This wave lasts from one to several years. Primary – This wave last for a few months to a couple of years. Intermediate – This wave lasts for a few weeks to a few months. Minor – This wave lasts for a few weeks. Minute – This wave lasts for a few days. Minuette – This wave lasts for a few hours. Subminuette – This wave lasts for a few minutes. A cycle has two phases: Impulsive phase Corrective phase
https://marketrealist.com/2014/12/whats-dow-theory The above chart shows two phases of the Elliott Wave for Home Depot’s (HD) stock. The impulsive wave is shown in the above chart. It consists of five waves. It forms higher highs in the uptrend and lower highs in downtrend. The corrective wave is shown in the above chart. It consists of three waves. It forms lower highs in an uptrend and higher highs in a downtrend. We’ll discuss the psychology behind the Elliott Wave Theory in the next part of this series. Applying technical analysis concepts The technical analysis concepts can be applied to stocks like Cabot Oil & Gas (COG), Concho Resources (CXO), EOG Resources Inc. (EOG), and Laredo Petroleum (LPI). These companies are part of the S&P Oil & Gas Exploration & Production ETF (XLE). Why is the Elliott Wave Theory important in technical analysis? Importance of the Elliott Wave Theory In the last part of this series, we provided an overview of the Elliott Wave Theory. In this part of the series, we’ll discuss the psychology behind the Elliott Wave Theory’s two phases—the impulse phase and the corrective phase.
https://marketrealist.com/2014/12/whats-dow-theory The above chart shows the entry and exit signal for Home Depot’s (HD) stock. It used the Elliott Wave Theory. In the impulsive phase, wave 1 forms at the beginning of an uptrend. In this phase, the stock price rises due to psychological factors—like investors expecting a change in trend or hedge funds buying at market bottoms. The fundamental news is negative during this period. All stock market forecasts are negative. This negative sentiment causes the stock price to fall. This forms wave 2. Wave 2 doesn’t fall below the beginning of wave 1. Wave 3 forms when stock market news is positive and the trend rises. In wave 4, stock prices fall due to profit booking. Wave 5 is formed when stock news is positive and investor optimism is high. In the beginning of the corrective phase, it’s difficult to predict that the market trend has stopped. The stock price starts dropping due to correction. This phase is called wave A. In wave B, the stock price increases on the anticipation that the long uptrend is still there. Wave C is formed when stock market news is negative and a downtrend is confirmed. The Elliott Wave Theory is used to identify the trend direction. It’s also used to identify entry and exit points for investing in stock markets. Applying technical analysis concepts The technical analysis concepts can be applied to stocks like Ford Motors (F), General Motors (GM), Tesla Motors (TSLA), and Goodyear Tire (GT). These companies are all major parts of exchange-traded funds (or ETFs) like the Consumer Discretionary Select Sector SPDR Fund (XLY). What are the advantages of technical analysis?
https://marketrealist.com/2014/12/whats-dow-theory Advantages of technical analysis In this part of the series, we’ll discuss the advantages of technical analysis. This is useful for trading strategy. Market news reflects the stock prices The stock price is a reflection of all fundamental news. The crowd market psychology is identified using the patterns. It’s used for price forecasting. This helps investors make informed investment decisions. Trend identification The direction of the stock market trend is identified using technical analysis. The stock may be in an uptrend, a downtrend, or a sideways trend. The trend direction is useful when you’re investing and trading in stock markets. Entry and exit recommendations Entry and exit strategy is recommended for short and long-term trading in technical analysis. Fundamental analysis is used for the long-term entry and exit point. When fundamental news is available in the market, the stock price already changed. Some traders use a combination of trend indicators, patterns, volume, and moving averages to determine the entry and exit point. The above chart shows the entry and exit signal for IBM’s (IBM) stock. In the above chart, the stock breaks above resistance. So, entry is suggested. Trendline resistance is used to determine the target level.
https://marketrealist.com/2014/12/whats-dow-theory Applying technical analysis concepts The technical analysis concepts can be applied to stocks like Cabot Oil & Gas (COG), Concho Resources (CXO), EOG Resources Inc. (EOG), and Laredo Petroleum (LPI). These companies are part of the S&P Oil & Gas Exploration & Production ETF (XLE). What are the disadvantages of technical analysis? Disadvantages of technical analysis In this part of the series, we’ll discuss the disadvantages of technical analysis. This is useful for trading strategy. Technical indicators’ mixed signals In some cases, one of the technical indicators will show a buy signal and another indicator will show a sell signal. This causes confusion in trading decisions. This is one of the disadvantages of technical analysis. So, some traders use a combination of technical indicators, patterns, volume, and moving averages to determine the entry and exit point. Accuracy Technical analysis is used to forecast stocks. All of the technical indicators give possible entry and exit points. The forecasting accuracy isn’t 100%. For example, when a possible entry or exit point for a stock is suggested, it doesn’t guarantee a successful trade. Stock may decrease after the entry. Stock can also rise after the exit. Biased opinion One technical analyst’s opinion may contradict another analyst’s opinion for the same stock. The technical methods that are used to analyze stocks can vary from one analyst to another.
https://marketrealist.com/2014/12/whats-dow-theory The above chart shows entry and exit points for Intel’s (INTC) stock. The chart shows two trading strategies. The strategies are by two different technical analysts. The stock is trading in the range. So, an analyst suggested entry 1 and exit 1 points anticipating rangebound stock price movement. Another analyst, anticipating breakdown, suggested entry 2 and exit 2 points. This is one of the disadvantages of technical analysis. Applying technical analysis concepts The technical analysis concepts can be applied to stocks like Cabot Oil & Gas (COG), Concho Resources (CXO), EOG Resources Inc. (EOG), and Laredo Petroleum (LPI). Some of these companies are part of the S&P Oil & Gas Exploration & Production ETF (XLE). Must-know: A glossary of technical analysis terms A glossary of technical analysis terms In technical analysis, there are a series of common terms. Understanding the glossary of technical analysis terms is helpful for investors. Technical analysis is used to predict stock prices. It uses price, time, and volume data. Line chart – A single line that connects stock prices is called a line chart. Bar charts – A chart that has open, high, low, and close data sets in a vertical line in the form of a bar. It’s also referred to as an open-high-low-close (or OHLC) chart. Candlestick charts – A chart that has open, high, low, and close data sets in a candle form.
https://marketrealist.com/2014/12/whats-dow-theory Support – A straight line that connects three or more of a stock’s data points. It usually indicates the stock is going down. Resistance – A straight line that connects three or more of a stock’s data points. It usually indicates the stock is going up. Trend – The directional movement of a stock price. Uptrend – Stocks are in an uptrend when they’re making higher highs and higher lows. Downtrend – Stocks are in a downtrend when they’re making lower highs and lower lows. Sideways trend – Stocks that trade in a range are in a sideways trend. Patterns – Price patterns are trends that occur in stock charts. The patterns form recognizable shapes. Triangle pattern – The pattern is in the form of a triangle. Rectangle pattern – The pattern that’s formed when stock trades sideways. Head and shoulder pattern – A reversal pattern that has three consecutive peaks. Double top and bottoms – Two consecutive peaks between two horizontal lines is called double top. Two consecutive bottoms between two horizontal lines is called double bottom. Triple top and bottoms – Three consecutive peaks between two horizontal lines is called triple top. Three consecutive bottoms between two horizontal lines is called triple bottom. Simple moving average – An average of the closing price of the stock over a specified number of periods. Volume – The measure of the number stock’s shares traded on the stock exchange in a day or a period of time. Relative Strength Index – The Relative Strength Index (or RSI) is a measure of the overbought and oversold position of a stock.
https://marketrealist.com/2014/12/whats-dow-theory The above chart shows entry and exit for IBM’s (IBM) stock. Entry is given for stock after the resistance breakout. The target is given at the next resistance level. Stochastic indicator – An indicator that compares the closing price of the stock with the stock price over a given time period. Moving Average Convergence Divergence – Moving Average Convergence Divergence (or MACD) is the difference between two moving averages. Bollinger Bands – Bollinger Bands are a channel of moving averages over the stock prices. Applying technical analysis concepts The technical analysis concepts can be applied to stocks like Ford Motors (F), General Motors (GM), Tesla Motors (TSLA), and Goodyear Tire (GT). These companies are all major parts of exchange-traded funds (or ETFs) like the Consumer Discretionary Select Sector SPDR Fund (XLY). Visit the Market Realist Technical Analysis page to learn more.