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Dow Theory

Terminology

Market Capitalization

Market capitalization (or market cap) is simply the stock price of a company multiplied by the number of shares outstanding. The shares outstanding are the shares that are currently owned by the stockholders.

Speculator

A Speculator is a stock investor who buys shares in small companies which have the potential to significantly improve their financial position. Alternatively speculators buy stocks without consideration to the company's financial position and focus solely on the stock price. Speculation is generally a high risk strategy that can also be extremely profitable. Speculators are primarily interested in short-term capital gains and usually only hold their positions for short time periods.

Dow Jones Industrial Average

This index (which is commonly referred to as the Dow) is the most widely followed index for tracking market activity and consists of the largest 30 stocks listed on the NYSE and NASDAQ.

Charles Dow and the Averages

Dow Theory - Charles Dow and the Averages; picture of a financial newspaper with the stock market page showing stock prices and a cup of coffee placed on the table for the investor to drink

The Dow Jones Industrial Average (more commonly known as the DOW) is the most famous and widely quoted market index not just in the U.S. but throughout the world. The DOW was formed in 1896 by Charles Dow and Edward Jones who also founded the Wall Street Journal. The DOW was however not the first index formed by Charles Dow, as the first Average he formed was in 1884 and consisted of 11 stocks which also included railroad stocks.

In 1896 Charles Dow split the original Average of 11 stocks into two categories, Industrials and Railroads. Charles Dow expanded the number of stocks and included 12 stocks in the Industrials Average.

In 1916 DOW Industrials was increased to include 20 stocks and in 1928 the list was again expanded to include 30 stocks which is the current number of stocks today. The Dow Jones Utility Average was not formed until 1929. The Railroad Average is now referred to as the Transportation Average and includes other transport based stocks such as airlines.

Unlike indices where the stock prices are weighted by market capitalization, the DOW Averages are simple arithmetic averages of the stock prices.

The DOW Industrials is by far the most popular average, the other two Averages constructed by Dow and Jones are the Dow Jones Transportation Average and the Dow Jones Utility Average. Both of these have nowhere near the following and are almost totally ignored by the financial press. When the financial press reports on the DOW they are specifically referring to the DOW Industrials. The DOW industrial index is closely followed by stock investors and especially stock speculators.

The Dow industrial index is the most

widely followed index in the world

Charles Dow was the editor of the Wall Street Journal and he regularly published articles which documented his observations and view of the stock markets performance (which was the New York Stock Exchange).

The Dow Jones Averages were included in The Wall Street Journal along with Charles Dow's articles describing his ideas. The Averages along with the articles provided their readers with a better understanding of the stock price movements and specifically the movements in the value of their portfolios.

Prior to Charles Dow's articles there was no real information available which rationalized the behavior of stock prices yet alone explained why stock portfolios would fluctuate the way they do. Charles Dow's articles provided the foundation for modern day technical analysis. While candlestick charting (which was an early form of market price analysis) existed prior to Charles Dow's writings, it was not known outside of Japan were it originated from.

The ideas Charles Dow's presented in his articles provided a fair amount of insight into the stock markets behavior and his most famous articles ultimately became known as the Dow Theory.

After the death of Charles Dow's in 1902, Samuel Nelson who was a friend of Charles Dow published the book The ABCs of Stock Speculation in which he named the work performed by Charles as the Dow Theory. Thus the ideas presented by Charles Dow were now known as a theory.

William Peter Hamilton who was Charles Dow's successor as editor continued to publish articles about Dow's ideas in the Wall Street Journal up until 1929. He also published a book The Stock Market Barometer in 1922 about Dow's theory.

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