WHICH STOCK TRADING THEORY WORKS?
“Too many cooks
spoil the broth.” “Two heads are better than one”.
“Clothes make the man.” “Don't judge a book by
its cover.”
“The more the
merrier.” “Two's company, three's a crowd.”
In today's
information age, there seems to be too much information out there and many
opportunities to get overloaded or just plain confused. The key is to decide
when certain ideas are valid in which context and also to decide on what you
believe. The same goes when it comes to investing. There are 3 popular technical theories or techniques that we
would like to discuss today: Elliot Wave Theory, Fibonacci numbers, and the Dow
Theory. They are somewhat different in their approaches, and we will tell you
how to deal with them. Explanations of each theory are brief so as the keep the
length of this article reasonably short.
THE DOW THEORY
Dow Theory comes
from Charles Dow, who was a journalist and co-founder of Dow Jones and Company.
He had several major beliefs in his Dow theory
Markets have 3 trends: Most of the time, the market would moves
sharply in one direction, recedes briefly in another, and then resumes the
original direction. This is the basis of most all technical analysis.
Markets have 3 phases: accumulation by astute investors, then trend
followers jump on board, and finally the same astute investors begin unloading
their shares.
The stock market
is relatively efficient: Stock prices react quickly to news.
Stock market
averages should confirm each other: When market indices begin to diverge, it
typically signifies a change in direction is occurring.
Trades are
confirmed with volume.
Trends exist,
until real signals indicate otherwise.
ELLIOT WAVE
THEORY
Developed by
Ralph Elliot in the 1920's, Elliot Wave Theory suggests that the market moves in repetitive
patterns called waves. The theory consists of the following:
Every market
action is followed by a reaction
There are 5 waves in the direction of the main trend followed by 3 corrective waves
The cycle is
over after the waves of 5 and 3,
The 5-3 move becomes 2 subdivisions of the next higher 5-3 wave
FIBONACCI NUMBERS
Fibonacci ratios
and sequences originate from a 12 century mathematician who found that the ratio 1.618 recurred an unusually high amount of
times in nature. It exists from the ratio of females to males in any given
beehive, to the length of the average human’s forearm compared to the distance
between his shoulders and fingertips. Because of the extraordinary recurrence
of this number in math and nature, some individuals use the Fibonacci ratio in
technical analysis, rationalizing that this natural number exists in financial
markets and thus can be used to predict price behavior.
