Charles Dow's Original Editorials and Their Relevance Today


Dow Theory Unplugged book

Dow Theory Unplugged

Dow Theory Unplugged: Charles Dow’s Original Editorials and Their Relevance Today is a collection of 220 original Wall Street Journal editorials penned by Charles Dow that form the basis of modern Dow theory. The following excerpt is the modern-day introduction to one of the sections of the book.

The Market Has Three Phases
By Paul Shread, CMT

Dow believed that major bull and bear markets each have three phases: the early stages of a new trend, when smart money begins to accumulate positions; the middle phase, when the reasons for the new trend become apparent; and the final stage, when public participation is high and investors discount not only present conditions, but future possibilities too.

Bull markets begin when economic conditions are still poor and the news discouraging, as the smart money begins to accumulate positions. In the second phase, the improvement in business conditions becomes apparent and corporate earnings rebound, drawing in more investors and sending prices higher. In the third phase, the public becomes heavily involved and the news is all good. Speculative excess becomes evident as stocks are driven to heights that not only discount current conditions, but future growth as well. It is at this point that the smartest investors begin to take money off the table.

“The market will ultimately turn when general business is still good, but not far from a turn,” [William Peters] Hamilton wrote in April 1922. [He was Dow’s successor at the Wall Street Journal.]

This early distribution marks the beginning of bear markets, as big players begin to sense that economic conditions may have peaked. The public begins to get frustrated as rallies fail. In the second phase, selling picks up and the decline accelerates as business activity and earnings falter. This panic phase is where the greatest declines are seen. The third and final phase of bear markets occurs when the news is all bad and investors are forced to sell at any price to raise cash. When all the bad news is priced in, farsighted investors begin to accumulate positions for the eventual recovery.

The market, Hamilton wrote in November 1922, “recedes to a safer level until it is entirely clear as to the nature of the unfavorable symptom which it cannot yet diagnose with certainty. Indeed, it may almost be said that a bear argument understood is a bear argument discounted.”

The market can reverse at any time, of course, but the clearer the three phases have been, the more significant the reaction is likely to be.

The years 1929, 1968, 1987, and 1999 all had clear speculative excess, and all were followed by significant bear markets. The end of World War II brought with it fear that the U.S. would fall back into a depression, thus setting the stage for a long uninterrupted bull market after the panic of 1946. The year 1982 was marked by the end of a sixteen-year bear market and cover stories about “The Death of Equities,” setting the stage for the greatest bull market of them all.


Valuation and sentiment thus play an important role in determining which phase the market is in.

On April 9, 1901—a little more than a month before the onset of a market panic—Dow wrote, “There has been a gigantic bull speculation, showing daily transactions of over 1,200,000 shares. There has been a recent public demand for stocks affording large operators opportunity to sell. Some of the houses which were among the largest buyers some time ago have been sellers in the last week on an equally large scale. … The supply of money available for speculative purposes has gradually diminished, while the offerings of securities have increased.

“This is not proof that the bull market is near its end, but developments like these will surely occur when the end of the bull market comes. Therefore, such conditions should promote watchfulness.”

Sometimes speculative excess is readily apparent, as it was in 1929 and 1999. In fact, Hamilton’s and [Robert] Rhea’s writings about 1929 could just as easily have applied to 1999, when Internet companies with no earnings were bid up to stratospheric valuations amid talk of a “new era.” [Rhea was a contemporary of Dow and a prominent Dow theorist.]

“The student should ask himself if stocks are not selling well above the line of values, if people are not buying upon hope which may be at least deferred long enough to make both the heart and the pocketbook sick,” Hamilton wrote in April 1929.

“Worthless equities were being skyrocketed without regard for intrinsic worth or earning power,” wrote Rhea. “… Veteran traders look back at those months and wonder how they could have become so inoculated with the ‘new era’ views as to have been caught in the inevitable crash.”

The 2007 top, on the other hand, did not witness much in the way of stock market speculation. Leading issues like Google, Apple, and Research In Motion were bid up to extraordinary heights, but those gains were also backed by strong earnings and sales growth. The speculation was much greater in the housing market—particularly in risky subprime mortgages and myriad ways they were repackaged and leveraged. Perhaps the historic collapse of Wall Street investment banks and other pillars of the U.S. financial system will be the first step toward greater oversight of derivatives, hedge funds, and other speculative areas the U.S. government has until now treated with a hands-off approach.

Dow’s notion of market trends and phases also became the basis for Elliott Wave theory, founded by R.N. Elliott in the 1930s. Under Elliott Wave theory, primary trends unfold in three phases and five waves. Wave one, the beginning of a new trend, shows a great deal of uncertainty and can be followed by a very sharp wave two reaction where it is not yet clear that the major trend has changed. Wave three—the strongest wave—then follows as it becomes clear that underlying conditions have changed. Wave four is typically a sideways correction, since the fear that predominated in the first two waves has now ebbed. Wave five, the final wave in the primary trend, becomes tenuous and selective as the smart money begins to position for a reversal.

Paul Shread, a Chartered Market Technician (CMT), was an editor and analyst for, where he published an article on the November 2007 Dow Theory Sell Signal and the July 2009 Buy Signal. He has been a guest on the Gabe Wisdom show on Business Talk Radio Network. He is a senior managing editor at QuinStreet.

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