The Life and Theories Of the Almighty Charles Dow

In this post, we are going to delve into the life and work of the legendary Charles Henry Dow. Asides from his biography we are going to focus on introducing the famous Dow theory and the famous Dow Jones index.

charles dow biography

Who was Charles Dow?

Charles Dow was the son of a farmer and was born in Sterling, Connecticut, in 1851. His father died when he was only 6 years old. He never finished high school and had to work as a laborer to help support his family.

Later he became a journalist, it is believed that he started covering the events of the city in the newspaper “The Springfield Daily Republican” in 1872, later he worked for other newspapers, even covering a post in 1879 as a reporter in the midst of the mining boom in Leadville, Colorado.

In 1880 Dow worked as a reporter in the city of New York, to later accept a position in the Kierman news agency where he met his colleague Edward Jones. Dow and Jones left their positions at the news agency and founded the company “Dow Jones Company” with Charles Bergstresser, in 1882. Jones left the company in 1889.

By 1883 the company Dow Jones began printing a daily bulletin “The Customer's Afternoon Letter“, this two-page publication was considered very radical for the times since it published the prices of the shares and information of the company's balance that previously were only available to the “insiders” (people close to the companies).

It was not until 1934 when the Securities Act (securities law) established that companies had to present quarterly and annually the financial statements instead of keeping investors informed publicly, as it was being done.

The company Dow Jones published the first index, which was designed to perfectly represent the movements of the stock market of the time, to said index it was called Dow Jones. In the end, “The Customer's Afternoon Letter” became the current “Wall Street Journal”, which is the best-known news service in the United States of that time and now. Dow was its editor until he died in 1902. He was also a member of the American stock market, from 1885 to 1891. His achievements gain him the title of one of the best traders in the world.

Dow Theory Explained

Dow Theory is the best-known method for determining the main market trend, it also tells us if the trend is bullish or bearish. This theory is an excellent tool for long-term investors. Martin Pring illustrated its usefulness with an example.

“Starting in 1897, an investor who bought shares of the Dow Jones Industrial Average (DJIA) following each buy signal of the Dow Theory, liquidating positions and reinvesting the money obtained in the next buy signal, would have seen their original investment of 44$ in 1887 grow to around 51,286$ in 1990, on the other hand, if our investor had kept the initial amount of 44$ throughout the aforementioned period (Buy & Hold), the total accumulated capital would only amount to 2,500$”
(Pring, M. J., Technical Analysis Explained, McGraw-Hill, New York, 1991)

Pring continues to point out that even after brokerage and tax costs, the results would have been better than the typical buy-and-hold strategy, and if we had taken the bull market after 1991, the results would have improved impressively.

The legendary Charles Henry Dow

Charles Dow's Indices

The first index, the famous Dow Jones, was created in 1884 and was made up of 11 stocks, of which 9 belonged to railway companies and the rest were divided between a communications company and a steamboat company, the corporations were as follows: Chicago & North Western, D. L. & W., Lake Shore, New York Central, St. Paul, Northern Pacific pdf, Union Pacific, Missouri Pacific, Louisville & Nashville, Pacific Mail (steamboats), Western Union (communications). The selection of the values was carried out according to the growth expectations of each value.

In 1896 Dow removed the stocks of the railway companies from the index and segregated it into two: the Dow Jones Industrial Average (DJIA) and the Dow Jones Railroad Average (DJRA) which eventually became in 1970 the Dow Jones Transportation Average (DJTA), after adding companies from both air and road transport. The Dow Jones Utility Average (DJUA) was first compiled in 1929.

The Dow Jones Industrial Average started with 12 stocks in 1886 and later expanded to 20 in 1916 to end at 30 in 1928. Today the index is composed of 30 stocks, the Dow Jones Transportation Average contains 20 and the Dow Jones Utility Average is composed of 15, General Electric is the only stock that still remains in the index since it was first composed of 12 stocks in 1886, after being removed from it twice.

The Dow Jones index was a very simple index, calculated by summing the total of quotations and then dividing it by the total number of stocks that make up the index. But after 1928 its calculation became a bit more complicated with the use of the “Dow Divisor”, a number that took into account the splits of the stocks. Norman Fosback explains its use as follows:

“Imagine that the price of the 30 stocks adds up to 3,000$, so the average of them would be 100. But if one of them was trading at 200$, but then it is divided in one by two, so the quotation price stays at 100$, leaving the total index sum at 2,900$. So to keep the average at 100 which is the value we had originally obtained, we must obtain a factor that we obtain by dividing the 2,900$ by 100 which was the original average and then dividing it by the 2,900$ that we had after the split, obtaining again the original value of 100.”
(Fosback, N., Stock Market Logic, IER, Fort Lauderdale, 1986)

August 17, 2001, the value of the divisor of the DJIA, DJTA, and DJUA was respectively 0.14452124, 0.20545179, and 1.6041980.

👉 Find out more about: Global stock indices: beginner’s guide

Development of the Dow Theory

At the beginning of the 20th century, people tended to think that the price of stocks fluctuated according to the fundamentals of each company and the attitude of intraday traders, this was a more than reasonable approach.

Between 1900 and 1902, Dow made several notes in the editorial section of “The Wall Street Journal”, although each stock moved independently, there was a fundamental trend that acted together on the market. He wrote very little about his theories and did not try to use his knowledge to publish stock forecasts in the newspaper's editorial.

In 1902 S. A. Nelson, who was a friend of Dow, wrote “The ABC of Stock Speculation”, becoming the first explanatory document of Dow's theories. Hamilton, an Englishman by birth, was editor of “The Wall Street Journal” and published in the corresponding section the section he called “The Price Movement”. This classic is an extensive work that explains what Hamilton wrote in the editorials of the newspaper. Hamilton died in 1929.

In 1932, Robert Rhea wrote his magnificent work “The Dow Theory”, written and based on a kind of synthesis of 252 writings from the editorial of “The Wall Street Journal” written by both Dow and Hamilton, this book has 139 pages of appendix where the writings of Hamilton are reproduced.

What Is the Dow Theory?

The Dow Theory is based on the fact that the indices discount everything, as Robert Rhea explains in the following quote:

“The fluctuations in the price of the Dow Jones railway and industrial stocks is like a composite index of all the hopes, disappointments and knowledge of everyone who knows something about financial matters, and for that reason the effects of future events (excluding acts of God) are always anticipated in its movement. The indices quickly value both calamities and fires and earthquakes.”
(Robert Rhea, “The Dow Theory”, Barron´s, New York, 1932).

The Dow Theory considers that the Market can be described in terms of primary trends (the bullish and bearish trends measured in years), secondary movements that correct the movements of the primary trend (measured from weeks to months), and daily fluctuations that are of lesser importance.

Dow also referred to the market phases that he defined as the bull market and bear market, both of which are divided into three parts, which we will analyze below.

“A major bull market is nothing more than an upward movement of quotations, interrupted by reactions in the opposite direction to the main movement, and with an average duration of approximately two years. During this time, the stock price rises due to the demand created by both speculative and investment purchases due to the improvement of economic conditions and the increase in speculative activity.

There are three phases in a bull market: the first has to do with the recovery of confidence in the company's economic situation in the future; the second is the response of the stock price to the already known and improved corporate earnings, and the third and last corresponds to the period in which speculation is rampant and apparent inflation, it is a moment in which stocks advance by desires and hopes of growth.”
(Robert Rhea, “The Dow Theory”, Barron´s, New York, 1932).

He also divided the Bear Market into three stages:

“A bear market is a market with strong downward movements corrected by important bullish rallies. All this is due to serious economic illnesses, and it will not end until the stock price has completely discounted the worst of the possible scenarios.

There are three main phases in a bear market: the first represents the abandonment of those desires for which stocks were bought at already exaggerated prices; the second phase has to do with the sales that occur due to the deterioration of the economic situation and the scarcity of company profits. The third is caused by anguished stock sales that have become a topic of conversation for many people, who begin to take into account their scarce value to start taking positions with part of their patrimony.”

(Roberto Rhea, “The Dow Theory”, Barron´s, New York, 1932).

According to the Dow theory, an uptrend is defined as a series of increasing highs and lows, while in a downtrend the opposite occurs, the highs and lows are decreasing. It also tells us that to confirm a trend, all indices must move in the same direction.

In addition, the narrower the period in which this confirmation occurs in terms of time coincidence, the more significant the movement will be.

Another point discussed by this theory is the accumulation and distribution of the market, if the quotations move within a range of more or less 5% for several weeks or more, accumulation or distribution is taking place. If the indices then break these levels upwards, the lateral movement that was taking place is of accumulation and the prices will probably continue to rise.

In case the break is downwards the movement that will take place will be the opposite. All these movements must be confirmed by all indices as we have explained previously, if not the results will not be conclusive.

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What are Dow's major theories?

Dow developed the Dow Theory, which analyzes market trends and defines bull and bear markets.

Why is Charles Dow considered a pioneer in finance?

Charles Dow's innovative theories and establishment of Dow Jones & Company revolutionized financial analysis and journalism.

How does the Dow Theory work?

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