Limitations of Dow Theory

Limitations of Dow's theory: (1) Dow's theory is mainly theoretical narrative, and its operability is poor; (2) Dow theory can only judge the big situation, but it can't do anything about the small fluctuations in the short term. (3) Ignore macroeconomic policies, speculators' speculation and other factors.

At the same time, it has the following limitations: 1, hysteresis.

Dow theory is a theory that describes the result, and price is the result of the market. The core of Dow's theory is "all-inclusive price" and the essence is "all-inclusive result". This is the problem. The results always appear after the market happens, and of course they can be all-inclusive. The signal of Dow's theory comes from the continuation of the results, which always appears after the market, and often can only be expressed as missing the opportunity; In addition, price changes are not a simple repetition of history. If we use the previous results to predict the future market and only consider the continuity of the market without considering its variability, then the basis for judging the market with Dow theory is obviously insufficient.

The analysis of the results can only describe the past, while the Dow theory can only speculate on the future market according to the inertia of price operation, and lacks the function of forecasting in advance, and can never predict the starting point and end point of the market. It is very simple to understand Dow's theory from the perspective of pure mathematics. The mathematical model of Dow theory (which can only be called the simplest model) is the moving price average index, and its function is to smooth and move back the price fluctuation curve. From a mathematical point of view, Dow theory has no predictive function at all, and lag is its basic attribute. So there is no need to make Dow's theory so complicated and mysterious, otherwise we will become masters of metaphysics or gamblers. There is no doubt that Dow theory is a lagging theory. The longer the time period, the more serious the lag. This is a defect that Dow himself has to admit. For this reason, Charles H. Dow claimed that his theory "is not used to predict the stock market, or even to guide investors, but a barometer reflecting the overall trend of the market." This is the essence of Dow theory.

The signal of Dow's theory is the continuation of the previous results, so Dow's theory is also a price inertia theory, which is the theory of chasing up and killing down in popular terms. Therefore, it works well in a unilateral market (big bull market or big bear market), but in a balanced market (consolidation period), false signals appear constantly. Terrible is that Dow theory can't tell when a unilateral market is a balanced market, which makes investors feel at a loss and even lose confidence. Investors have the feeling that "a thousand dollars is hard to buy and I knew it early".

Because the Dow theory lacks the function of predicting the market, the so-called staunch defenders of the Dow theory believe that "predicting the market is absolutely impossible", which is undoubtedly just a stubbornness and shortsightedness of today's advanced science. For more than a hundred years, this defect has become a major historical shackle, which still imprisons people's thinking.

2. Become a tool for major institutions to cheat money.

The technical analysis indicators based on Dow theory are all single-factor price indicators, and the main institutions often cheat investors by artificially creating price changes to profit from them. This is a bad consequence that Dow himself did not expect.

3. Uncertainty of trend forecast

This is most prominent in the cowhide market, that is, during the price consolidation period, the signal is often just the opposite to the result, and inexperienced people often encounter the dilemma of repeated stop loss; Experienced investors have to take risks to take the reverse operation of "selling with golden forks" and "buying with dead forks". But when the market suddenly breaks out, they may get caught up in it and suffer huge losses.

It is difficult to predict the stage of the market.

The lag of Dow theory can only be understood when the market ends. This kind of uncertainty in the process of market development increases the difficulty of operation, and often hits the mentality of investors. Therefore, investors continue to practice their mentality by suffering losses, and even "psychology" has become popular, becoming a trick for some so-called "masters" to shirk their responsibilities and even cheat.

5. The strength between different contracts of the same variety is uncertain.

Dow's theory itself lacks this function, and even if it can respond to indicators, it is difficult to determine whether it can last in the later period. Therefore, investors who intend to do intertemporal arbitrage (the arbitrage method of buying strong contracts and selling weak contracts at the same time) often do the opposite and even go into misunderstanding.

Other traditional technical theories, such as wave theory and period theory, have more or less similar defects to Dow's theory, so I won't repeat them here.

—— Excerpted from Hubble Multi-factor Prediction System