It is interesting and amazing to note that not until Charles Dow started compiling the Dow Jones Industrial and Dow Jones Rail Index and started writing about the stock market a little over a hundred years ago, stock speculation was regarded merely as a game for the rich or as gambling for the brave. Sure, there were the tape readers, but the majority of the public regarded Wall Street as a source of excitement - the entertainment provided freely (unless you were on the wrong side) by figures such as Cornelius Vanderbilt, Jay Gould, and the infamous Daniel Drew.
In a series of stunning editorials for the Wall Street Journal at the turn of the century, Dow laid out the foundation of his own theory on the stock market. Among them were:
The method of making money in stocks, according to Dow, was to study basic conditions and exercise enough patience to capture the major movements. One of the few speculators who discovered this relatively new concept of making money on Wall Street at the time was Jesse Livermore. He was able to accomplish this only through trial and error and the making and losing of several fortunes.
William P. Hamilton, Dow's understudy and the fourth editor of the Wall Street Journal, continued Dow's legacy after his death in 1903. The Dow Theory as interpreted by Hamilton forms the basis of all modern technical analysis today. He wrote about the Dow Theory for the Wall Street Journal for more than 20 years. His additions to the Theory included:
Hamilton's predictions of the trends were uncannily accurate, even as he developed a wide following from his editorials. A major reason why he was accurate almost all the time was his lack of a writing schedule - choosing only to write when he had something to say about the market, sometimes going for weeks without writing a single word.
The one significant time when he erred was in late 1925 and early 1926 when he erroneously labeled a serious secondary reaction in a primary bull market as a bear market. Followers of Hamilton lost heavily during that period, as the market bottomed out in March 1926 (Industrials 135.20 and Rails 102.41) and was getting ready to resume its long advance that would not end (tragically) until September 1929.
Even so, Hamilton would always be remembered for penning the following editorial on October 25, 1929, just days before the crash. His words proved prophetic - calling for the beginning of a new primary bear market. Part of his now-famous editorial is reproduced below:
A Turn in the Tide - October 25, 1929
On the late Charles H. Dow's well known method of reading the stock market movement from the Dow-Jones averages, the twenty railroad stocks on Wednesday, October 23 confirmed a bearish indication given by the industrials two days before. Together the averages gave the signal for a bear market in stocks after a major bull market with the unprecedented duration of almost six years. It is noteworthy that Barron's and the Dow-Jones NEWS service on October 21 pointed out the significance of the industrial signal, given subsequent confirmation by the railroad average.
Hamilton passed away six weeks after he wrote the above editorial. It is a
tragedy that probably not a great number of people at the Wall Street Journal or Barron's today have even heard of the Dow Theory, let alone have a complete understanding of it.
The next great Dow theorist, Robert Rhea, initially stumbled upon the Dow Theory during his endeavor to find "a system" for helping him make money in the stock market. In his attempts to disprove the theory, he became a convert. Rhea was a very serious student, and he was able to utilize the Dow Theory as interpreted by Hamilton to his advantage, buying and holding stocks in 1921, and basically holding them until late 1928 (he reversed his short position when he realized Hamilton's advice was incorrect in early 1926), missing only the final blowoff phase. He also "played" the short side successfully during the subsequent deflation. In 1932, he began publishing his newsletter based on the Dow Theory, called the "Dow Theory Comment."
Rhea called the bottom of the stock market in July 1932 almost to the exact day and the subsequent top in 1937. On July 21, 1932, with the Industrials at 46.50 and the Rails at 16.76, Rhea instructed his broker to tell his friends "the Dow Theory implied heavy buying for the first time in over three years." Further, on July 25, 1932, Rhea sent a memo to 50 correspondents, part of which is reproduced below:
The declines of both Rail and Industrial averages between early March and midsummer were without precedent. The thirty-five year record of the averages shows a fairly uniform recovery after every major primary action, and such recoveries average around 50% of the ground lost on the decline; are seldom less than a third and more than two thirds. Such recovery periods tend to run to about 40 days, but are sometimes only three weeks - and occasionally three months.
The time element is in favor of a normal reaction at this time - because the slideoff was normal (the normal time interval of major declines being about 100 days).
The market gave the unusual picture of hovering near the lows for more than seven weeks, and might be said to have made a "line" during the latter weeks of that period.
Because of all these things, and because the volume tended to diminish on recessions and increase on rallies during the ten days preceding July 21, almost any one trading on the Dow Theory would have bought stocks on July 19th. Those who did not, had a clean cut signal again on the 21st. Since that date the implications of the averages have been uniformly bullish, and it is reasonable to expect that a normal secondary will be completed, even though the primary trend may not have changed to "bull". So much for the speculative viewpoint.
Followers of Rhea who bought stocks during that period and held until 1937 made a fortune.
In July 1949, with the Dow Jones Industrials registering a low at 161.60 and with the country in the midst of a severe recession, a new primary bull market was born. E. George Schaefer, a Dow Theory disciple for more than 20 years, started his newsletter writing career near that time, calling his subscribers to load up on common stocks in June 1949. He remained steadfastly bullish in the great corrections of 1953 and 1957 and cautiously bullish since 1960 until the final top in 1966.
Schaefer believed that Hamilton strayed away from Dow's original principle of investing in "values" and that Rhea spent most of his life improvising Hamilton