The Hindu Business Line : Trader's Corner

The stock markets have an undeniable influence on the thoughts of the men/women related to it. Traders and full-time investors can think of little else in their waking moments, and in their sleep too. The fascination that the bourses hold for the observers who stand on the periphery, is no less.

They see the movement of the stocks emulated all around them. Elliott waxed eloquent about the similarity in the patterns of stock markets to the movement of the planets in the solar system. Benoit Mandelbrot, who is also known as the father of fractal geometry likened markets to oceans when he recently said that “markets, like oceans have turbulence”.

This opinion has already been voiced by Charles Dow almost a century ago. His famous article in the Wall Street Journal on 1901 in which he used the example of tides in the ocean to explain the trend reversal process in stock markets is truly unmatched to this day.

To the uninitiated, his words ran thus, “A person watching the tide coming in and who wishes to know the spot which marks the high tide, sets a stick in the sand at the points reached by the incoming waves until the stick reaches a position to where the waves do not come up to it, and finally recede enough to show that the tide has turned. This method holds good in watching and determining the flood tide of the stock market. The average (of stock prices) is the peg, which marks the height of the waves. The price-waves, like those of the sea, do not recede all at once from the top. The force, which moves them checks the inflow gradually, and time elapses before it can be told with certainty whether high tide has been seen or not.”

Dow’s method of determining a market top should be used on front-line indices. As per this theory, the long-term bull market will stay intact as long as the indices keep making a new high every few months. But there will come a time when the indices will struggle to record a new high even though the level of optimism remains high. That should alert an analyst regarding an impending bull-market top. — Lokeshwarri S.K.

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