STOCK GOODIES PLAYS OF THE WEEK

[Black_NITE]

Dow Theory

There is also proof that one of the oldest systems around can outperform the market and reduce risk. Dow Theory seeks to buy when both the Dow Transports and the Dow Industrials record new reaction highs and sell or move into Treasuries when both record new reaction lows. The move out of stocks and into Treasuries greatly reduces risk because one is not exposed to riskier stocks. There have been a few big bad bear markets over the years and preserving capital is one of the keys to investment success.



Stephen Brown of New York University, William Goetzmann of Yale, and Alok Kumar of the University of Notre Dame published a study on Dow Theory in the Journal of Finance. The Dow theory system was tested against buy-and-hold for the period from 1929 to 1998. Over the 70-year period, the Dow theory system outperformed a buy-and-hold strategy by about 2% per year. In addition, the portfolio carried significantly less risk. If compared as risk-adjusted returns, the margin of outperformance would be even greater. Over the 18 years from 1980 to 1998, the Dow theory system has underperformed the market by about 2.6% per year. However, when adjusted for risk, the Dow theory system significantly outperformed buy-and-hold over this timeframe. Keep in mind that 18 years is not a long time in the history of the market and this period was during one of the greatest bull markets in history (1982 to 2000).