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Dow Theory

 

Technical analysis theory was proposed from ideas of Charles Dow and his colleague Edward Jones in the end of 19th century. Dow and Jones published their ideas in the Wall Street Journal and are currently assimilated by many technicians, though the majority of them are not familiar with the source. Dow Theory still dominates and has its own role in modern study of technical analysis.

  1. The Averages Discount Everything
    Market price can be affected by each factor that may probably influence on both demand and supply.
  1. The Market Has Three Trends
    According to Dow, uptrends are successively higher peaks and troughs, while downtrends are successively lower peaks and troughs. 
    Dow considered three parts of a trend:
    1. Primary trend
    2. Secondary trend
    3. Minor trend
  1. Primary trend is the most important trend to determine. This is because the dominant trend is the one that influences on the movements in stock.
  2. Secondary trend moves in the reverse direction of the primary trend, or as an alteration to the primary trend.
  3. Minor trend is commonly the corrective moves within a secondary move, or those moves that go against the secondary trend.  
  1. Three Phases of Major Trends
    Charles Dow mostly concentrated on the major (primary) trends. He distinguished it in three phases:
    1. Accumulation phase: the smartest investors enter the market feeling the change in the current market direction.
    2. Public participation phase: most of technicians join, as the price is quickly growing.
    3. Distribution phase: a new phase is now commonly recognized and well hiked. financial news are all confirming which all ends up in rising speculative volume and broad public's participation.
  1. The Averages Must Confirm Each Other

Dow stated that unless both Industrial and Rail Averages go above the previous peak, there is no verification of inception or continuation of a bull market. Signals did not have to occur at the same time, but the quicker one followed another depending on the strength of the confirmation.

  1. Volume Must Confirm the Trend
    Volume in increasing or decreasing according to whether the price is moving in direction of a trend or in the opposite course. Dow considered the volume as a secondary indicator. His buy or sell signals depend on closing prices.
  1. A Trend is Considered Effective until it Reaches the Level of Reversal
    The on the whole, the technical approach in market analysis is based on the idea that trends keep on moving until there is an external strength, causing it to change its direction.


Failure Swing.
The failure of the peak at C to overcome A, followed by the violation of t he low at B, constitutes
a "sell" signal at S.

Nonfailure Swing.
Notice that C exceeds A before falling below B. Some Dow theorists  would  see a Il sell" signal at S1, while others would need to see a lower high at E before turning bearish at S2.


 

Dow only took into account closing prices. Averages had to close higher than a previous peak or lower than a previous trough to be essential.

Failure Swing Bottom.
The "buy" signal takes place

when point B is exceeded (at Bl).

Nonfailure Swing Bottom.
"Buy" signaIs occur at points Bl or B2.



 

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