Dow Theory

The Dow Theory is a theory of technical analysis that was developed by Charles Dow, the founder of Dow Jones & Company and creator of the Dow Jones Industrial Average (DJIA). It is one of the oldest and most widely followed theories in the field of market analysis.

The Dow Theory is based on three main principles:

1. The Primary Trend: According to the Dow Theory, the market moves in three primary trends – the uptrend (bull market), the downtrend (bear market), and the sideways trend (consolidation or range-bound market). These trends are considered to be the result of the collective actions and sentiments of all market participants.

The primary trend is the major, long-term direction of the market and can last for several months to several years. It is the most significant trend that traders and investors should focus on.

2. The Three Movements: The Dow Theory suggests that within the primary trend, there are three movements – the main movement, the secondary movement, and the minor movement.

– The main movement represents the primary trend and can last for months or even years. It is the most important movement that traders and investors should try to identify and follow.

– The secondary movement is a countertrend or corrective movement within the primary trend. It usually lasts for a few weeks to a few months and retraces a portion of the previous main movement.

– The minor movement is the short-term fluctuations or noise within the secondary movement. It can be caused by various factors such as news events or market sentiment and is less significant for long-term analysis.

3. Confirmation: The Dow Theory emphasizes the importance of confirmation between the Dow Jones Industrial Average (representing the industrial sector) and the Dow Jones Transportation Average (representing the transportation sector). According to Dow, for a trend to be considered valid, both averages should move in the same direction.

If the DJIA is making new highs or lows, the DJTA should also confirm the trend by making new highs or lows. This confirmation provides additional confidence in the strength and sustainability of the trend.

In addition to these principles, the Dow Theory also incorporates various technical analysis tools and concepts such as trendlines, support and resistance levels, volume analysis, and chart patterns. These tools are used to identify trend reversals, entry and exit points, and to confirm the validity of the primary trend.

It’s important to note that the Dow Theory is a subjective approach to market analysis and relies on the interpretation of price and volume data. It is not a foolproof method and can be subject to individual biases and interpretation. Therefore, it is often used in conjunction with other technical analysis tools and indicators to make more informed trading decisions.

Overall, the Dow Theory provides a framework for understanding market trends and identifying potential trading opportunities based on the analysis of price movements and market behavior.