Dow Theory - All You Know Need To Know To Profit From Dow Theory In 6 Bullet Points
Dow theory is a theory about price movements that provides much of the foundation for technical analysis.
This technical analysis method was derived from Dow's 255 editorials on The Wall Street Journal shortly after his death.
Dow himself never used Dow theory, though.
If you know these 6 key points from Dow theory you stand a pretty good chance of making a profit trading currencies or stocks:
This technical analysis method was derived from Dow's 255 editorials on The Wall Street Journal shortly after his death.
Dow himself never used Dow theory, though.
If you know these 6 key points from Dow theory you stand a pretty good chance of making a profit trading currencies or stocks:
- Markets have three trends.
An uptrend (trend 1) is defined as when successive highs in a trend close higher than previous highs and when lows close at higher lows than previous ones.
The opposite holds for downtrends (trend 2).
Dow theory observes the following theme in the market: prices move sharply in one direction, then invert briefly in another direction and finally continue in their original direction - Trends have three phases: accumulation, public participation phase and finally the distribution phase.
Phase 1 (accumulation) happens when investors in the know are actively buying or selling stock against the general knowledge of the market.
At this stage, the price does not move much as the investors with inside information are a minority.
Eventually, the general public becomes aware of this information and catches up (phase 2, public participation).
This is when trend followers and other technical analysis traders participate in the price action.
This phase continues until a speculative bubble appears.
This is when investor commence to distribute their holdings in the market (phase 3). - The stock/foreign exchange/commodities market incorporates all news as soon as this is made public.
This part of Dow theory ties in very closely with the Efficient Markets Hypothesis (EMH). - Market indices must confirm themselves.
In foreign exchange markets for example this means that exchange rates must be moving hand in hand with the economic data for the two nations.
These indices must be moving in the same direction, when they stop then a trend reversal must be imminent - Price trends must be confirmed by volume.
Large price movements must be backed up by large volumes.
If we see a dramatic move on low volumes there may be many reasons for this but this would not indicate the presence of a trend according to Dow theory. - Trends exist until strong signals indicate that they have ended.
Dow theory argues that price trends exist despite white noise.
The market may temporarily move in the opposite direction temporarily but trends should be given the benefit of the doubt.