Dow Theory
The identified trend is accepted when it is supported by strong evidence. The theory explains that if two indices move in the same direction, the identified primary trend is real. Whereas if the two indices do not match, there is no clear trend. focuses on price movements, transaction volumes, capturing trends using picture representations and comparing indices.
Key Points
Dow Theory’s trading strategy is primarily based on the ideas of stock price movement advanced by Charles H. Dow in his 19th-century Wall Street Journal editorials.
Mainly indicates that several indices must provide the same signal to confirm a trend.
Lists a set of basic principles. Identifying and following a trend must comply with these principles.
Explanation of the theory of Dow
The theory of Dow was developed by Charles H. software-assisted as it did not exist today. the evolution and usefulness of speculation are well described by Robert Rhea in his book “The Dow Theory” by scrutinizing the Wall Street Journal editorials of Charles H. Dow and William Peter Hamilton in the 19th century. This was one of the first attempts to understand the market using fundamentals that indicated future trends.
The original version of the theory focused on comparing the closing prices of two averages: the Dow Jones Rail (or Transport) (DJT) and the Dow Jones Industrial (DJI). The argument was that if one crossed a certain threshold, the other followed. To illustrate this, Dow’s likened the market to the ocean. According to the economist, if you are on one side of the beach and the waves go up to a certain point, the waves on another part of the beach will eventually reach the same point. The same goes for markets because they too are part of a whole.
Paradigms of the theory of Dow
To explain the theory, it is essential to understand the different rules imagined by Dow. These paradigms are commonly known as the Principles or Principles of Dow Theory.
These are the primary, secondary and minor trends defined by their duration. Primary trends can be upward or downward trends that last for months or years, while secondary trend that moves away from the primary will last for weeks or months. Minor trends are treated as insignificant changes that last from a few hours to a few weeks and are not as big as the others.
The different phases of bear markets are distribution, public participation and panic. Bull markets, on the other hand, have a phase of accumulation, public participation, and excess.
Stock indices react quickly to all forms of information. It can be related to the entity or the economy as a whole. For example, any economic shock or problem in running the business will affect stocks and cause indices to go up or down.
Trade volume increases during an uptrend and decreases during lows.
Several indices which evolve according to an identical pattern reveal a trend since they give the same signal. While if two indices move in the opposite direction, it is difficult to deduce a trend.
Traders should be aware of trend reversals. They are easy to confuse with secondary trends, so Dow is warning the investor to be careful and confirm trends with different sources before believing this is a reversal.
How Does Dow Theory Work in Technical Analysis?
The Dow idea become essential to technical inventory marketplace evaluation and acted because of the underlying precept for its persevered advancement.
The technical framework of the evaluation emphasizes the want to pay near interest to marketplace records to figure trends, and reversals and decide whilst to shop for or promote an asset for optimum earnings for the reason that marketplace is the indicator of destiny performance.
In this way, technical evaluation according to the idea assists traders in making worthwhile buying and selling selections with the aid of using detecting installed long, mid, or short-time period trends.
