What is Dow Theory? A Comprehensive Guide to Its 6 Core Principles
1. Introduction to Dow Theory
Dow Theory is a technical analysis method developed by Charles H. Dow, co-founder of Dow Jones & Company and the first editor of The Wall Street Journal. Based on his editorials, the theory offers deep insights into how markets operate and respond to economic information.
2. The Six Core Principles of Dow Theory
The Market Discounts Everything: All available information, including future expectations, is already reflected in market prices.
- The Market Has Three Types of Trends:
Primary Trend: Long-term movement lasting from several months to years, indicating the overall market direction.
Secondary Trend: Short-term corrections within the primary trend, lasting from weeks to months.
Minor Trend: Daily or weekly fluctuations with minimal impact on the overall trend.
- Primary Trends Have Three Phases:
Accumulation Phase: Informed investors begin buying.
Public Participation Phase: More investors join, and prices rise significantly.
Distribution Phase: Informed investors start selling, anticipating a downturn.
Market Averages Must Confirm Each Other: For a trend to be valid, indices like the industrial and transportation averages must move in the same direction.
Volume Confirms the Trend: Trading volume should increase in the direction of the primary trend and decrease during corrections.
A Trend Remains in Effect Until a Clear Reversal Occurs: A trend continues until there is a definitive signal indicating its reversal.
3. Application of Dow Theory in Investing
Dow Theory assists investors in identifying market trends, enabling informed buy or sell decisions. By monitoring indices and trading volumes, investors can determine optimal entry and exit points in the market.
4. Conclusion
Dow Theory provides a solid foundation for technical analysis, offering principles that help investors understand and predict market trends. Proper application of this theory supports effective investment decision-making