Dow Theory in Technical Analysis
Dow Theory is a set of principles that help determine the movement and direction of the market.
Do you want to trade the market but don't know how to get started? Can't figure out the trends? Then read on, we will help.
In this article we will try to answer your questions and tell you:
- What is Dow Theory
- Principles of Dow Theory
- How to trade Dow Theory
- With what indicators to apply the Dow theory?
Dow Theory - Who Was Charles Dow?
Charles Dow was the son of a farmer and was born in Stirling in 1851. His father died when Charles was only 6 years old, so the boy had to leave school and start working to support his family.
Later, Charles Dow began his career as a journalist, and in 1889 he founded the Dow Jones Company. This company was the first to publish an index designed to reflect the movement of the stock market. This index eventually became known as the Dow Jones.
What is Dow Theory?
Dow theory is based on the analysis of the highs and lows of market swings, which can be used to predict the direction of the market.
According to Dow Theory, the importance of these highs and lows lies in their position relative to previous highs and lows.
This methodology allows you to understand the trading chart and better understand what is happening with the asset.
This simple analysis will help even beginners to figure out in which area a financial instrument is developing.
Another important point! Charles Dow supported the general consensus that the price of an asset and the resulting fluctuations on a trading chart contain all the necessary information, both currently available and expected in the future.
Dow Theory: Basic Principles
The Dow Theory is based on 6 principles:
- Market considers everything!
This means that any event that affects supply and demand is reflected on the trading chart in the price of the corresponding asset.
- There are only three types of trends in the market.
According to Dow theory, the market moves in three types of trends:
- Main trend (long-term). Duration from 1 to 3 years. This is the strongest trend.
- Secondary trend (medium term). Duration from 3 weeks to 3 months. Usually this is a correction of the main trend, that is, movement within its framework, but in the opposite direction.
- Minor trend (short-term). Duration less than 3 weeks. Minor trend correction.
- The main trends are divided into 3 phases
- Bullish or uptrend: accumulation phase - participation phase - accumulation phase.
- Bearish trend: accumulation phase - participation phase - implementation phase.
The following principles:
- Trading volume must confirm the trend:
- Uptrend: If the price goes up, the volume should increase. If the price goes down, the volume should decrease.
- Downtrend: The opposite will happen. If the price rises, the volume must decrease. If the price goes down, the volume should increase.
- Dow Jones Transport & Industrial Confirmation:
Dow Theory tells us that the existing trend must be confirmed by these two indices (they must follow the same trend). If not, it could be a sign of a weakening or trend reversal.
Validity of the current trend until the change is shown.
Dow Theories in Technical Analysis
After examining the 6 principles on which the Dow theory is based, it can be seen that the main principle of the Dow theory in technical analysis is to use the high and low points of the market to determine the market situation, therefore:
- Upward or bullish trend: If a sequence of higher highs and higher lows can be seen on the trading chart, according to Dow theory, we see an uptrend and there are more buyers than sellers in the market.
- Downward or bearish trend: If a sequence of lower and lower highs and lows can be identified on the trading chart, according to Dow theory, we are in a downtrend, that is, there are more sellers than buyers in the market.
What happens otherwise?
Financial markets can only exist in two states:
- In trend
- In consolidation
With this approach, a market that is no longer trend-following develops to consolidate until the next momentum, resulting in a trend reversal.
Dow Theory: Support and Resistance
What are the advantages of this method?
Everything is very simple and logical:
- It allows you to explore every scenario
- It predicts the market trend
- It indicates market entry points
What are the disadvantages?
- The price may continue to move without returning to the desired area.
- To understand the effectiveness of a signal, it is important to consider history or backtesting.
Dow Theory: Cascade Lows
What are the advantages of this method?
- This type of Forex signal is available to everyone, allows you to use all the possibilities of the market and is ideal for a trending market with a small pullback.
- Very often it requires a larger stop loss, which affects the ratio of profit / loss on each position.
- Are there any downsides?
- This is a rather aggressive way to enter the market, so the strategy needs to be tested first.
Dow Theory: Cascade Highs
The case is the same, but in reverse order.
Dow Theory in Technical Analysis: Benefits
- Is Dow Theory Really the Best Way to Spot a Trend in the Forex Market?
- Is this the fastest and most reliable method for determining the trend in the CFD market?
Yes, many private and professional traders use the Dow Theory because it doesn't fail.
- This is the fastest available indicator for Forex trend confirmation.
- Unlike most indicators, there is no delay in this analysis because it is based on price, the most direct information possible.
- Dow Theory is applicable to any market and is based on human behavior.
- This concept is easy to understand, it's a simple yet effective approach.
As you can see, this method of Dow analysis is very effective during a trend and is therefore completely suitable for all traders.
Dow Theory: Conclusion
Did you find a suitable technical analysis method in this article?
If so, be sure to let us know!
Financial markets are constantly changing. However, the basic principles of how trends and consolidation periods work have not changed since Charles Dow first revolutionized technical analysis.
A good trading strategy can be chosen based on various theories, and the Dow theory is really very good!