Table of Contents

• What is the Dow Theory?
• Basic principles of Dow Theory
  • The market reflects everything
  • Market trends
  • Three Phases of Major Trends
  • Cross-Index Correlation
  • Trading Volume Matters
  • The trend will remain valid until the reversal occurs
• Summary

What is Dow Theory?

Essentially, the Dow Theory is a framework for technical analysis based on the work of Charles Dowf on market theory. Dolph is the founder and editor of The Wall Street Journal and co-founder of Dow Jones & Company. As part of the company, he helped create the first stock index known as the Dow Jones Transportation Average (DJT), followed by the Dow Jones Industrial Average (DJIA).

Dow never wrote down his ideas as a specific theory, nor did he refer to them as such. But despite this, many people learned from him through his editorials in the Wall Street Journal. After Dow's death, other editors such as William Hamilton refined these ideas and put his editorials together in what is now known as the "Dow Theory."

This article will introduce the Dow Theory in detail and discuss the different stages of market trends based on the results of Dow Jones. As with other theories, the principles stated below are not absolute and are intended for public interpretation only.

Basic principles of Dow Theory

Markets reflect everything

This principle is closely related to the so-called efficient markets hypothesis (EMH). Dow believed that markets reflect everything, meaning that all available information is already reflected in prices.

For example, if there is a general expectation that a company will disclose its earnings gains, this will be reflected in the market before the company officially releases its earnings report. Demand for the stock will increase ahead of the company's report, and then the price likely won't move much after the expected positive report is eventually released.

Dow notes that in some cases, a company may see its share price fall after making a profit because it performs less than expected.

Many traders and investors, especially those who make extensive use of technical analysis, still believe that this principle is correct. However, those who prefer fundamental analysis disagree and believe that market value does not reflect a stock's intrinsic value.

Market trends

Some people say, Dow's work gave rise to the concept of market trends, which are now considered an important part of the financial world. Dow Theory believes that there are three main market trends:

• Main trends– lasting from months to years , which is the most important market movement.

• Secondary trends– last from weeks to months.

• Short-lived trends–Tend to end in less than a week or no more than ten days. In some cases, they may last only a few hours or a day.

By studying these different trends, investors can look for opportunities. Although primary trends are the ones to prioritize and pay attention to, opportunities to profit often arise when secondary and short-lived trends move in the opposite direction to the primary trend.

For example, if you believe that the primary trend of a cryptocurrency is up and the secondary trend is down, then there may be an opportunity to buy it at a relatively low price and later increase its value. Try to sell.

The question now is to identify exactly the type of trend you are observing, which is why deeper technical analysis is performed. Today, investors and traders use a variety of analytical tools to assist them in identifying the type of trend they are exploring.

The three phases of the main trend

Dow divides long-term major trends into three stages. For example, in a bull market, the three stages would be:

• Accumulation–Before After the bear market, market sentiment was mainly negative and asset valuations remained low. Before the price rises significantly, savvy traders and bookmakers will accumulate assets during this period.

• A large number of retail investors participate–At this stage, the market will achieve more rapid growth, just like the savvy traders before As the opportunity was observed, a large number of retail traders began to actively buy. During this stage, prices can rise rapidly.

• Excess and Allocation–In the third stage, most traders continue to buy, but In fact, the uptrend is nearing its end. Market makers begin to dump their holdings by selling shares to other participants who have not yet realized that the upward trend is about to change.

In a bear market, these stages are exactly the opposite. The trend will start with a selling signal, followed by a large number of retail investors participating in the selling. In the third stage, retail investors will continue to be pessimistic, but investors who can recognize that the market is about to shift will start accumulating again.

There is no guarantee that this principle will apply, but thousands of traders and investors consider these stages before taking action. It is worth noting that Wyckoff theory is also based on the ideas of accumulation and distribution, describing a similar concept of market cycles (transitioning from one phase to another).

Cross-index correlation

Dow believes that a major trend in a market index can be confirmed by a trend in another market index. At the time, this primarily involved the Dow Jones Transportation Average and the Dow Jones Industrial Average.

At that time, the transportation market (mainly railways) was closely linked to industrial activity. This makes sense: to produce more goods, rail activity first needs to increase to provide the necessary raw materials.

Therefore, there is a clear correlation between the manufacturing and transportation markets. If one person is healthy, the other person is likely to be healthy too. However, since many goods are digital and do not require physical delivery, the principle of cross-index correlation is less used today.

Trading volume is important

As As is true for most investors, Dow believes that volume is a key secondary indicator, meaning that strong trends should be accompanied by volume. The higher the volume, the more likely the move reflects the true trend of the market. When trading volume is low, price movements may not represent true market trends.

Trends remain valid until a reversal occurs

Dow believes that if the market shows a certain trend, it will continue to run in that trend. For example, a company's stock price starts to rise after good news, and the price of the stock will continue to rise until there is no clear reversal signal.

Therefore, Dow believes that the current reversal trend should be viewed with skepticism before confirming the emergence of the main trend. Of course, it is not easy to distinguish the occurrence signals of secondary trends and major trends. Traders are often disturbed by misleading reversal signals, and ultimately find that they are only signals of secondary trends.

Summary

Some people think that the Dow Theory has been Elimination, especially in cross-index correlation (the principle stating that one index or average can be supported by another). Still, most investors believe the Dow Theory is relevant in today's markets. Dow's work was not only used to find trading opportunities, but also created the concept of market trends.