Dow Theory is a type of technical analysis used to examine market patterns and forecast future price movements. Charles Dow, one of the founders of Dow Jones & Company and largely regarded as the pioneer of modern technical analysis, created this hypothesis.
Dow Theory is built on a set of ideas aimed to help traders and investors find trading opportunities and comprehend market patterns. The Dow Theory’s guiding ideas are as follows:
- The market discounts everything: The market reflects all available information about a given security or asset, according to this theory. This means that all news, events, and other factors that could affect the price of a security have already been factored into the market price.
- There are three market trends: Always, the market is in one of three trends: uptrend, downturn, or sideways trend. An uptrend is distinguished by higher highs and higher lows, whereas a downtrend is distinguished by lower highs and lower lows. A sideways trend is characterised by the market’s lack of direction.
- The market trends consist of three stages: There are three phases to any trend: the accumulation period, the public engagement phase, and the distribution phase. During the accumulation phase, intelligent capital purchases the security or asset. During the phase of public participation, the public purchases the security or asset. During the distribution phase, savvy investors sell the asset or investment.
- The market averages must be consistent: According to Dow Theory, for a trend to be regarded legitimate, the DJIA and DJTA must be going in the same direction.
- Volume must confirm the trend; in Dow Theory, volume is a key signal. In an uptrend, volume should grow as the price rises, and vice versa for a decline. If the price is moving in one direction, but volume is not confirming the trend, this could indicate that the trend is invalid.
- Trends persist until a decisive reversal occurs, according to Dow Theory. A market reversal occurs when the market begins to move in the opposite direction of the preceding trend.
Traders and investors can examine the market and predict future price changes using these ideas. For instance, if both the DJIA and DJTA are in an uptrend and volume confirms the trend, a trader may elect to purchase a security or asset that is also in an uptrend.
Dow Theory has been utilised for more than a century and is still extensively employed. Although it is not an ideal strategy for anticipating market trends, technical analysis has proven to be a significant tool for traders and investors seeking to find profitable trading opportunities.
