Dow Theory
Dow Theory is the foundation of modern technical analysis, developed by Charles Dow in the late 19th century. It establishes fundamental principles for understanding market movements.
By the TradingCalculator.Pro team · Updated on · About us
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1. The Market Discounts Everything
Market prices reflect all available information: fundamental, political, psychological, and expectations. Any factor that can affect supply and demand is already incorporated into the price.
2. The Market Has Three Trends
Primary Trend: Main market movement lasting from 1 to several years. Secondary Trend: Corrections against the primary trend, lasting weeks or months. Minor Trend: Short-term fluctuations lasting days or weeks.
3. Major Trends Have Three Phases
Accumulation Phase: Informed investors buy when sentiment is negative. Public Participation Phase: The general public recognizes the trend and participates. Distribution Phase: Informed investors sell when optimism is at its peak.
4. Indices Must Confirm Each Other
For a trend signal to be valid, different market indices must move in the same direction. A divergence between indices suggests the trend may be weak or false.
5. Volume Must Confirm the Trend
Volume should increase in the direction of the main trend. In an uptrend, volume increases on rallies and decreases on corrections. The opposite occurs in downtrends.
6. A Trend Persists Until Clear Signals Indicate Its Reversal
A trend remains in effect until there is definitive evidence that it has changed. Minor fluctuations are not sufficient to indicate a trend change. Clear reversal patterns are required.
Practical Application
To apply Dow Theory: 1) Identify the primary trend by observing highs and lows. 2) Wait for volume confirmation. 3) Look for reversal signals only when there are clear patterns. 4) Trade in the direction of the main trend. 5) Use secondary corrections as entry points.
Limitations
Dow Theory does not predict the duration or magnitude of trends. Signals may arrive late, after the movement has already begun. Not suitable for very short-term trading. Works best in liquid markets with large capitalizations.