Basics Of Charting And Stock Market AnalysisBasics Of Technical AnalysisTrading Skills

Dow Theory-The Foundation Of Modern Technical Analysis

The Dow Theory- The Foundation Of Technical Analysis was devised in late 18th century by Charles Dow, He was American Journalist and founded world’s first market Index which is Dow Jones Industrial Average. Dow theory for market analysis later became the groundwork for Technical Analysis.

The following are the some very important concepts from the Dow Theory-The Foundation Of Technical Analysis which are very useful, and still today they are as relevant as before a century ago. So every curious learner of technical analysis must understand and apply it:

Commandments of Dow Theory-The Foundation Of Modern Technical Analysis

The price discount everything:

As the current price is a result of the opinion of all the market participants including insiders, market makers and professional it must have already discounted each and every information available or foreseeable. This information includes earning reports, balance sheet data, financial ratios, expected growth in sales or orders, economic factors, industry conditions and also the condition of the general market. It may also include the information that is not available publicly. In short, it means that:

Price is the most smart information available about the investment value of stock

The price movement consists of three trends:

The price of stocks in general moves in trends. This trends can be classified into three type by its price move size and time taken. These are the Major trend, Intermediate trend, and minor trend. The major trend in the stock or market, in general lasts for one or more years. And it consists of price move greater than 20-50%.

The price does not rise or fall in the direction steadily but it is frequently interrupted by corrective moves in the opposite direction of the major trend. These corrective moves of the major trend are Intermediate trends. These intermediate trends last for months and consists of 10-20% price moves.

These intermediate trends are also interrupted by minor moves in the opposite direction of the intermediate trend. These minor moves are called minor trends. Minor trend consists of price move of less than 10% and lasts for less than a couple of weeks to days.

Dow Theory- The Foundation Of Technical Analysis -Major And Minor Trend
Dow Theory- The Foundation Of Technical Analysis -Major And Minor Trends

The Primary or Major Trend:

If each successive rally tops in the primary trend is on higher level and each successive bottoms of corrective moves are also on higher levels than the primary trend is said to up and this market is called Bull market.

Conversely, If each successive rally tops in primary trend are on the lower level and each successive bottoms of corrective moves are also at lower levels than the primary trend is said to be down and that is called a Bear Market.

The Secondary Trends:

The secondary trends are in opposite direction to the major trend. If the major trend is up, the corrective down waves are the secondary trend that is down. If the Major Trend is down then upside recoveries that interrupt the downtrend are secondary trends.

The Minor Trends:

The small up and down fluctuations that cause the secondary trend are minor trends. The minor trends are very chaotic.

The Four Market Phases:

Primary trends usually consist of three phases. The first is the accumulation, it starts right at the bottom of the bear market. Strong holders accumulate plenty of shares because the price is generally very low and attractive. The second phase is a markup, which comes after accumulating a lot of stocks. The strong holders now bid up thus their buying and mark up the price to very high level. This swift rise in price attracts the weak holders in buying.

Now at the very top of the bull market starts the distribution phase. After marking up the price now strong holder unloads their position as the weak holders buy thus keeping the price up. After the completion of the distribution of stock to weak holders. Now the strong holders put the rest of the supply to the market. This marks down the price to the bottom of the bear market. Now the weak holders panic and sell their position that is absorbed by strong holders for further accumulation.

They All Moves Together:

When the market moves, they move altogether. It means that when the bull market is in progress most of the stocks on the exchange moves up and when the bear market is underway the most moves down.

The Volume Goes with the Trend:

In a Bull market, trading volume increases when prices going higher and decrease as prices decline; In Bear Markets, turnover increases when prices go down and reduce with recovery in price.

The Secondary Trend Can be Sideways:

Many times the secondary trend can be neutral. Because there is no tendency of the price going in no particular direction but just horizontally within a small range. So the secondary trend can be sideways trend. It signifies that pressure of buying and selling is more or less in balance.

Closing Price Are Important:

In Dow Theory, only the closing price is most important among the OHLC because it is the final result of all activity between bulls and bears. The High and Low of day indicates extreme points of intraday price fluctuation so it is less important as per Dow theory.

All the above commandments are very important from the point of view of basic of technical analysis. Each and every beginner of technical analysis must comprehend these commandments like ABC in English.

3 thoughts on “Dow Theory-The Foundation Of Modern Technical Analysis

  • Excellent read, I just passed this onto a colleague who was doing some research on that. And he just bought me lunch since I found it for him smile So let me rephrase that: Thank you for lunch!

  • I would like to thank you for the efforts you’ve put in writing this blog.

  • I love anything & everything that is written well… yeah you got some good content going on there for sure.

Comments are closed.