The Dow Theory, from theory to practice

The six principles of this theory

The Dow Theory is based on six fundamental principles, which are as follows:

1. The market reflects all known information
2. The three market trends
3. The three phases of the primary trend
4. Market averages must confirm each other
5. Volume must confirm the trend
6. Trends exist until definite signals prove that they have ended

1/The market reflects all known information

According to Dow, the market reflects all available information, whether it be economic, political, or otherwise. The market therefore reflects all known data.

2/The three market trends

The Dow Theory identifies three market trends : the uptrend, the downtrend, and the sideways trend (also known as the consolidation or range). We will discuss these trends in detail in the PDF.

3/The three phases of the primary trend

Each primary trend is composed of three phases: the accumulation phase, the phase of professional and public participation, and the distribution phase.

4/Market averages must confirm each other

The Dow Theory assumes that market averages must confirm each other for a trend to be valid. For example, if the Dow Jones Industrial Average is rising but the transportation index is falling, the uptrend is not confirmed.

5/Volume must confirm the trend

Trading volume must confirm the trend to be valid. The Dow Theory considers that high volumes during an uptrend or downtrend confirm the trend, while low volumes indicate a weak trend or a consolidation trend.

6/Trends exist until definite signals prove that they have ended

The Dow Theory assumes that market trends exist until definite signals prove that they have ended. Therefore, investors must closely monitor signs indicating the invalidation of a trend and be ready to adjust their positions accordingly.

How to use this theory

The Dow Theory can be used to make informed trading decisions. Investors can use this method to identify market trends and take positions accordingly. Here are the three phases of the primary trend and how investors can use them:

1/Accumulation phase

The accumulation phase is the first phase of the primary trend. It is characterized by low trading volumes and prices that stagnate or tend to decrease. Investors can use this phase to accumulate positions at attractive prices.

2/Participation phase of professionals and the public

The second phase of the primary trend is the participation phase of professionals and the public. This phase is characterized by an increase in trading volumes and rising prices. Investors can take advantage of this phase to take bullish positions.

3/Distribution phase

The distribution phase is the last phase of the primary trend. It is characterized by high trading volumes and prices that tend to decrease. Investors can use this phase to sell their positions before prices fall too much.

Putting Dow’s theory into practice

To apply Dow’s theory, I have prepared a PDF with practical examples that can be applied on a daily basis. To receive it, enter your details at the bottom of the page.

Summary

Dow’s theory is a technical analysis method for the stock market based on the study of market trends. It is based on six fundamental principles and can be used to make informed trading decisions. Investors must closely monitor signs of a trend reversal and be prepared to adjust their positions accordingly.

Conclusion

Dow’s theory is an important technical analysis method for investors. It helps understand market trends and make informed trading decisions. Investors must be prepared to adjust their positions based on signs of a trend reversal. Dow’s theory can be used in combination with other technical analysis methods to improve market forecasting accuracy.

 

Joseph Pergnan

 

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