Dow Theory

Dow Theory

Dow Theory is a theory of technical analysis that was developed by Charles Dow, the founder of the Dow Jones & Company and the Wall Street Journal, in the late 19th and early 20th centuries. The theory is based on the idea that the stock market reflects the overall health of the economy and that trends in the stock market can be used to predict future economic trends.

Dow Theory is based on six key principles:

The market discounts everything – this means that all known and unknown information about a company or the economy is reflected in its stock price.

The market has three trends – primary, secondary, and minor. Primary trends can last for several years and are the most important, while secondary trends can last for several weeks or months and are considered corrections within the primary trend. Minor trends are short-term fluctuations within the secondary trend.

The market averages must confirm each other – this means that changes in the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA) must confirm each other in order to confirm a trend. If the DJIA is rising but the DJTA is falling, it may indicate a potential trend reversal.

Volume confirms the trend – changes in volume should confirm the trend in order to provide further confirmation of a trend.

Trends persist until there is a clear reversal – trends are assumed to continue until there is a clear reversal, indicated by a change in the direction of the primary trend.

The trend is the investor’s friend – investors should follow the trend and avoid trying to predict market movements based on personal opinions or emotions.

Dow Theory provides a framework for understanding market trends and predicting future movements based on historical patterns. It remains an important tool for technical analysts today.

 

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