What is the Dow theory? The basis of technical analysis needs to be known

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What is the dow theory

What is the Dow theory?

Dow Theory is the cornerstone of technical analysis in forex markets, trade coin, .. help reflect available information and market volatility.

Watch now: What is technical analysis? Detailed instructions for beginners

Dow Theory was first introduced by Charles Dow. After his death, William Hamilton continued his work. In 1932, his work was published jointly with the name Dow Theory of Robert Rhea.

It is the first theory to explain that the market moves in trend. And while a lot has changed in the stock market,forex, electronic money… Over the years, the fundamental tenets of Dow Theory have remained valid.

If it comes to the outstanding technical analysis tools commonly used today like Trendline, RSI, MACD, ... good Elliott wave. You should remember that Dow Theory is one of the foundations of those tools.

Principles of Dow Theory

These principles have been developed by Charles H Dow over many years of market observation. Whether in the era of technological development today. With the market moving continuously, Dow theory has always been applied appropriately.

The Dow theory consists of 6 important principles:

Market price movements reflect all

This principle reflects the whole market activity of investors. It includes people who have insight and have the best information on trends and events.

Stock market indices devalue everything known and unknown in the public domain. If an unexpected event occurs, stock market indices will quickly re-examine themselves to reflect their correct values.

The market has 3 trends

The long-term trend of stock prices is called the main trend. This trend indicates an upward or downward trend that lasts for a year or several and results in an increase or decrease.

On the main trend line, there are periods that are interrupted by secondary trends that go against the main trend, which are reactions or corrections when the main trend goes up or down excessively in a certain period. there.

Secondary trends again include minor trends. Usually fluctuations day after day and do not play an important role in the market.

Main trend

It is a general trend of up or down that lasts for a year or a few. Each new price increase is higher than the previous price. And for every price response, the downward trend is still higher than the previous one, but the main trend is still the upward trend.

This main trend is called the bull market. On the contrary, each decrease in price reaches a level lower than the previous decrease.

Each subsequent price increase is not enough to bring the price back to the previous increase, the main trend is the downtrend. This major trend is called the bear market.

Secondary trend

It is the reactions that disrupt the rising or falling process of the main trend. They are intermediate declines or corrections that occur on the bull market or opposite bullish or intermediate rally in the bear market.

Usually this trend lasts from three weeks to several months. They usually reverse the value by about 1/3 to 2/3 for the previous increase or decrease during the course of the main trend.

Thus, we have two criteria for identifying secondary trends: Any price movements that go against the main trend. It lasts for about 3 weeks and results in a loss of more than 1/3 of the previous decline in the main trend that is considered a secondary trend.

Small trend

Those are small fluctuations that are usually 6 days, rarely last more than 3 weeks, and for traders who use the Dow theory they are of no importance.

Usually in the intermediate wave, in the secondary trend or between two secondary trends, about 3 small waves can be distinguished. This small trend is easily manipulated.

Trends are confirmed with volume

The trading volume (volume) must be confirmed with the price. Trends should be supported by volume. This means that trading activities tend to increase when the price is following the main trend.

On the bull market, the volume increases when prices rise and decrease when prices fall. On the bear market, trading volume increases as prices fall and trades stall when prices recover.

The same is true for secondary trends. Note that the convincing signal of trend reversal can be drawn from the analysis of price action. Trading volume is only added when there is a question.

Sideways can replace the secondary trend

The market may remain sideways (trading between a range) for a long time. For example, the price of bitcoin has ranged from $ 9700 to $ 10000 for a long time. These sideways markets can replace the secondary trend.

Closing price is the most amazing

Dow theory does not pay attention to the highest price or the lowest price of the day, only the closing price.

Indicators must confirm each other

We cannot confirm a trend based on only one indicator.

For example, At the inception of development, Dow used the Dow Jones industrial index and the trucking industry index. The market is said to only increase if the indicators are moving in the same upward direction. A market cannot be classified as bullish, by the action of an indicator alone.

Bull market in the Dow theory

Consists of three stages: The accumulation phase, the marking phase, the distribution phase.

Cumulative period

The first phase of the bull market is largely indistinguishable from the final bear market reaction. Excessive pessimism at the end of the bear market, still reigns at the beginning of a bull market.

This is the period when those who have patiently see value in owning stocks for a long time. Stock cheap, but no one seems to want.

They will increase the price and bid gradually when the volume of shares offered decreases. The financial statements still reflect the bad situation of the market during this period. Market activity was moderate but started small price increases.

Phase marked

This is usually the longest period and sees the biggest price increase. At that time, it was also the time when the market was the most active. This period was marked by improving business conditions and increasing stock valuation.

The moment income and profits begin to rise again, confidence begins to change. This is the easiest time to make money because of the wide participation and trend catchers.

Transitional period

The third phase of a bull market is marked by excessive speculation and the appearance of pressure inflationary. (Dow formed these theorems about 100 years ago, but this scenario is certainly familiar.)

In this final phase, the public fully participates in the market, overvalues ​​and extremely high reliability. This is a mirror image of the first phase of the bull market.

Bear market in the Dow theory

The bear market is also divided into 3 phases: the distribution phase, the transitional period, the desperate phase.

Distribution phase

Like accumulation, the distribution phase marks the beginning of a bear market. When users began to realize that conditions were not as good as they used to be, they began selling stocks.

While the market is in decline, there is little confidence that a bear market has begun. Most forecasters it will still increase. The visionary investors feel the profit has reached a high level. Study and start selling your holdings.

The trading volume is still high but tends to decrease in the increase. The public is still active but has begun to show signs of looming as the hope of profitability begins to diminish.

Phase marked

Phase two of a bear market also offers the biggest move. This is when the trend has been identified as down and business conditions begin to deteriorate. Estimates fall in income, a shortage occurs, profit margins fall and sales fall. As business conditions worsened, the sell-off continued.

Despair period

This is the final stage of a bear market. Here, all hope is lost and the stock is upheld. Valuations are low, but sales continue as participants seek to sell whatever. Bad news, bleak economic outlook and no more buyers found.

The market will continue to decline until all bad news is fully priced in stocks. Once the stock fully reflects the worst possible outcome, the cycle begins again.

Important models in Dow theory

There are several important models in Dow Theory. Traders can use these forms to identify trading opportunities. Some models that we will study include:

  • Model 2 peaks, 2 bottoms (double top, double bottom)
model of double-bottomed double-bottomed theory dow
Image source: zerodha.com

  • Model 3 peaks, 3 bottoms (triple top, triple bottom)
model 3 peak 3 bottom theoretical dow
Image source: zerodha.com
  • Trading range
trading range
Image source: zerodha.com
  • Flag price model
flag pattern
Image source: zerodha.com

Besides resistance and support is also a core concept of the Dow theory.

As is said in many indicators, everything is just a whim. Whether the application and the transaction succeeds or not is up to you. Thereby drawing a successful trading method and finally good luck and victory.

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