The Dow theory has been around for almost 100
years, yet even in today's volatile and technology-driven markets, the basic
components of Dow theory still remain valid. Developed by Charles Dow, refined
by William Hamilton and articulated by Robert Rhea, the Dow theory addresses not
only technical analysis and price action, but also market philosophy. Many of
the ideas and comments put forth by Dow and Hamilton became axioms of Wall
Street. While there are those who may think that it is different this time, a
read through The Dow Theory will attest that the stock market behaves the
same today as it did almost 100 years ago.
Dow created the Industrial Average, of top blue chip stocks, and a second average of top railroad stocks (now the Transport Average). He believed that the behavior of the averages reflected the hopes and fears of the entire market. The behavior patterns that he observed apply to markets throughout the world.
Markets fluctuate in more than one time frame at the same time:
Various cycles have subsequently been identified
within these broad categories.
Primary Movements have Three Phases
Look out for these general conditions in the market:
A secondary reaction may take the form of a ‘line’ which may endure for several weeks. Price fluctuates within a narrow range of about five per cent.
Breakouts from a range can occur in either direction.
See Trading Ranges for more detail.
A bull trend is identified by a series of rallies where each rally exceeds the highest point of the previous rally. The decline, between rallies, ends above the lowest point of the previous decline.
The start of an up trend is signaled when price
makes a higher low (trough), followed by a rally above the previous high (peak):
What if the series of higher Highs and higher Lows is first broken by a lower Low? There are two possible interpretations - see Large Corrections.
Each successive rally fails to penetrate the high point of the previous rally. Each decline terminates at a lower point than the preceding decline.
A bear trend starts at the end of a bull trend: when a rally ends with a lower peak and then retreats below the previous low. The end of a bear trend is identical to the start of a bull trend.
What if the series of lower Highs and lower Lows is first broken by a higher High? This is a gray area - see Large Corrections.
A large correction occurs when price falls below the previous low (during a bull trend) or where price rises above the previous high (in a bear trend).
Some purists argue that a trend ends if the sequence of higher highs and higher lows is broken. Others argue that a bear trend has not started until there is a lower High and Low nor has a bull trend started until there is a higher Low and High.
For practical purposes: Only accept large corrections as trend changes in the primary trend:
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