Posts Tagged ‘Dow theory’

07.03.2012 Post in Trading

countCharles Dow is often considered as the founder of the technical analysis. Jointly with his companion he implemented the famous Dow Jones industrial average, created one of the leading world financial information agencies and began the publishing of the comprehensive financial data. Moreover, he wrote several articles concerning the financial market.

The suggestions described in these publications were later summarized. Today they are known as Dow theory. This theory became fundamental for the modern technical analysis. Though Dow described the processes occurring at the securities market, his theory is applicable to the other financial markets.

Charles Dow paid a lot of attention to the well-known principles as directed character of the price changes, cyclical character of the market processes, the interrelation between the trading volume and exchange rates etc. The theory is based on 6 tenets

1. The market has three types of movements

    Dow confirms that trends can be subdivided into primary (long-term) trends, secondary (intermediate) trends and minor (short-term) trends. Each type of trend is in turn an upward or downward. The upward trend means that each high and low is higher than the previous one. In the downward trend each high and low is located lower than the previous one.

    The primary trend may last from less than a year to several years. The secondary trend serves as a correction and usually lasts for over 3 months. The minor trend is defined as lasting for less than three weeks reflecting the short-term market fluctuations.

    2. Market trend has three phases

      Phases of the long-term trend are: an accumulation phase, a public participation phase, and a distribution phase.

      During the first phase provident investors with significant capital make trade operations that appear to be against the general opinion of the market. The second phase begins when active and technically oriented traders take part. These traders are intended to follow the market trends. The phase is accompanied by the strengthening of the trend and price changes. Then begins the third phase: the public is fully involved in the market resulting in agiotage. Thanks to the experienced investors begins the new accumulation phase.

      3. The stock market averages must confirm each other

        According to Dow, the industrial and transportation averages must confirm the current trend and provide signals of its reversal with slight divergence in time.

        4. The market discounts everything

          Everyone knows the expression “the price accounts everything”. Charles Dow supposed that the market responds very quickly to any information. Any factor that can affect the demand or supply is immediately reflected in dynamics of price and averages.

          5. Trends are confirmed by volume

            moneyThe increase of the trading volume takes place when the prices are moving within the main trend. Otherwise the price changes do not reflect the real market opinion.

            6. Trends exist until definitive signals prove that they have ended

              A trend will be changed in any case, but if the signals of price changes are not clear, this fact can be considered as a signal of temporary corrective movement, but not as a sign of a trend reversal.

              Thus, it is evident that some part of these assumptions is applicable to the Forex market. The ideas of Charles Dow are relevant even now despite more than 100-years history and the fact that the modern analytical tools emerged.

              Added by Kristina Leshkevich,
              InstaForex Clients’ relationship manager