Good afternoon! In my blog, I would like to briefly and clearly talk about the importance of Dow theory.
The Dow Theory is one of the main theories of chart interpretation that links charts to investor psychology. Charles Dow believed that the stock market moved like the ocean and consisted of three waves - primary, secondary and daily. He compared strong market fluctuations to ebbs and flows.
There are 6 basic principles that explain the Dow Theory.
1. Indexes take everything into account. Indices take into account all factors that can somehow influence supply and demand in the market. According to the Dow theory, any factor will be reflected in the dynamics of the index, even events such as earthquakes, disasters or other “acts of God’s will.”
2. Classification of trends. Charles Dow divided trends into three categories: primary trends, secondary trends and small daily fluctuations. The primary trend, or wave, is a long-term change in price. An increase in price corresponds to a bull market, and a decrease in price corresponds to a bear market. A bull or bear market is generally considered to begin when the price reaches 20% of the previous low or high. In Dow theory, the primary trend has 3 different phases. A bull market has phases of accumulation, rising volume, and a final explosive move. A bear market has phases of selling, panic, and lack of buyers. Secondary trends are short-term price changes that are contrary to the main long-term trend. They can be caused by various factors such as news, reports or other short-term influences. Minor daily fluctuations are small price fluctuations during the day that do not have a significant impact on the overall market dynamics.
3. The principle of confirmation. The principle is that in order to determine the presence of a bullish or bearish market, it is necessary to check the movement of not one, but several key indices in the market (the main ones are the S&P500, industrial, utilities and transport).
4. A trend must be accompanied by volume. Trading volume is the number of shares or coins traded over a certain period of time. Volume is inherently an important indicator for determining the strength and direction of a market trend. If the price movement is confirmed by high volume, then this indicates the presence of a strong trend in the market. As a general rule, trading volume should increase as bullish and bearish trends develop, with maximum trading volume expected at a market peak or bottom. If a trend supposedly begins, but there are no volumes in it, then it is most likely not a new trend, but a decoy for hamsters.
5. Only the closing price is important. Charles Dow believed that the most important price was the closing price. At closing, sales volume increases as there is a natural battle between buyers and sellers to determine the winner.
6. The trend continues. Dow argued that the price direction would continue until there were signs of a reversal. A trend is a long-term price movement, and a position should only be opened in accordance with the direction of the trend. Dow Theory does not predict how long a trend will last, it simply suggests following it until a reversal signal or trend break occurs. It is important to understand that no theory can predict the future with accuracy or reliability. The Dow Theory is just a tool that can help investors better understand and analyze market trends and make more informed decisions. From my own experience, I can say that trading with a trend already brings 70% of success, and the remaining 30% are levels, zones, as well as other patterns, all this, of course, subject to risk and money management.
