The Dow Theory appeared around1890, and it was its appearance that paved the way for the concept of technical analysis to spread. In many ways, the Dow theory was the basis for successive trading techniques, including the famous Elliott Wave Theory.
Introduction to the Dow Theory
This theory derives its name from Charles Henry Dow, who founded the "Wall Street Journal", co-founded the Dow Jones Company with Edward Jones, and invented the Dow Jones Industrial Index.
However, it was Mr. Dow who directly developed it. He simply wrote a series of articles about stock price movements, which were later systematized by successive generations of analysts - and in particular by William Peter Hamilton and Robert Rhea - who named the theory after him.
1. The price includes everything
"Price includes everything" means that the market will take into account all factors affecting prices, such as the economy, politics, and psychology, and reflect them in the price.
2. Three trends in the market
In any market, three trends must coexist: short-term, medium-term, and long-term trends.
1) Primary trend: The primary trend is usually a long-term trend, sometimes even as long as 1 year. The primary trend affects other trends, so for traders, it is the most important trend.
2) Secondary trend: The secondary trend is a correction to the main trend, and the duration ranges from three weeks to three months. It moves downward in a bull market and upward in a bear market.
3) Minor trend: also known as "short-term fluctuations", usually lasting several hours to several weeks. It is a fall in a secondary trend. At this time, the market "noise" is high, and slight price fluctuations will affect market sentiment.
3. Three stages of the trend
1) Accumulation stage
This is a consolidation phase. The market hesitates, and the previous trend is almost over. It is often a good moment for traders to enter the market, but at the same time risks associated with doing so are greater.
2) Absorption stage
Once market actors have a confirmed direction, we enter the absorption stage. The main trend generally appears at this stage, and the trend lasts the longest. Price volatility is greatest at this time.
3) Distribution stage
When signs of instability appear, traders begin to close their positions. At this time, the price may continue to stick in the same direction because of inertia, but they will eventually reverse.
4. Take advantage of the trend
The Dow Theory postulates that traders should follow the primary trend to place orders and not be disturbed by short-term fluctuations.
This has implications for trading volumes. In a major uptrend, transaction volume will increase with price growth. Conversely, under a major downtrend, trading volume will increase as prices fall.
5. Assume that the trend remains valid until a clear reversal signal appears
One of the tenets of the Dow Theory is that a trend will continue to play out until a clear reversal signal appears.
Remember that when prices make higher highs and higher lows, an upward trend dominates. Conversely, when prices have lower highs and lower lows, a downward trend exists.
The trend breaks when a lower low than the previous one is formed in an uptrend, or a higher high than the previous one is formed in a downtrend.
Although technical analysis has made great strides over time, the Dow Theory remains a pillar of technical analysis, its analysis of market sentiment still being regarded as a classic. And it probably is also the first technical tool many crypto traders come into contact with.