Dow Theory( That investors must understand: The key to effective technical analysis

Import: Why Dow Theory Still Matters Today

Since the 20th century, the (Dow Theory) has shaped the way investors around the world analyze stock markets. Although more than a century has passed, the fundamental principles of this theory remain robust and applicable to all trading assets, whether stocks, crypto, gold, or currency pairs.

The (Dow Theory) is not just a price analysis tool but a philosophy of market reading that incorporates investment psychology and herd behavior. Investors who truly understand this theory will have an advantage in planning both short-term and long-term trades.

What is the (Dow Theory): A Clear Definition

(Dow Theory) is a technical analysis system focused on studying price movements within economic cycles, using trends across various stock categories as indicators.

Its origin comes from articles in The Wall Street Journal written by Charles H. Dow along with William Peter Hamilton, aiming to forecast market directions and explain investor behavior at different market cycle phases.

The Foundations of Dow Theory: Reading the Market Like Reading Ocean Waves

If you compare stock price movements to the power of the ocean, you’ll find waves of main, secondary, and minor sizes.

During an uptrend (Uptrend), prices will make new highs that surpass previous highs (Higher High) and new lows that are higher than previous lows (Higher Low). This phenomenon reflects strong buying momentum.

Conversely, in a downtrend (Downtrend), prices will make new lows lower than previous lows (Lower Low) and new highs lower than previous highs (Lower High). This indicates selling pressure dominates the market.

Classifying Price Trends: Understanding 3 Levels of Movement

1. Primary Trend (Primary Trend)

The primary trend is the longest movement, lasting from 200 days up to 3-4 years.

Understanding the primary trend helps investors know the overall market direction. Investing against it is risky and likely to lead to losses.

2. Intermediate Trend (Intermediate Trend)

This trend lasts shorter, from 3 weeks to 3 months, often appearing as a correction or consolidation to build strength for the next move.

Mid-term traders will be most interested in this trend.

3. Minor Trend (Minor Trend)

Minor trends are movements within a day or over 2-3 weeks, short-term fluctuations that are usually insignificant for long-term investment decisions.

Six Fundamental Principles of Dow Theory: Building a Solid Foundation

Principle 1: The market discounts all information

All news, from company fundamentals, government announcements, to market sentiment, is reflected in the price chart.

Because of this, technical analysts do not need to wait for new information; the market signals are embedded in price movements.

Principle 2: Trends have three categories

As explained above, price movements are not random but follow trends divided into primary, secondary, and minor.

Principle 3: Each trend has three phases

Phase 1 - Accumulation: Select investors start buying when prices are low. The trend is still unclear, and the market appears calm, but knowledgeable traders are accumulating.

Phase 2 - Public Participation: As the trend becomes clear, the general public begins trading heavily, volume increases, and this is the prime period for speculation.

Phase 3 - Distribution: Large investors start selling off their positions. Prices remain high, but warning signals appear. Retail investors continue buying, but this is a high-risk phase.

( Principle 4: Confirming the trend requires agreement among indices

Charles Dow used the Dow Jones Industrial Average and the Dow Jones Transportation Average to confirm trends. If one rises while the other falls, it’s not a strong bullish signal.

) Principle 5: Volume must confirm the trend

In an uptrend, volume (Volume) should increase over time. In a downtrend, selling volume should rise. If trend and volume align, it indicates the “price is genuine.”

( Principle 6: Trends continue until clear reversal signals appear

Trends can persist for a long time until a clear reversal signal occurs, such as a lower low )Lower Low### when prices should be rising.

Reversal Patterns: Double Bottom and Double Top

Double Bottom - Signal that the market is turning bullish

A Double Bottom occurs when prices hit two lows at similar levels and cannot go lower. This pattern resembles a “W” or “U.”

When prices break above the high between the two lows (between two lows), it signals the end of the downtrend and the start of a new uptrend.

Double Top - Warning of a trend reversal from up to down

A Double Top is like a mirror image of the Double Bottom. Prices reach two highs at similar levels, forming an “M” shape.

When prices break below the low between the two highs, it indicates the end of the uptrend and the market is likely to decline.

Advantages and Limitations of Dow Theory

( Benefits

✓ Simplicity: The principles of Dow Theory are straightforward and logical, not complex, making it easy for beginners to learn and apply.

✓ Systematic Market Reading: Helps identify market trends methodically, allowing investors to plan strategically.

✓ Emphasis on Volume: Giving importance to volume confirms trend strength.

✓ No reliance on economic data: Investors can trade even when economic data is unstable or delayed.

) Limitations

✗ Lagging: Waiting for trend confirmation can cause delays; signals often come after the price has moved.

✗ Ignoring fundamentals: Dow Theory focuses solely on price and volume, ignoring company fundamentals, major news, or other factors.

Trading Strategies Using Dow Theory

Today, many investors prefer trading products like CFD ###Contract for Difference( to trade both directions.

When analysis indicates an uptrend )Higher High, Higher Low###, investors can:

• Place Buy Orders to capitalize on upward movement
• Set appropriate Lot Sizes
• Use leverage according to risk appetite
• Clearly define entry points, take-profit, and stop-loss levels

Similarly, during a downtrend, investors can place Sell Orders to profit from falling prices.

By correctly understanding the trend, investors can make informed trading decisions, plan profits, and manage risks effectively.

Conclusion: Starting to Learn Dow Theory

The ###Dow Theory### is more than just a technique; it’s a way of thinking about the market that recognizes how investor community stability creates trends.

For investors eager to practice and experiment with this theory risk-free, starting with a demo account offering virtual funds is recommended, allowing safe testing of various strategies.

Deep study of Dow Theory combined with good risk management and patience will lead investors toward success in trading.