Introduction to DOW Theory (1)
Dow’s theory is widely regarded as one of the earliest forms of technical analysis. Published by Charles H. Dow who sees that stock prices tend to move up or down in trend, and they tend to move together, although the level of movement may vary. Charles Dow used this knowledge to develop the Dow Jones Average that is still in use today.
Charles Dow did not use his observations to forecast a potential price movement but saw it as a barometer of the business climate in general. After Dow’s death in 1902, his close friend Samuel A. Nelson attempted to explain the Dow method in his book, The ABC of Stock Speculation. William P. Hamilton, who succeeded Charles Dow as Editor of The Wall Street Journal, refined the Dow principle and developed it into a theory, which he described in his book The Stock Market Barometer: A Study of Estimated Value (1922). Dow and Hamilton’s work was studied by Robert Rhea who refined Dow Theory further into the theories we know today, in his book The Dow Theory, 1932.
Basic Principles of Dow Theory
Average Value discounts everything. This means the average value reflects the combined activity of thousands of people or millions of traders, speculators and investors at one time. Accordingly, any known and anticipated events are included in the calculation, as well as any conditions that may affect the supply and demand of individual stocks.
Price movement consists of three trends
Primary or Primary Trends that usually last at least a year may continue for many years. This trend is usually responsible for price movements, ups or downs in the minimum range of 20%. Primary Trends are interrupted by Secondary Trends that move against Primary Trends to fix them if the trend is too wide (stretched).
Secondary Trends interfere with the movement of the Primary Trends, moving in the opposite direction. However, identifying secondary trends while in the process of formation is very meaningful, you will find it difficult to find early trend resistance. Secondary Trends last for at least three weeks but may continue for several months and are usually repeated at least 1/3 of the previous price movement. Sometimes Secondary Trends can retrace previous movements but often stop at 1/2 or 2/3 from the previous movement. ½ to 2/3 Correcting the previous trend.
Minor trend is the average of daily fluctuations. It usually lasts less than six days and is not important in Dow Theory.