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What is Dow theory? What does it help us with? This is a question posed by many as they begin to explore the trading world. Below are some fundamental insights synthesized by COINSTRATEGISTS. Hopefully you will find them interesting and useful.
WHAT IS DOW THEORY?
Dow Theory is a fundamental cornerstone of technical analysis in forex and cryptocurrency trading markets, aiding in market information and fluctuations. This work on the Dow Theory by Robert Rhea, introduced by Charles Dow and developed by William Hamilton, appeared in 1932.
It serves as the initial framework for explaining that markets move in trends. Despite significant changes in stock, forex, and cryptocurrency markets over recent years, the basic principles of Dow Theory remain valuable. It forms the foundation of widely used technical analysis tools such as Trendline, RSI, MACD, and Elliott Wave.
PRINCIPLES OF DOW THEORY
What is Dow Theory? Amidst market fluctuations, it continues to be applied effectively. Here are 6 key principles:
MARKET PRICE FLUCTUATIONS REFLECT EVERYTHING
This principle reflects the market activity of investors, including those with the best insight and information about trends and events.
Stock market indices reflect public information about all events, known or unknown. When unexpected events occur, they will adjust quickly to accurately reflect market value.
3 MARKET TRENDS
The long-term trend of a stock’s price, also known as the primary trend, represents a price change lasting one or more years, which can result in an increase or decrease.
On the main trend line, there are periods interrupted by secondary trends that go against the main trend, which are reactions or corrections that occur when the main trend increases or decreases excessively over a certain period of time.
Secondary trends are smaller, often unimportant fluctuations that often change from day to day.
MAIN TRENDS
It is a general trend that lasts for a year or several years, with each price increase being higher than the previous one. Even though there are price reactions, the upward price trend is still the dominant trend.
This main trend is a bull market, in which each price decline is lower than the previous one.
If each subsequent price increase is not strong enough to bring the price higher than the previous one, it is a bearish trend, called a bear market.
SECONDARY TREND
These reactions disrupt the primary trend, with declines or corrections in bull markets and price increases or rallies in bear markets.
This trend usually lasts from three weeks to several months and reverses the value of about 1/3 to 2/3 of the previous increases and decreases.
To recognize the secondary trend: it is a price movement opposite to the main trend, lasting about 3 weeks and decreasing by over 1/3 compared to the previous price drop.
SMALL TREND
Small fluctuations usually last 6 days, rarely more than 3 weeks, and are not important to the Dow theory trader. Usually, in intermediate waves or between two secondary trends, there are usually 3 small waves that are easy to manipulate.
THE TREND IS CONFIRMED WITH VOLUME
Trading volume must confirm price action, and trends must be supported by volume, meaning trading volume increases as prices follow the main trend.
In a bull market, trading volume increases when prices rise and decreases when prices fall. In a bear market, volume increases when prices fall and decreases when prices recover.
The same is true for secondary trends. Reversal signals can be seen from price movements, while trading volume is only added when needed.
SIDESWAYS MARKETS CAN REPLACE SECONDARY TRENDS
The market can remain sideways (trading between a range) for a long time. For example, bitcoin price fluctuated between 9700$ and 10000$ for a long time. Sideways markets of this type can replace secondary trends.
THE CLOSING PRICE WAS THE BEST
Dow Theory does not pay attention to the highest or lowest price of the day, but only to the closing price.
INDICATORS MUST CONFIRM EACH OTHER
We cannot confirm a trend based on just one indicator. When it started, Dow used the Dow Jones industrial index and transportation. The market is only considered bullish if both indexes are pointing up. The market cannot be classified as bullish based on just one metric.
BULL MARKET IN DOW THEORY
What is Dow Theory? Consists of three phases: Accumulation phase, marking phase, distribution phase.
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ACCUMULATION PHASE
The early stages of a bull market often do not differ much from the final reaction of a bear market, when pessimism still prevails.
This is a time for patient people to see the value of owning stocks in the long term, even though they are cheap but currently no one wants to buy them.
When the volume of shares sold decreases, the share price will gradually increase. Financial reports still show a difficult market situation. Average market activity but starting to see small price increases.
MARKING PHASE
This is the period that usually lasts the longest and witnesses the strongest price increases, and is also the time when the market is most active. This period is recognized by improving business conditions and increasing stock values.
As income and profits begin to increase, confidence also begins to change. This is the easiest time to make money because there is widespread participation and many people join the trend.
EXCESSIVE STAGE
Phase three of the bull market is when excessive speculation and inflationary pressures become evident, a description that was researched and established by Dow about 100 years ago.
At this final stage, the public is fully engaged in the market, overvalued and extremely confident, similar to the first stage of a bull market.
BEAR MARKET IN DOW THEORY
What is Dow Theory? The bear market is also divided into 3 phases: Distribution phase, transition phase, and despair phase.
DISTRIBUTION PHASE
The distribution phase, like accumulation, begins when users realize unfavorable business conditions and start selling shares.
While the market is falling, few people believe that a bear market has begun. Most forecast that the market will continue to increase. Experienced investors have begun selling stocks to profit from the price increase.
Trading volume is still high but is decreasing during the bull run. Public interest remains strong but has shown signs of waning as hopes for profits dwindle.
MARKING PHASE
The second phase of a bear market is when the downtrend is clear and business conditions begin to deteriorate, leading to reduced earnings, shortages, profit margins and sales. The sell-off continued as business conditions worsened.
DESPERATE STAGE
This is the final stage of the bear market, when all hope is lost and stocks are being sold cheaply due to acquiescence. Bad news and a recessionary economic outlook cause participants to try to sell without finding buyers.
The market falls until the bad news is full in stocks. When enough bad results are reflected, a new cycle begins.
IMPORTANT MODELS IN DOW THEORY
What is Dow Theory? There are several important patterns in which traders can apply to spot trading opportunities, including:
– 2 tops, 2 bottoms model
– 3 tops, 3 bottoms model
– Transaction scope
– Price flag model
CONCLUDE
As stated in many indicator tools, theory is the basis. Success in trading depends on your practical application and execution of trades. Through this, you will develop an effective and hopefully successful trading method.
