What is Dow Theory? The basic concept of Dow Theory Charles Dow is the founder of Dow Jones, an American financial information company, and one of the founders of the Wall Street Journal.
Charles Dow worked as an editor at the Wall Street Journal until his death in 1902.
In the last years of his life, he wrote commentaries on the foreign exchange market.
These articles are the only surviving account of Charles Dawe’s own observations of the regularity of the foreign exchange market.
These records are based on average daily movements in foreign exchange prices.
To this day, many successful investors use the Dow Jones railroad and industrial indexes to analyze currency prices and even the economy.
It is the most reliable indicator ever devised.
The method of analyzing market trends using the foreign exchange average index is often called Dow Theory.
Main principles of Dow Theory Main principles of Dow theory include the following points, as shown in Figure 1-1.
Figure 1-1 Main Principles of Dow Theory II. Three Assumptions of Dow Theory There are three extremely important assumptions of Dow Theory.
This is similar to the three assumptions that investors typically see in technical analysis, but Dow theory is more focused on understanding the meaning of markets.
(1) Hypothesis 1: Daily or weekly index or stock market fluctuations can be artificial reactions. SecondaryReactions can be limited, such as common adjustments, but the main reactions are not.
Investors may say that the main force can affect the main trend of securities. The detailed analysis of this view is shown in Figure 1-2.
Figure 1-2 Main trends affecting securities (2) Hypothesis 2:
Market indices reflect every piece of information, that is, all the hopes, disappointments and knowledge of every market player who knows something about financial matters are reflected in the daily closing price fluctuations of the Shanghai and Shenzhen indices or other indices, so they will always properly anticipate the impact of future events.
If there is a disaster, such as an earthquake or a war, the market index is usually quickly assessed.
(3) Hypothesis 3: Dow Theory is an objectified analytical theory. To successfully utilize it to assist speculation or investment behavior, in-depth research and objective judgment are needed.
And when you use it subjectively, you keep making mistakes and losing money.
Experts remind that in the market, people continue to evaluate and judge the endless subjects such as financial policies, speeches of leaders, institutional violations, GEM and so on every day, and continue to reflect their own psychological factors into the market decision-making.
As a result, the market always seems difficult to grasp and understand for most people.
Dow Theory mainly describes the trend of the foreign exchange market, and it is also very important for the classification of the different levels of the trend.
The following is the main content of Dow theory.
Dow theory asserts that foreign exchange moves in the same direction as market trends to reflect market trends and conditions.
The changes of foreign exchange can be divided into three trends: main trend, medium trend and short trend, as shown in Figure 1-3.
Figure 1-3 Major, medium, and short-term trends In Figure 1-3, the three major trends are described as follows.
(1) Main trend: From numbers 1 to 6, the main trend in the figure is upward, which is an upward trend.
(2) Medium-term trend: the two trends from numbers 2 to 3 and 4 to 5 are opposite to the direction of the main trend and belong to the secondary callback trend.
(3) Short-term trend: from the letters A to B, such a very short time of small fluctuations, is a short-term trend.
Master the operation law of Three trends As for the three trends of foreign exchange changes proposed in Dow Theory, the main operation law is shown in Table 1-1.
Table 1-1 Three trends of foreign exchange changes proposed by Dow Theory Experts remind that the secondary correction trend represents a correction to the main trend.
A moderate decline or “correction” in a bull market;
A bear market is a moderate rise, or “rebound.”
(1) In Dow Theory, no matter the upward trend or downward trend, its operation process is divided into three stages respectively, as shown in Figure 1-4.
Figure 1-4 Introduction of the operation process of each trend in Dow Theory (2) Volume can verify the operation of the trend.
For example, in a downtrend, because the buying force is never able to flood in, and the selling pressure is in a wheel mode, so the whole process tends to show a typical “downtrend” pattern.
(3) The basic trend will continue until a clear reversal signal is given.
When a major trend is established, it usually moves in the existing direction until some external force changes the direction of its motion.
Markets are always evolving, bull markets cannot last forever, and bear markets will hit bottom sooner or later.
The analytical methods of Dow theory mainly include the following.
(1) Two indexes are used to determine the overall trend.
In the Dow Jones composite index, 30 industrial indexes and 20 railway indexes are representative data, and the combined data analysis of the changes of the two determines the trend analysis conclusion of Dow theory to a large extent.
It should be noted, however, that if the two are separated and only the changes shown by one index are analyzed, the results of the analysis are not reliable enough to signal the occurrence of a valid reversal.
(2) Judging the change of trend according to the volume.
Generally speaking, in the foreign exchange market, when the main trend changes, the trading volume will also change accordingly. Therefore, investors can make a judgment of the main trend based on the trading volume.
It’s important to note, however, that the right conclusions are not drawn from a few days of volume analysis, but rather from overall trading analysis over a period of time.
(3) The game can replace the secondary trend.
In the forex market, trades often develop to form tops or bottoms over a period of time, but in terms of timing, they tend to occur during the consolidation of major trends.
At this point, it is quite possible that one index develops into a set, while the other develops into a typical sub-trend.
(4) Put the closing price first.
This is one of the main principles of Dow theory.
As the final evaluation of the stock price of the day, the closing price is what most investors pay attention to, and they usually make trading orders at this price. Therefore, Dow Theory believes that the closing price is the first element that should be paid attention to in foreign exchange investment.
(5) The trend before the reversal trend will still be influenced by the main trend.
When a major new trend is identified, its effects persist.
Of course, this persistent effect will diminish over time.
In other words, a reversal trend can occur at any time after a new trend is confirmed, which requires investors to keep an eye on the market.
(6) Stock market fluctuations reflect all market behavior.
Among the factors affecting the mentality of the masses, the rise and fall of the stock market index is an important aspect. Therefore, investors should start from the stock price index of the whole market, analyze the market mentality and behavior, and then choose the direction of foreign exchange investment.
V. Main Defects of Dow Theory The defects of Dow theory are mainly reflected in three aspects, as shown in Figure 1-5.
In addition, Dow theory mainly discusses the trend of selected foreign exchange, and needs to use two indexes to confirm it, so it has a lag and is of limited help to foreign exchange investors in choosing foreign exchange products.
Experts caution that investors should be aware that Dow theory can only infer the trend of foreign exchange, but not the rise or fall of a broad trend.
