Applying Dow Theory to Modern Markets
The Basics of Dow Theory
Dow Theory is a method of analyzing and interpreting stock market trends that was developed by Charles Dow in the late 19th century. The theory is based on the idea that the stock market moves in trends, and that these trends can be identified and used to make investment decisions.
Key Principles of Dow Theory:
- Market Discounts Everything: According to Dow Theory, all information – public, private, and even insider – is already reflected in the stock prices.
- Markets Have Three Trends: Dow Theory identifies three main trends in the market – the primary trend, the secondary trend, and the minor trends.
- Volume Confirms Trends: Dow believed that trading volume should confirm the direction of the trend. For example, if prices are rising on high volume, it is a bullish sign.
Applying Dow Theory to Modern Markets
1. Identify the Primary Trend
The first step in applying Dow Theory to modern markets is to identify the primary trend. This can be done by looking at long-term charts and analyzing the overall direction of the market. Is it in an uptrend, downtrend, or sideways trend?
2. Look for Secondary Trends
Once you have identified the primary trend, look for secondary trends within that primary trend. These are shorter-term movements that can provide opportunities for trading or investing.
3. Use Volume to Confirm Trends
Pay attention to trading volume to confirm the direction of the trend. If prices are rising on high volume, it is a bullish sign. Conversely, if prices are falling on high volume, it is a bearish sign.
4. Watch for Confirmation from Averages
Another key aspect of Dow Theory is the use of moving averages to confirm trends. Look for crossovers of short-term and long-term moving averages as signals of potential trend changes.
Conclusion
While Dow Theory was developed over a century ago, its principles still hold true in modern markets. By applying these principles to your analysis of the stock market, you can gain a better understanding of trends and make more informed investment decisions.
