Dow Theory has been considered as one of the most important guides for price trends since its establishment in 1900. In this post, we will find out what it is and how it’s used. Let’s get started.

Dow Theory: All You Need To Know

Who is the Originator of Dow Theory?

Charles Dow, the founder of Dow Jones And Company and the famous “Wall Street Journal“, came up with the eponymous Dow Theory. With this newspaper, he published the prices of the stocks and the annual financial statements of the companies in the stock market, which were difficult to obtain for the readers according to the conditions of that time, and became the first media tool to make a press on this stock market issue. This method has managed to attract more attention. In addition to these, Charles Dow created a new index from the share prices of some companies established for the stock market.

Charles Dow is best known as the person who laid the foundation for modern financial journalism. In addition, he was instrumental in the widespread and further development of fundamental analysis with his studies on company balance sheets. Charles Dow has succeeded in taking the first steps of the technical analysis method with the new stock market indices he has created.

What are the Basic Principles of Dow Theory?

Trends in the market

Some people in the financial field say that the projects that Charles developed on technical analysis led to the formation of the concept of “trend”, which is thought to lead the financial market today. It doesn’t exploit some btc loophole to give you some secret investment tips. According to the Dow Theory, there are three main types of market trends. These three trends are:

Main trend

It is the main market movement and the main trend can be expected to take months or years.

Secondary trend

The secondary trend requires only a few weeks at times. Sometimes it can take up to several months.

Tertiary trend

Tertiary trend disappears in less than a week or persists for more than 10 days. In some cases, the tertiary trend may be effective for a much shorter period of time, depending on the situation.  

Investors can uncover new opportunities by observing these three disparate trends. Even if the main trend is of serious importance, the most profitable situations occur when the main trend, secondary and tertiary trends are in conflict.  

E.g; If you believe a coin is showing a positive main trend, but a negative secondary trend is showing, this could be a very good opportunity to buy the coin at a lower price and sell it when the coin’s value rises. When we look at the problem here, the need to determine what kind of trend is and the need for deeper technical analysis comes into play here. Investors in the financial market use many different methods and tools to analyze new trends. So in some cases, several analysis techniques will be more useful to you than using a single method.

The market reflects everything

It is believed that the Dow market reflects everything, which means that all information is reflected in prices. E.g; If a report on a financial company’s increase in revenue is expected to come out, the financial market will bring it forward before the reports are released. In addition, the demand for the stocks of the company increases even before the reports are published, and after the publication of the expected positive report, there is no big change in prices.

Many financial investors and those who use technical analysis very often continue to believe this principle is true. However, investors who analyze with the fundamental analysis technique, unlike technical analysis users, suggest that the markets do not specify the real stocks.  

Stages of Major Trends

Charles Dow said that the main long-term trends consist of three phases. These three stages are:

General participation

General participation is the fact that more people start to invest collectively in the investment market as a result of the investors realizing the opportunities that will arise with different analysis methods. When it comes to this stage, the prices in the market begin to rise rapidly due to the fact that too many investments are made all at once.

Spooling

Assets are still undervalued as market sentiment remains widely negative, following the previous “bear market”. Investors start saving during a bear market before there is a significant increase in prices.

Distribution and redundancy

The third stage is distribution and redundancy. In this process, investors continue to analyze and evaluate opportunities, but the end of the trend is approaching. In this case, market makers immediately begin to distribute their savings. If an investor does not realize that the trend is about to change without adequate information, then market makers sell their savings to them before the trend changes.

Cross-Index correlation

Charles Dow had the idea that the volatility and trend in the markets should be confirmed together with the volatility in other markets.

At that time, the transport market, and in particular the railways, had very close relations with industrial activities. Therefore, in order to produce more products, there had to be an increase in railroad activities, which would first provide the necessary raw materials. As a result, there was a clear correlation between the transport market and the manufacturing sector. Because if one of them was healthy, the probability of the other being healthy was high. However, the principle of cross-index correlation does not currently work as well between markets as before. This is because many products no longer require digital and physical transportation.

Trends are valid until a reversal is confirmed

Charles Dow believed that if the market was in a trend, the trend was sustainable. E.g; If stocks of a business start to trend upwards after a positive news release, they should continue to rise until a definite trend change is seen. Charles Dow, therefore, advocated the idea that one should be suspicious of trend movements until the beginning of the main trend is certain. In addition, it is not easy to distinguish between the main trend and a secondary trend, and investors can often be faced with trend movements that cause mistakes.  

Volume Is Very Important

One of the principles that Charles Dow believes and puts forward is the principle that “volume is very important”. Charles Dow advocated the idea that volume was an important secondary indicator, as did some investors today. In other words, the more the volume of transactions made by investors increases, the more likely it is that real trends will occur in the market. If the trading volume is low, however, it may mean that price movements do not reflect a true market trend.

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