Introduction to Dow Theory
When Charles Dow published his observations at the end of the 19th century in the Wall Street Journal he, unfortunately, did not name his observations. His theory was named "Dow Theory" by later chartists and it is Dow Theory in which modern technical analysis has its roots.
Dow Theory is based on the philosophy that market prices reflect every significant factor that affects supply and demand - volume of trade, fluctuations in exchange rates, commodity prices, bank rates, and so on. In other words, the daily closing price reflects the psychology of all players involved in a particular marketplace - or the combined judgment of all market participants.
The goal of the theory is to determine changes in the major trends or movements of the market. Markets tend to move in the direction of a trend once it becomes established, until it demonstrates a reversal. Dow theory is interested in the direction of a trend and doesn't offer any forecasting ability for determining the ultimate duration of a trend.
Dow's original "trend following' system highlighted the following points
- Classification of a trend
- Principles of confirmation or divergence
- Use of volume to confirm trends
- Use of percentage retracement
- Recognition of major bull and bear markets
- Signaling the large central section of important market moves
- Dow theory has been successful in identifying 68% the major trends over the years
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Introduction to Dow Theory
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