Dow Theory is one of the trading methods developed by Charles Dow - the father of the school of technical analysis. To this day, the Dow theory remains the foundation of all technical analysis methods.

Principle 1 - The movement of the market is the sum of three trends

The three trends that Dow addresses in his theory are:
  • Basic trend: Lasting a few years, is also the big trend of the market
  • Intermediate trend: lasting for 3 weeks to several months, is in the basic trend and there will be many intermediate trends to form a basic trend.
  • Small trend: last for a few hours to a few days. This is the least sustainable trend, it will have more noise than the two above and especially this trend is one that the sharks are very fond of because it is easy to manipulate prices. Hence, we are all taught that price manipulation only happens in the short term, but in the long run, the price will return to its true value.

Principle 2 - A market trend always has 3 phases

A trend, whether an uptrend or a downtrend, is formed by three phases. Our task is to clearly identify each phase to predict the next direction of the trend.

An uptrend must have 3 phases:
  • Accumulation - restores confidence in the crowd
  • Reaction - the crowd begins to join
  • Speculation - the crowd is overly confident and greedy following the trend.
A downtrend must have 3 phases:
  • Distribution - the crowd is bored with the market
  • Doubt - the crowd started selling more
  • Panic - selling while screaming and cursing.
Lesson: always keep an eye on market sentiment to get an estimate of what phase a trend is in. For example, if the market is getting too excited and the crowd is buying aggressively, it is the last phase of the uptrend, ready to move to the first phase of the downtrend.

Principle 3 - All news is reflected in the market

Have you heard of the efficient market theory? That concept means that any information happening in the market will be reflected in the final price. Therefore, we do not need to find out much information, because if we know it, it will run into the price.

Is it possible to learn news, events to predict and analyze the future moves and so we have suggestions in the upcoming purchase? But the current information cannot be used to trade anymore.

Lesson: news is something worth reading, but should not rely on trading news as it already reflects on prices. Instead, we should exploit that information from the perspective of input data to analyze future news.

Principle 5 - Volume confirms and direction for the trend

Volume is the only indicator that is independent of price and even it leads prices, thereby leading the whole trend.

In particular, a weakening trend is often associated with low volume. In contrast, when the volume is high, the trend is usually very persistent because there is already volume support. Any market too, the volume is still an indispensable factor, but if you still find it mysterious that you do not know how to use it, not it is not usable.

Lesson: Be sure to consider the volume as the volume confirms the price.

Principle 6 - The trend will continue otherwise a reversal occurs
Dow believes that price moves in trend. Trend reversals are difficult to predict correctly unless they happen and differences in trend magnitude make it more complicated to predict the trend.

However, a trend in the Dow is still in existence until there is evidence confirming a formal reversal. For example, an uptrend turns into a downtrend when the back high is lower than the previous one and the next low is lower than the previous one.

Lesson: don't try to predict the trend and then act against the current trend. Just follow the old trend, because, in any trend, you can only sell at the top once or buy the bottom once.