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- The reversal of a downward primary trend occurs when the market no longer falls to lower lows and highs.
- These periods of sideways (or horizontal) price movements are seen as a period of consolidation.
- Note that the Dow Theory assumes the market doesn’t move in a straight line, but rather from highs (peaks) to lows (troughs), with the overall trend of the market trending in a specific direction.
- This implies that there is no need to investigate further why assets are priced the way they are, but to act on price movements and volume and depend on signals and confirmation for trend reversals.
There Are Three Primary Kinds of Market Trends
- A peak is defined as the highest price of a market movement in a period, while a trough is seen as the lowest price of a market movement in a period.
- Trading volume rises when prices move with the primary trend and falls when they move against it.
- Charles Dow focused on closing prices, disregarding intraday movements of the index.
- Aspects of the theory have lost ground—for example, its emphasis on the transportation sector and railroads—but Dow’s approach forms the core of modern technical analysis.
This implies that there is no need to investigate further why assets are priced the way they are, but to act on price movements and volume and depend on signals and confirmation for trend reversals. Markets experience primary trends which can last a year or more, such as a bull or bear market. Within the broader trends, secondary trends make smaller movements, such as a pullback within a bull market or a rally within a bear market; these secondary trends can last a few weeks to a few months. Reversals in primary trends can be confused with secondary trends. It is difficult to determine whether an upswing in a bear market is a reversal or a short-lived rally followed by still lower lows. The Dow Theory advocates caution, insisting that a possible reversal be confirmed by comparing indexes.
The Market Discounts Everything
The Dow Theory attempts to identify the primary trend a market is in. It is comprised of three primary trends, each made up of secondary and minor trends. The theory assumes that the market already has knowledge of every possible factor and that prices reflect current information.
Note that the Dow Theory assumes the market doesn’t move in a straight line, but rather from highs (peaks) to lows (troughs), with the overall trend of the market trending in a specific direction. Finally, minor trends are day-to-day price fluctuations in the market. A reversal in the primary trend is signaled when the market cannot create successive peaks and troughs in the direction of the primary trend. The reversal of a downward primary trend occurs when the market no longer falls to lower lows and highs. Consecutive higher highs and higher lows in a downward-trending market demonstrate a possible reversal to an upward trend.
Trading volume rises when prices move with the primary trend and falls when they move against it. For example, in a bull market, buying volume should increase as the price rises and falls during secondary pullbacks because traders still believe in the primary bullish trend. If selling volume picks up during a pullback, it could be a sign that more market participants are turning bearish. One of the main techniques used to identify trend reversals in Dow Theory is peak-and-trough analysis. A peak is defined as the highest price of a market movement in a period, while a trough is seen as the lowest price of a market movement in a period.
Identifying Trends and Signals in Dow Theory
The overall goal of the Dow Theory is to identify the market’s primary trend through proof and confirmation. During an uptrend, a reversal occurs when the index consecutively fails to reach higher highs and higher lows over a long period. Instead, the index moves in a series of lower highs followed by lower lows.
The Role of Closing Prices and Line Ranges in Dow Theory
Charles Dow focused on closing prices, disregarding intraday movements of the index. The Dow Jones Industrial Average, known as the Dow, is affected by the prices of the stocks that make up the index. Earnings potential, competitive advantage, management competence—all these factors and more are priced into the market, even if not everyone knows all or any of these details. In more strict readings of this theory, even future events are discounted in the form of risk.
The sixth tenet of Dow Theory contends that a trend remains in effect until there is a clear sign that the trend has reversed. Similarly, the market will continue to move in a primary direction until a force, such as a change in business conditions, is strong enough to change the direction of this primary move. According to the Dow Theory, the primary bull and bear trends pass through teoria de dow three phases. Dow believed the overall stock market reflects business conditions in the economy, allowing analysts to assess these conditions and predict market and stock trends.
The Origins and Evolution of Dow Theory
The Dow Theory, established by Charles H. Dow, posits that the stock market’s direction can be gauged by analyzing the movements of specific market averages. By analyzing these averages, investors can gain insights into the overall business conditions and future market directions. For a trend to be established, Dow postulated indices or market averages must confirm each other. This means that the signals that occur on one index must match or correspond with the signals on the other. If one index, such as the Dow Jones Industrial Average, shows a new primary uptrend, but another remains in a primary downward trend, traders should not assume that a new trend has begun. These periods of sideways (or horizontal) price movements are seen as a period of consolidation.
A downward trend is a series of successively lower peaks and troughs. One challenging aspect of implementing Dow Theory is accurately identifying trend reversals. Remember, a follower of Dow Theory trades with the overall direction of the market, so it is vital that they recognize the points at which this direction shifts.
The Dow Theory operates on the efficient market hypothesis (EMH), which states that asset prices incorporate all available information. Aspects of the theory have lost ground—for example, its emphasis on the transportation sector and railroads—but Dow’s approach forms the core of modern technical analysis. Dow fleshed out the theory in a series of editorials in the Wall Street Journal, which he co-founded.
Therefore, traders should wait for the price movement to break the trend line before coming to a conclusion on which way the market is headed. For example, if the price were to move above the line, it’s likely that the market would trend up. An upward trend in Dow Theory is a series of successively higher peaks and troughs.
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