Dow
Theory
Initially, the principles behind
Dow Theory were used only for American indices created by Charles Dow:
Transportation and Industrial. Most of them however can be successfully applied
to the Foreign Exchange market.
·
Indices discount everything. According to Charles Dow any factor
which influences demand and supply will be reflected in the index. These
factors cannot be foreseen but they are nevertheless taken into account by the
market and shown in the price action of the index.
·
There are three movements on the market. Uptrend is characterised
by the fact that every following top is higher than the previous one and every
next bottom is higher than the previous one. Downtrend is characterised by the
fact that every following top is lower than the previous one and every bottom
is lower than the preceding one. When the market is in the flat position every
next move (up or down) is approximately at the same level as the preceding one.
·
Dow classified market
trends as follows:
- primary trend (a broad trend that can last upto several years);
- secondary trend (lasts between three weeks and three months and is considered as a correcting trend to the primary one. Interim rebounds are one-two thirds (or even half) of the range formed during the primary trend);
- daily trend (a short-term movement within the secondary trend, which has very little long-term forecasting value).
- primary trend (a broad trend that can last upto several years);
- secondary trend (lasts between three weeks and three months and is considered as a correcting trend to the primary one. Interim rebounds are one-two thirds (or even half) of the range formed during the primary trend);
- daily trend (a short-term movement within the secondary trend, which has very little long-term forecasting value).
·
Another classification
was suggested by Thomas DeMark:
- short-term trend (if the price has moved less than 5%);
- mid-term trend (if more than 5% but less than 15%); long-term trend (if more than 15%).
- short-term trend (if the price has moved less than 5%);
- mid-term trend (if more than 5% but less than 15%); long-term trend (if more than 15%).
·
DeMark designed a
forecasting method to predict the beginning of a trend, both mid-term and
long-term. The method is based on specially designed coefficients.
·
The primary trend has
three phases. During the first phase all unfavourable market information has
been discounted by the market and the far-sighted and better informed traders
start to buy. The second phase starts when the traders who do technical
analysis enter the market. Once all economic data becomes more favourable, the
third, final phase begins, which is characterised by high activity on the
market supported by the mass media and optimistic economic forecasts in the
newspapers and on TV. Despite the positive sentiment, the final phase is the
first sign that the prevailing trend is about to end.
·
Indices must confirm
each other in order for the signal to have authority (referred to Industrial
and Rail (or Transport) indices). Charles Dow said that any significant uptrend
or downtrend signal on the market must be considered together in the Industrial
and Rail indices. If we applied this principle now on the basis of modern
technical analysis, it would mean that a signal from one technical indicator
must be confirmed by a signal from another technical indicator.
·
Trade volume must
confirm the prevailing trend. If prices move in accordance with the prevailing
trend, it increases the volume and inversely, when there is a rebound, volume
decreases.
·
The primary trend
remains intact until a change in that trend has been given by the theory. The
last major signal remains in force until a new signal develops. Many analysts
believe that a bull market must always be moving to new highs. However, the
market can undergo extended periods of sideways or lackluster trading without
the primary trend changing. If the last major signal under the theory is bullish,
the primary bull market trend remains in force until a bear market signal is
given.
