"Dow Theory": The origin of market technical research undoubtedly belongs to Dow Theory. Initially, Dow Theory originated from the editorials of Charles Henry Dow, a journalist, the first Wall Street Journal reporter, and co-founder of Dow Jones & Company. Although most people regard Dow Theory as a technical analysis tool, Charles Dow considered it a barometer reflecting the overall market trend. By understanding the basic definitions, fundamental trends, and operational principles of Dow Theory, investors can effectively predict future price movements based on price pattern studies.
The Basic Model of Dow Theory
1. Basic Definition
Dow Theory is the origin of all market technical research. Although often criticized for being slow to react and frequently mocked by opponents, Dow Theory is highly respected by most, especially those with experience in the stock market. However, people rarely realize that this theory is purely technical, focusing solely on the behavior of the stock market itself rather than the business statistics relied upon by fundamental analysts.
After Charles Dow's death in 1902, William Peter Hamilton and Robert Rhea inherited Dow Theory and later organized and summarized it in their commentaries on the stock market, forming the Dow Theory we know today.
As an investment analysis tool, Dow Theory requires certain assumptions for technical analysis: market behavior discounts all information, security prices move in trends, and history repeats itself.
2. Basic Trends
Dow Theory states that stocks move in the same direction as the market trend, reflecting the market's trends and conditions. Generally, stock movements are categorized into three trends: primary, intermediate, and short-term.
Primary Trend: Lasts one year or more, with most stocks rising or falling with the overall market, typically by more than 20%.
Intermediate Trend: Moves in the opposite direction of the primary trend, lasting over three weeks, with a magnitude of one-third to two-thirds of the primary trend.
Short-Term Trend: Reflects only short-term price changes, lasting no more than six days.
A bull market is characterized by a primary trend consisting of three upward movements, interrupted by two declines, such as periods of weakness. Throughout the cycle, declines may be lower than expected, each lower than the last. The cycle typically consists of several intermediate declines and recoveries.
3. Operational Principles
The operational principles of Dow Theory can be summarized as follows:
(1) Market averages calculated using closing prices can explain and reflect most market behavior. This is Dow Theory's most significant contribution to the securities market. Today, all stock exchanges worldwide calculate price indices in similar ways, all derived from this principle.
(2) Market fluctuations exhibit certain trends. Despite varying forms of price movements, they can ultimately be categorized into primary, secondary, and minor trends.
(3) Primary trends have three phases. In an upward trend, the first phase is accumulation, the second is the upward movement, and the third is another accumulation period after prices peak.
(4) Two market averages must confirm each other. Dow Theory holds that the industrial average and transportation average must move in the same direction to confirm a market trend.
(5) Trends must be confirmed by trading volume.
(6) Once a trend is established, it will continue until a clear reversal signal appears.
"Dow Theory": Dow Theory is a tool or equipment to enhance the knowledge of investors or speculators and cannot be separated from economic fundamentals and current market conditions—this is the essence of Dow Theory. As investors, mastering the basic definitions and trends of Dow Theory and skillfully applying its operational principles enables rational investment decisions based on the overall market trend.
