Dow Theory: Understanding the Principles of Stock Market Analysis
Dow theory is a market analysis technique that was developed by Charles Dow in the late 19th and early 20th centuries. It is based on the idea that the stock market reflects the overall health of the economy and that trends in the market can be used to predict future economic conditions.
Principles of Dow theory:
The basic principle of Dow theory is that the stock market is made up of three distinct movements: primary, secondary, and minor. The primary movement is the long-term trend of the market, which is determined by the overall economic conditions. The secondary movement is a short-term reaction to the primary movement, while the minor movement is a day-to-day fluctuation.
One of the key components of Dow theory is the concept of market averages. Dow believed that the stock market could be analyzed by looking at the performance of a few key averages, such as the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA). These averages were thought to be a good indicator of the overall health of the market, as they represented a cross-section of different industries.
Dow theory also emphasizes the importance of trend analysis. According to Dow, trends in the market can be identified by looking at the movement of the averages over time. A trend is established when the averages move in the same direction for an extended period of time. Once a trend is established, it is thought to continue until there is a clear change in direction. Another key principle of Dow theory is the concept of confirmation. According to Dow, a trend is confirmed when the DJIA and the DJTA move in the same direction. This is thought to be a strong indication that the trend is likely to continue.
In summary, Dow theory is a market analysis technique that was developed by Charles Dow in the late 19th and early 20th centuries. It is based on the idea that the stock market reflects the overall health of the economy and that trends in the market can be used to predict future economic conditions. By analyzing market averages and trends, investors can gain valuable insights into the direction of the market and make more informed investment decisions.