What is Dow Theory?

What is Dow Theory?

Dow Theory is perhaps the longest-standing method of market analysis still used in modern finance. It suggests that markets experience primary trends (which last several years), intermediate trends (which last under a year), and minor trends (which last less than a month). Markets are in an upward trend if an average exceeds certain thresholds, followed by a similar movement from another average. Longer, larger trends are considered more predictive than smaller ones, though correctly reading the primary trend in the main goal.

Dow Theory’s theoretical tenets were presented in editorials written by Charles Dow around 1900 and summarized by his successors. Dow is also the creator of the Dow Jones Industrial Average – an index comprised of 30 significant U.S. stocks, typically the biggest and most frequently traded.

Dow Theory reflects Dow’s belief that the stock market is a dependable way to measure to measure business conditions and trends for the entire economy. The original indicators used to gauge the primary trend were the convergence or divergence of indexes for Manufacturing and Rail. Today, the convergence or divergence between the Dow Jones Industrial Average and the Dow Jones Transportation are interpreted as bullish or bearish signals.

Statistically, these indicators have not proven to be as successful as Dow intended, but a good market analyst can still glean insight from this theory – one of the reasons it has stuck around as other indicators have fallen by the wayside.

The Dow Theory can be just one of many tools in a trader’s toolbox. Increases in computing power mean more tools are being developed with each passing year, and institutional and retail investors are using them to develop strategies. There are several common indicators that traders use for technical analysis in trading. A few examples include the Moving Averages indicator, MACD, RSI, Stochastics, Aroon, and more.

Trend trading seeks to capture an ongoing bullish or bearish trend and invest with momentum. Usually it’s best to use the help of Artificial Intelligence to determine whether a trend is confirmed over the short or long-term.

There are myriad ways to use technical analysis in trading, and which indicator or methodology a trader decides to use usually depends on their experience, skillset, and the quality of the tools (A.I.) available to help them find trade ideas.