Dow Theory

The Foundation of Technical Analysis

Dow Theory was developed from the writings of Charles Dow, co-founder of Dow Jones & Company, in the late 19th century. It is not a trading system but rather a set of principles for understanding and analyzing market behavior. Many of the concepts used in technical analysis today, such as the idea of market trends, are derived from Dow Theory.

The Six Tenets of Dow Theory

1. The Market Discounts Everything: All known and knowable information is already reflected in the prices of stocks and market indexes.
2. The Market Has Three Trends: These are the Primary (long-term), Secondary (medium-term corrections within the primary trend), and Minor (short-term noise) trends.
3. Primary Trends Have Three Phases: A primary uptrend (bull market) consists of an accumulation phase, a public participation phase, and a distribution phase. A primary downtrend (bear market) has the reverse.
4. The Averages Must Confirm Each Other: Dow originally asserted that for a valid trend to be established, both the Dow Jones Industrial Average and the Dow Jones Transportation Average must confirm each other's direction.
5. Volume Must Confirm the Trend: In an uptrend, volume should increase as prices rise and decrease as prices fall. In a downtrend, volume should increase as prices fall.
6. A Trend Is Assumed to Be in Effect Until It Gives Definite Signals That It Has Reversed.

Relevance Today

While the markets have evolved significantly since Dow's time, the core principles of Dow Theory—particularly the concepts of trends, confirmation, and the market discounting all information—remain highly relevant and form the philosophical basis for modern technical analysis.