Basic Technical Analysis - Dow Theory

Here is a detailed explanation of Dow Theory in 10 points:

1. Market Trends: Dow Theory emphasizes that the market moves in three main trends: primary, secondary, and minor. The primary trend is the market's long-term direction, lasting several months to years. Secondary trends are corrective movements against the primary trend, lasting weeks to months. Minor trends are short-term fluctuations that can last hours to weeks.

2. The Averages: Dow Theory focuses on the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA). The theory suggests that the movement of both averages should confirm each other to validate a trend. If both averages make higher highs or lower lows, it is considered a confirmation.

3. The Three Phases: Dow Theory defines three phases in a primary trend. The accumulation phase occurs when smart money (informed investors) starts buying stocks, often during market bottoms. The public participation phase follows, marked by increasing investor interest and rising prices. The distribution phase occurs when smart money starts selling stocks to the uninformed public.

4. Volume Confirmation: Dow Theory emphasizes that volume should confirm the price movements. The higher volume should accompany rising prices in an uptrend, indicating increased buying pressure. Conversely, in a downtrend, higher volume should accompany falling prices, indicating increased selling pressure.

5. Trend Continuation: Dow Theory suggests that trends are more likely to continue than reverse. It advises investors to assume the current trend will persist until there is evidence of a reversal. This helps avoid premature decisions based on minor fluctuations.

6. Support and Resistance: Dow Theory acknowledges the importance of support and resistance levels. Support is a price level where buying interest is expected to emerge, preventing further declines. Resistance is a price level where selling pressure is expected to increase, preventing further advances. The theory suggests that these levels can help identify potential reversal points.

7. Trendline Analysis: Dow Theory emphasizes the use of trendlines to identify and confirm trends. An uptrend is confirmed by an ascending trendline connecting higher lows, while a downtrend is confirmed by a descending trendline connecting lower highs. Trendlines help traders visualize the strength and direction of the trend.

8. Time Confirmation: Dow Theory suggests that trends require time to develop and complete. It discourages making hasty decisions based on short-term fluctuations and advises considering the overall time frame of the primary trend.

9. Intermarket Analysis: While not explicitly mentioned in the original Dow Theory, Intermarket analysis has become an important extension. It involves analyzing the relationships between different markets, such as stocks, bonds, currencies, and commodities, to gain insights into broader market trends.

10. Limitations: Dow Theory has some limitations, including subjectivity in interpreting price patterns, lagging signals, limited indicators, and the lack of quantitative analysis. It should be used in conjunction with other tools and strategies to make more informed investment decisions.

Remember that Dow Theory provides a framework for technical analysis, but it is not foolproof. It is essential to combine it with other tools, conduct thorough research, and consider fundamental analysis to make well-rounded investment decisions.