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What is the Dow Theory?

Propounded by Charles H.Dow, the Dow Theory states that the financial markets accurately indicate the health of the business enverment, and that an invvestor can ideentify the direction of the market and individual stocks by analysing the market's performance.

six basic tenets of the dow theory

The Market Has Three Movements:

a. The “main movement” – primary movement or major trend –
may last from less than a year to several years. It may be bullish or bearish.

b. The “medium swing” – secondary reaction or intermediate reaction –
may last from 10 days to three months and generally retraces from 33% to 66% of the primary price change since the previous medium swing or start of the main.

c. The “short swing” or minor movement varies with opinion from hours to a month or even more.

The three movements may be simultaneous: for instance, a daily minor movement in a bearish secondary reaction in a bullish primary movement.

Market Trends Have Three Phases

Dow Theory asserts that major market trends comprise three phases – an accumulation phase (phase 1),
a public participation (or absorption) phase (phase 2),
and a distribution phase (phase 3).
Accumulation or phase 1 is a period when investors “in the know” are actively buying stocks against the general opinion of the market. During this phase, stock prices do not change much because investors demanding (absorbing) stocks that the market at large is supplying (releasing) are in the minority. Eventually, the market catches on with these astute investors and a rapid price change occurs indicating phase
2. And this happens when trend followers and other technically-oriented investors participate. This phase continues until there is rampant speculation. At this point, the astute investors begin to distribute their holdings to the market marking what is phase 3.

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