Tenets of Dow Theory:
1. Averages discount all news. According to Dow’s theory,
any factor that can someway influence the supply or demand will be reflected in
the dynamics of the averages. These events are, of course, unpredictable.
Nevertheless, they are taken into account by the market right away and are
reflected in the dynamics of the averages.
2. There are three types of tendencies on the market. During
the uptrend, every following peak and every following fall are higher than the
previous one. During the downtrend, every following peak and every fall are
approximately at the same level as the previous ones.
Dow also distinguished three categories of movements:
primary, secondary and daily fluctuations. He assigned the highest significance
to the primary movement, which lasts over a year, and sometimes several years.
The secondary (or reaction) movement is a correction movement as regards the
primary movement and usually lasts as much as three weeks to three months. Such
intermediate corrections retrace 1/3 to 2/3 (very often a half) of the movement
of the prices during the previous (primary) move. Daily fluctuations or
short-term trends last not more than three weeks and represent short-term
fluctuations within the intermediate trend.
3. The primary tendency has three phases. The first phase,
or the accumulation phase, when the most far-seeing and wise investors start
buying, as all unfavourable economic information has been already considered by
the market. The second phase begins when those who use technical methods for tracing
trends join the game. Economic information becomes more and more optimistic.
The trend passes to its third, or final, phase when public at large starts
participating, and a flurry that is stirred up by mass media begins on the
market. Economic forecasts are optimistic. The volume of speculations rises.
That’s when the the most far-seeing and wise investors that were
"accumulating" at the end of the previous move when no one wanted to
"accumulate", start "to distribute". That’s the end of the
tendency.
4. Averages must confirm each other. Here Dow meant the
industrial and railroad industrial averages. To Dow, any important signal of
bull market or bear market has to be presented in both averages.
5. The volume must confirm the trend. The volume must rise
in the direction of the primary trend.
6. The trend exists until definite signals prove that it has
changed.
History repeats itself. This postulate is based on the
objective character of laws of physics, economics, and psychology. The rules
that were valid in the past function now as well and will function in the
future. All interpolation techniques of future prediction are, in fact, based
on that. And the future, intrinsically, repeats the past.
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