Dow’s Theory

Dow’s theory is a set of principles that apply to price trends in the market. Although these principles are very general, most analysis techniques are based on them.

Here are the main ones.

1: TRENDS

A trend (trend) indicates the direction of the market. Up-trend is defined as an uptrend, ie when prices tend to rise. Down trend is defined as a downtrend, ie when prices tend to decline.

NB: we will see that even in an uptrend (or bearish) trend, the price is not a line that always tends to rise (or fall). The price fluctuates over time, so it is useful to identify the current trend to understand where the price is going (although often it is not easy).

The market is made up of three types of trends: Primary, secondary and tertiary (also called Tide, Wave and Ripple).

These trends refer to different time frames, where the first is in the long term (years), the second over the medium (months), and the third over the short period (days).

Based on this principle there is a main trend to be followed over the long term, on which then set long-term profits. This trend, however, over time, can follow changes (retracements), giving rise to secondary trends. Finally, there are the tertiary trends that according to this theory are seen as simple fluctuations.

NB: In the cryptocurrency market, where prices are extremely volatile (ie they change very quickly), even the tertiary trends gain importance.

In image 1 we can see in red the main trend on the bitcoin traced today March 11, 2018. This trend is clearly bearish.
Inside, traced in green, we can see one of the many secondary trends, this track is instead bullish.
Within the secondary trend we can see how the price is not always upward but in reality it oscillates, going to enlarge we could identify various tertiary trends within it.

Dow theory: examples of trends
Image1 : TradingView – Dow’s theory: examples of trends

Each trend is in turn divided into three phases:

  1. Accumulation : Phase in which institutional investors intervene, here the price rises slowly (or falls if it is a bearish trend);
  2. Intermediate phase or speculation : the price continues to rise and many investors are starting to enter the market;
  3. Distribution : We have reached the maximum level, where institutional investors generally start selling.

These phases therefore determine a cyclical price trend. You could also go on to specialize in further sub-phases, in which you would see that even within a single phase the price fluctuates.

2: THE MARKET AND NEWS

The market is influenced by all the news, which in the field of cryptocurrencies are several times a day.
What does this mean ? that although the trend is well defined bad news (or good) can distort it.

3: SIMILAR INDEXES AND CONFIRMATION

Similar indices must confirm each other. What does this mean in the cryptocurrency field? that although we operate on a certain crypto we must also keep the others under control. For example, Bitcoin tends to affect the market of all secondary coins (called altcoin) and it is therefore useful to monitor it even if you do not invest directly on it.

4: VOLUMES

Trends must be confirmed by volumes. That is, we must not only look at the price that rises and falls but also on how many transactions of purchase / sale are based. This is because a trend based on a few volumes could easily change.

5: EXISTENCE OF TRENDS

A tendency continues to exist until there is a well-defined signal that marks its end. So we must be careful to say that we have gone into an uptrend (or bearish) trend only to have seen a slight change: better to wait for confirmation signals.

7: CLOSING PRICES ONLY

Down from the importance only to the closing prices of the market, ignoring the intraday fluctuations. However, in cryptocurrencies, where markets are always open, it is not applicable.

8: LINES

There are market periods that are horizontal, that is, they form lines. These periods are characterized by a balance between purchase and sale.
Prices fluctuate around 5% during this period. 

NB: these periods are moments of pause in which the trend is not well defined.Care must be taken because after these periods the previous trend could change.

References:

  1. Robert d. Edwards, John Magee, “TECHNICAL ANALYSIS OF STOCK TRENDS”, 8th edition of 2001, STL (Pag 13-23);
  2. Ettore Coliva, Lucio Galati, “ANALISI TECNICA FINANZIARIA”, 1th edizione del 1992, UTET Libreria (Pag 18 – 19).
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