So what is dow theory? What are the basic tenets of Dow theory? How is the application in communication?
If you want to understand and understand the technical analysis in your head from cryptocurrencies or trade coins, dow theory is the first thing you need to learn. Dow theory is the foundation of current technical analysis in financial markets in general and the cryptocurrency market in particular, no matter what school of technical analysis you study, you must understand the fundamentals of dow theory first.
So what is dow theory? What are the basic tenets of Dow theory? How is the application in communication?
What is Dow theory?
Dow Theory was developed by Charles H. Dow is the founder of the Wall Street Journal and co-founder of Dow Jones & Company. As part of the company, he helped create the first stock index, known as the Dow Jones Transportation Index (DJT), followed by the Dow Jones Industrial Average (DJIA).
The fundamentals of Dow theory express Dow’s belief in how the stock market reacts as well as how to measure financial market health in search of profits.
Dow believes that the stock market as a whole is a reliable measure of the overall condition of an economy. And by analyzing the overall one can accurately assess those conditions as well as determine the main trend of the market and the direction of development of each individual stock.
The whole theory of technical analysis has so far been derived from Dow theory. Therefore, if you want to understand technical analysis in coin investing as well as trading coins, you need to know the basic principles of Dow theory.
The basic principles of Dow theory
The market reflects everything.
The market reflects all factors that have a general effect on supply and demand, including information such as inflation, interest rate data, financial statements,… From the past to the present as well as the emotions of investors, all can affect the market and be reflected in the price in the market.
While it is impossible to predict events such as earthquakes or natural disasters, the market can reflect these incidents by having an almost immediate impact on prices.
For example, if a company is expected to release financial statements that show better business results, the market will reflect this before it happens.
Demand for their shares will increase before the report is released, and then the price may not change much when the final report is released. There are also some cases where a company’s share price may fall as soon as the good news is given, as it is not as good as expected.
It should be noted that the information does not help the trader or the market itself know everything, but only to predict events that will occur in the future. All factors that have occurred, are imminent and probable will be reflected in the market price. When things change, the market is forced to adjust along with the price to reflect that changed information.
The market that reflects everything is practically not new to traders, this is always used in the financial sector, a lot of traders just need to look at price movements without looking at other factors that can also determine the trend of the market.
This principle in Dow theory is also closely linked to Eugene Fama’s Efficient Market Hypothesis (EMH). However, dow theory differs in that it is used to predict future trends.
First, the trend is defined as follows, the uptrend is when the current highest trading price is higher than the previous peak prices. At the same time, the lowest prices at the present time are also higher than the lowest prices of the past, or on the graph of new highs and troughs higher than the old troughs.
Conversely, a bearish market is when the current market’s highest and lowest prices are lower than past highs and lows, or on a graph of new lows lower than the old peaks.
According to Dow Theory, the market has three types of trends:
- Main (long-term) trends
The main trend can last from several months to many lies, this is the main movement of the market. Usually the main trend is the trend of long-term investors interested.
Almost no one can predict these cycles and it is also very difficult to manipulate (as a price).
- Level 2 (medium-term) trend
The medium-term trend usually lasts from 3 weeks to several months, which is the corrective phase of the main trend, i.e. the price period goes against the main trend.
They are temporary bearish episodes, also known as uptrends or bull markets, or temporary bulltrends, or downtrends. These corrections are usually corrected by a third to a second (50%) of the main trend.
This is the period when long-term investors following the main trend find opportunities to buy at the lowest prices as much as possible.
For example, when the PRICE OF BTC crosses the $10,000 mark confirming the long-term uptrend, a lot of investors have bought BTC with price milestones around it. This buying zone is safer because if you buy at the lower levels and the long-term downtrend has not been broken, the price may fall further.
- Level 3 (short-term) trend
The short-term trend usually lasts from a few days to less than 3 weeks, in some cases it only lasts a few hours to 1 day. These are usually small, rapid fluctuations and go against the level 2 trend.
Due to its short-term nature, it is likely to be manipulated by a large group of people or organizations.
Three stages of the main trend
Dow identifies three major long-term trends: Accumulation Phase, Public Participation, Distribution.
- Accumulation phase
After the previous Bear market period, asset valuations (stocks, indices, cryptocurrencies,…) remained low due to mostly negative market sentiment due to bad information,… Investors who lack information, ignorance will be afraid and sell off.
On the contrary, investors, knowledgeable smart traders, have information that the market has “received” all the worst news, the community has sold out almost all, the selling pressure is no longer, they will start to accumulate at this stage, at this stage, at this time the supply is abundant and the price is low due to the small number of buys that the number of sellers sell off. That’s a lot.
This accumulation takes place almost silently with little effect on the market price, the price has almost no significant fluctuations.
- Price boom period, active community participation
Investors who have participated in the accumulation are confident that in the long run the market will continue to grow. When this actually happens, the price starts to rise again, the optimistic news is released, the negative sentiment dissolves, nearly everyone many people realize the opportunity that smart investors and traders have seen.
People are increasingly actively buying in, making the price spike, the more the community increases interest, pushes the price higher and higher, the bullish trend is clearly formed.
- Distribution stage
The press began to bring more optimistic news, the price increase of the market. Speculative demand in the market reaches its peak, the price increases very sharply, smart investors who have participated in the purchase at the accumulation stage begin to sell to new entrants to the market but make a profit, there will be many signs of reduced purchasing power, The trend began to weaken, knowledgeable traders who had been involved before also noticed these signs and also began to sell.
The buyers at this stage are the final market participants, the new, ignorant ones. Like sheep for meat, participants always hope that the profits will continue after having missed many previous opportunities, they think the mayor is just adjusting and will continue to rise, but unfortunately, they are “swinging the top” and the chances of exiting the “row” are actually quite slim.
On the contrary, in the bear market, these stages are basically reversed, starting with people who notice signs of declining purchasing power, a weaker trend, a downward trend, they will sell their assets to the last market participants (new ones), The next stage the price really went down and a lot of bad news was released people started to run away.
When all the worst news has been released, when smart investors notice the opportunity will start to accumulate again, and continue the stages as above.
Correlation between indicators
According to dow, the main trends on one market index should be confirmed by the trends observed on another market.
At the time of Down’s introduction of this principle, the indices in question were mainly the Dow Jones Transport Index and the Dow Jones Industrial Average. Previously, the transport market (mainly railways) associated with industrial activities, more developed industry, producing more goods, it is necessary to increase railway activities to transport raw materials and goods for industrial activities.
As such, there is a clear correlation between the manufacturing industry and the transportation market. If one market grows, so does the other. However, the principle of correlation between these indicators is no longer relevant today because many goods are digital and do not require actual delivery.
Here’s a chart showing the Dow Jones Industrial Average (DJI), NASDAQ-100 and S&P 500, and you can see a clear correlation between the three.
Volume is an important factor.
According to Dow, volume is an important indicator for confirming trends. A strong trend will be accompanied by a large trading volume, the higher the volume of price movements the more likely it is to represent the real trend of the market. Conversely, when the trading volume is low, there is a high probability that the closing volatility does not represent the true trend of the market, which can be a false signal.
More specifically, in an uptrend the purchase volume will increase as the price increases and the trading volume decreases as the price moves in the opposite direction (correction).
For example, when the price breaks up (breakout) an important price zone or breaks the wife of a new peak, the buying volume must be large and when the price returns to the test, the trading volume decreases (smaller).
Thus in case the volume runs against the trend (the price increases but the volume decreases, the price decreases but the trading volume increases) it is a sign of weakness in the current trend and there may be a trend reversal in the near future.
The trend will continue until the reversal is confirmed.
If the market is trending up or down, it will continue that trend until there is a clear reversal confirmation.
For example, in September 2020 the solana price peaked at $4.90 for the first time, after which the price continued to fall and there was a rebound in price that did not exceed the old peak of $4.90. The price drops then lower again and forms a bearish flag pattern. Since then the price has been steadily falling to lower support levels.
Because of this, Dow believes that reverse trends should be questioned until they are confirmed as the main trend. Of course, distinguishing between a second-tier trend and starting a new major trend is not easy, and traders often mistakenly believe the main trend has reversed which is ultimately just a second-tier trend.
Expanding on this idea, you won’t be able to be sure which is the top or bottom of a trend, you can’t be sure the trend has reversed until there’s a clear confirmation signal, so if you sell as a trader, stand and try to “catch the top, catch the bottom”, or trade in favor of the current trend if it has not been reversed.
Notes on Dow theory
The Dow theory still has certain limitations on short-term trades, it’s quite late, and it’s not always quite true on short-term trades at a low time frame.
Now the market also trades in low time frames such as 15-minute, 5-minute, even 1-minute frames, rather than just day-to-day trading like traditional markets before, in lower time frames the market is more noisy, the information is less accurate. Today’s market is also more complex, the influence of crowd psychology, the Internet, technology.
Above I have shared all the knowledge of Dow Theory, it is really important if you want to become a financial investor, a successful trader. Reading and understanding the full tenets of Dow theory will help you better understand technical analysis indicators in financial markets in general and cryptocurrencies in particular.
Finally, thank you for taking the time to read your article, wishing you investments as well as trading successfully and making more profits with Dow Theory.