A Quick Look at the Dow Theory and How it Can Help you in Trend Following – Introduction
Trend following is an important concept in the financial market. The concept is without a doubt the foundation of all trading operations. This is because, to succeed, you need to buy securities you believe will continue moving up. You can also short securities you believe will fall. A key concept in trend following is the Dow theory. This theory has six major parts that you should always remember.
First, the theory says that the market has three main trends. First, the primary trend is the main direction that a security is moving. For example, if the price of crude oil is moving up, this is the primary trend. Second, the secondary trends are also known as the reactive trends. These trends last a few days or weeks and happen mostly as the traders are considering the next movements in the trends. Finally, the short swings are movements that last a few hours.
Second, the theory says that the market tends to move in three phases. The first phase is known as the accumulation phase. In this, investors who have a good understanding about the product increase their buying (in a bullish market) and selling (in a downward trend). The second phase is known as the public participation phase. This is where ordinary members of the investing community moves to follow the phase of the first phase. Finally, the distribution phase happen when speculators enter the market and overbuy or oversell the product. This is a similar thing that happened in the cryptocurrencies industry.
Third, the theory talks about news. In this phase, the market starts taking news from all sources. This happened in the cryptocurrencies craze. At the time, the market used to move depending on the news that emerge on a certain day. For example, if a certain investor said a good thing about the currencies, the price used to go up and vice versa. Another theory that explains this situation is the efficient market theory and the belief that all news is taken into the current price.
Fourth, the major averages in the market confirm one another. This theory was created using the reference of the industrials, transportation, and utilities. Therefore, when one industry moved up, the price of the other indices tends to move up as well. The same trend is seen today where the price of various securities leads to the movement of other assets.
Fifth, the Dow theory talks about the role of volume in the market. In this, when the price of a security moves up, the trend is confirmed by the movement in the volumes. As I have written before, you should always ensure that you look at the volumes of an asset when following a trend. This is because a trend with no volume can expose you to false breakouts.
Finally, the theory says that the trend will continue until a counter trend emerges. This is better demonstrated by the Newton’s Law of Motion. This law says that the direction of an object will continue moving in a direction unless a new equal force is applied in the opposite direction. Therefore, following these laws will help you know when to buy an upward trend or short a downward trend.
A Quick Look at the Dow Theory and How it Can Help you in Trend Following – UsefulTips