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What is Dow theory?


Dow Theory: It is originated by Charles Henry Dow, he was an American and co-founded the Dow Jonas & company. He was the first to create an index to measure the overall price movement in US stock. Charles Dow was the father of modern technical analysis. After he died in 1902, William Peter Hamilton writes a journal based on Dow theory principals.
Alfred Cowles III is the first person who formally tested the theory in 1934. After the death of Hamilton's, Robert rhea refined the theory and in 1932 he wrote a book whose name was "The Dow Theory: An explanation of its Development and an attempt to define its usefulness as an aid to Speculation".

Dow Theory has 6 tenets which are as follows:
  •  Average Discount: The stock price shows all the effects of change in market demand and supply. All other factors which affects the stock price. That’s why stock price shows the discount rate.
  • Market has 3 Trends: 
1.     Primary trend
1.     Secondary trend
1.     Minor Trend

Primary market trend is up to 1 to 3 years. If investors want to gain from the market then they have to remain in a stock. Primary trend if go up then the low price is above the previous low price and the high price is higher then previous one.If market goes down then the high price is lower than previous one at the time of closing of a market.
Secondary market trend is remains for 3 weeks to 3 month. In this market trend those investors are willing to invest who can withdraw the money from the market under 1 month. This is a short term change in the price of a stock against the primary trend which means if stock prices are goes up in primary trend then the decrease in the price is secondary trend.
Minor market trend is remains for 1 day to 3 weeks. The investors invest in these times to gain from the minor changes in the market. Investors invest for 1 or 2 days.
  • Average must confirm: If the market trend shows the future action of an industry then the market average and industry average must move together.
  • Market has 3 phases:
1.     Accumulation Phase: The stock price goes down and there is a stage when stock does not move further. That stage is known as accumulation. And in this stage the big investors purchases the stock.
2.     Public participation Phase: In this phase the stock prices moves upward and the favourable news are coming in the market related to the stock. Now the small investors start investing in a stock.
3.     Distribution Phase: In this phase where the price of stock is increases and many investors purchases the stock. The smart stockholders start selling the stocks to gain from the market. After this phase the price of stock goes down.
  • Price and Volume relationship: The volume prices moves according to the price of a stock. If the volume doe not complement the movement of a stock price. Then investing in that stock is not good. 
  • Price action determines the trends: In bullish trend the price of a stock goes up and in bearish trend the stock prices moves downward. The price of a stock shows reversal action if any factor affects the price of a stock.


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