Six Tenants of Dow Theory

Question: Briefly explain the six tenants of Dow Theory. Critically evaluate the major technical techniques and indicators for successful trading. Answer: There are six tenets of Dow Theory: 1. Everything is discounted by average The market projects all the information that is available and it can be positive or negative. The only thing is that an act of God cannot be predicted. Prices project all the relevant information and the expectation of the various parties (Adriaanse, 2002). The process of average discounts the positive and the negative news all and hence, the price of the stock contains all the information 2. Three trend is available in the market Three trends are seen in the market that is the primary trend, the secondary and the minor trend. The primary trend is the major trend and remains in effect for over 1 year. This trend is helpful for them who invest in the long term. The secondary trend can be said to be a correction in the primary trend. This trend helps in knowing the correct direction and to know about the position of the primary trend. The minor trend is a short swing that remains in operation from hours to month (Adriaanse, 2002). The intraday investors for dealing in stocks use the minor trend. 3. Three phases exist in the market The market witness three phases that is the accumulation, absorption and the distribution phase. The entire three trends depend upon the market scenario. The three trends are based upon the Dow concept of uptrend and low trend. 4. Average must be confirmed When there is a change in the average or a new is witness in the secondary or intermediate high then the other, average is required to do the same to make the signal valid. The validity of the signal is essential as it ensures that a change has occurred. This helps to take appropriate course of action. 5. The trend must be confirmed by the volume The volume should show an increment in the direction of the trend that is major. In the case of an uptrend the volume, show an increment during the rally. Volume should be used to confirm the trend because if the volume and the chart do not match then it is a case of divergence that means that the change is not valid. 6. A trend remains intact until a definite sign of reversal According to Dow Theory, market continues to be in trend and will deviate until the time a definite sign of reversal is seen (Adriaanse, 2002). A trend cannot be judged by a general low because in a trend there is always ups and downs. On the contrary, for a trend to change it must be accompanied by a change and reversal. The major technical indicator or tools that are used for successful trading are: Relative strength indicator (RSI) It provide the overbought and oversold level. When above the level of 70 it is, overbought while below 30 is oversold. When overbought, it must be sold and when oversold (below 30) must be bought. Average Strength Index (ADX) - it projects the strength of the trend. It can be used to know whether the stock has the potential to reach the overbought or oversold level. It does not show the direction but helps to answer whether the power of the trend (Adriaanse, 2002). Bollinger band it shows the movement as per the band. The higher band and the lower band can be used to know the buy and sell level. Fibonacci Retracement that shows the retracement level and the higher and lower value can be determined (Graham Smart, 2012). Various levels can be used to know the level from where it will find support and resistance. It is one of the best method that helps in ascertaining where the stock will move. References Adriaanse, G 2002, Technical Indicators, master thesis, University of Amsterdam. Graham, J. and Smart, S 2012, Introduction to corporate finance, Australia: South-Western Cengage Learning.