Down Theory was established in early 20th century by Charles Dow based on his market observations. According to this theoory the stock moves in a pattern of Tops and Bottoms which can be qualified as Higher Top (HT), Higher Bottom (HB), Lower Toop (LT) and Lower Bottom (LB).
When a stock moves in the sequence of HB –> HT –> HB –> HT it’s said to be in uptrend and every new HT can be used as buying opportunity with preceding HB as the stop loss. The trend is valid as long as this sequence continues.
When a stock moves in the sequence of LT –> LB –> LT –> LB it’s said to be in downtrend and every new LB can be used as selling opportunity with preceding LT as the stop loss. The trend is valid as long as this sequence continues.
The trend is said to be strong when the volume spikes while HB or LT are formed.
The Dow Theory should be used with 2 years data points on a daily line chart. Since this is a lagging indicator of the trend, it’s not suitable for the short term or intraday trading. However it is an excellent tool to identify demand and supply zones for a stock.