Understanding Dow Theory

Charles Dow is the one who has put forth Dow Theory in 1990’s to understand demand and supply by studying price and volume.

Principles of Dow Theory:

1) Averages Discount Everything-
Market averages discount everything means all the news and factors which affects the stocks are already priced in the index or in stock price. This shows that just like stocks, the averages of these stocks, which we call INDEX also discounts everything in the market and everything is already priced in.

2) The Market has Three Trends-
A) Primary Trend:
Primary trend also called as major trend lasts from more than one year to up to may be around 3 to 5 years duration. The primary trend can be Bull run (bullish) or Bear run (bearish).
B) Intermediate Trend:
The intermediate trend lasts from around three weeks to months but normally less than a year. The intermediate trend may be bullish or bearish, but not necessarily the primary trend is.
C) Short Term Trend:
The short term trend may last from a week up to as long as 6 weeks. It is a minor trend and may be bullish or bearish or consolidation. As it is very short term, it is a bit difficult to analyse

The major critics against Dow Theory is it informs the market trend after rather than before. There is an inevitable lag between the actual turn in the trend and the recognition of the change in trend.