Dow Theory is named after Charles H Dow, who is considered as the father of Technical Analysis.
Using Dow theory, the trader can identify the prevailing trend of the market or stock. The trader can initiate the long position once the bullish trend is identified and short position when bearish trend is identified.
Dow theory is beneficial for identifying medium to long term trends only. The short term price movements cannot be forecasted and the money making opportunities are missed by trader.
Support and resistance represent key junctures where the forces of supply and demand meet. A support line refers to that level beyond which a stock’s price will not fall.
A resistance line refers to that line beyond which a stock’s price will not increase.
- : Dow Theory is named after Charles H Dow, who is considered as the father of Technical Analysis. Dow Theory is very basic and more than 100 years old but still remains the foundation of Technical Analysis. Dow theory focusses on price movement of the stock. Stock prices are going up or down based on buyer’s and seller’s estimation of value of the stock. The concept behind Dow theory is demand and supply. The trader need to identify the trend in the stock and trade according to the trend.
- : In order to forecast the trend for Dow theory, the line chart is better to use with minimum look up period of two years. It should be daily chart also with volume information.
- : The following are the steps involved in determining the trend using Dow theory. 1) Open the line chart, preferably line chart with minimum look up period of 2 years. The volume information also to be seen. 2) Spot the major tops and bottoms in the chart with “T” & “B” skip the minor tops and bottoms 3) Qualify the tops and bottoms whether they are higher or lower comparing to the previous top / bottoms and mark them as “HT”, ‘LT’, ‘HB’ and ‘LB’ 4) Identify the sequence of Higher Bottom (HB) and Higher top(HT) and it is backed by good volume, we can identify the trend as Bullish. 5) If the sequence is identified through lower top (LT) and lower bottom (LB) and backed by good volume, the trend can be identified as Bearish.
- : Dow theory is good for deriving the trend. But the trend is valid for medium (Few months) to long term (years). Short term trend (few days to weeks) cannot be forecasted using Dow theory. Dow theory does not give the nature of the trend. The opportunity of making profits after the trend reversal can be missed if we follow Dow theory because, as per Dow theory the buy or sell should be initiated only after the price crosses previous High or Low.
- : When we identify the trend as bullish, the Buy can be initiated once after the price crosses the previous High (HT). When we identify the trend as Bearish, the Sell can be initiated once after the price crosses the previous Low (LB).
- : Support and resistance represent key junctures where the forces of supply and demand meet. A support line refers to that level beyond which a stock’s price will not fall. The support line is formed because at this price, lot of buyers take a long position because they feel that price is good to buy. In Support line, the demand is more than supply and that price zone is called demand zone from where price starts moving up. Similarly a resistance line refers to that line beyond which a stock’s price will not increase. Because at this zone, the sellers come into picture as they feel that the price is good price to sell. This is called resistance or supply zone.