The principles behind the Dow Theory are relatively simplistic and, because of this, it is a great tool for new traders. The fundamental belief behind the Dow Theory is that any factor that would influence the market will have already been factored into the offer price. It may be the case that such factors cannot be predicted, but, even so, they are already factored in.
Put simply, technical analysis uses charts and graphs to predict price movements. By showing the events of the past, it is believed that future developments can be predicted.
The principals state that:
· A chart can define a trend because prices do not move randomly
· History repeats itself so changes can be tracked and charted over time
Technical Analysis, the Dow Theory and Market Trends
The Dow Theory states that you can interpret technical analysis charts by assessing three market trends. These are:
· Primary Trend: a broad trend that can for years.
· Secondary Trend: A trend that lasts between weeks and months, often correcting the primary tren.
· Daily Trend: A daily/weekly short term movement that does little to effect the primary tren.
These trends occur simultaneously and are spotted using technical analysis charts that provide a visual representation of trends.
The Relationship Between Dow Theory and Technical Analysis
If we assume- as the Dow Theory states- that markets reflect all available information, then we must also believe that an aggregate of emotions is also factored in. Such emotions will be reflected in short term trends, but will not affect the primary trend that runs simultaneously.
When assessing technical analysis using the Dow Theory, we must assume that the offer price represents total sum of hopes, fears and expectations of all market participants (including traders, investors and brokers). This means that although the unexpected can and will occur, it will never affect the primary trend, only the short term trend. In conclusion, the Dow Theory allows you to interpret technical analysis graphs and helps you predict upcoming trends. Understanding the three trend lines that the Dow Theory relies upon is essential to a successful use of the theory. Watch trades closely and take a chronological approach and you should be able to make successful trades as a result.