Welcome back, trader!
Today we're going to explore a fundamental resource in the world of investing.
It was created by Charles Dow, none other than one of the founders of the Wall Street Journal and one of the pioneers in technical analysis of the stock market. Dow Theory is based on six basic principles (which we are going to tell you about in 30 seconds) that help us understand market behavior and identify trends and patterns that can be used to make winning decisions.
Who was Charles Dow and how did he create this theory?
He created the theory based on his observations and his own experience.
He was born in 1851 in Connecticut, USA and became a professional journalist and economist. He was one of the first to use charts to analyze stock market behavior and his theory has evolved over time, and was expanded by other technical analysts such as William Hamilton and Robert Rhea. Today, it remains a fundamental tool for understanding market behavior and making informed investment decisions.
The basic principles of Dow Theory
We have six basic principles:
1. The market discounts everything: all available information about a company or an industry is already reflected in its stock price.
2. Indices must confirm each other: to confirm an upward or downward trend, several indices related to the same sector or industry must be analyzed.
3. Trends have three phases: a first phase of accumulation, an intermediate phase of public participation and a final phase of distribution.
4. The main trend has three phases: a bullish phase, a bearish phase and a sideways phase.
5. Volume must confirm the trend: this means that volume must increase during bullish phases and decrease during bearish phases.
6. The trend continues until proven otherwise: it will be assumed that the current trend will continue until there is a clear signal of change.
How does Dow Theory apply to the stock market?
We can apply it, of course, in stock market analysis by identifying upward or downward trends, consolidation and trend reversal patterns, and mutual confirmation between various indices related to the same sector or industry. All of these advantages are important.
For example, if it is observed that several indices related to the technology sector are experiencing an uptrend, this may indicate that there are investment opportunities in specific technology companies. It can also be useful in identifying patterns such as ascending or descending triangles, which may indicate an impending change in trend.
What are the limitations of Dow Theory?
Although it is a valuable tool for understanding market behavior and making informed decisions it has some important limitations. For example, it does not take into account external factors such as political or economic events that can affect the market.
It can also be difficult to apply it to volatile markets (hello, cryptocurrencies) or startups without sufficient financial history available. However, these limitations can be overcome by using additional tools such as professional backtesting indicators, fundamental analysis or technical analysis.
Conclusion
The market has its own personality. Its own mood swings. So we keep learning from it every day. This theory can help us minimize risks by identifying clear signals of change in current trends.
On a daily basis, we watch for these signals, so we can adjust our strategies to
maximize profits and minimize losses.
Don't miss any of our tools to stay up to date and take your trading to the next level.
REFERENCES
For this article, prompts have been used to request information
interpreted and provided by AI (Google Bard). Written and edited
by Kevin David Terán and verified by Pedro Arizaleta and Erwin Sánchez
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