Table of Content

What is Dow Theory and How to Use It? Its Goals, Principles, Strategies, and Impact on the Market

The Phases and Main Principles of Dow Theory: Insights into its Implementation in Financial Markets, Stocks, Commodities, Forex, and Cryptocurrencies.


The Role of Dow Theory in Shaping Emotional Reactions and Decision-Making in Financial Markets
Dow Theory's Emotional Reactions in Trading

🙋‍♂️Hello, respectful readers. ✍In this article, we will examine the basic principles of the "Dow Theory", a powerful method of analysis in financial markets. The Dow Theory has a long history in the field of technical analysis. Used to understand trends and turns in the market, this method has gained wide acceptance among investors and traders and has formed the basis for other analysis techniques. In this article, we will cover the basics and main principles of the Dow Theory, explaining how it works and how it evaluates the markets. We will also review the relevance of this theory today and how it contributes to understanding market fluctuations and making more informed investment decisions. Let's get started.


📆The History of Dow Theory (Its Inception and Formation)

The Dow Theory is considered a critical turning point in the early 1900s when the foundations of technical analysis were laid. Charles Dow and Edward D. Jones played a significant role by gathering hard-to-reach information from the market through their company and writing articles and analyses for 📰the Wall Street Journal. Charles Dow shared his views on the market in his column in the Wall Street Journal, and over time, these articles evolved into the synthesis that formed the basis of the Dow Theory. The Dow Theory did not originate as a formal theory. After Charles Dow's death in 1902, his thoughts were brought together by William Hamilton and other editors and named as the Dow Theory.

The birth of the Dow Theory was a necessary step in better understanding market behavior and trends. Charles Dow's journey, starting with his arrival in New York and finding a job on Wall Street, followed by co-founding Dow Jones & Company with Edward D. Jones, marked the period when the foundations of technical analysis were laid. By collecting market news and developments and preparing articles for The Wall Street Journal, Dow and Jones made an indispensable contribution to Charles Dow, often referred to as the 'father of technical analysis,' did not actually write 📙a book on this theory. However, the Dow Theory is based on the articles he wrote for The Wall Street Journal between 1900 and 1902, which were later compiled and published by Hamilton and Rhea after his death. William Hamilton is considered the person who truly developed the Dow Theory by compiling Charles Dow's ideas. Along with Robert Rhea's book titled 'The Dow Theory' in 1932, the Dow Theory was firmly established on its modern foundations. The Dow Theory has been a valuable analytical method used from the past to the present and has formed the basis for other analytical methods. It continues to be a valuable tool for market participants.the newspaper's launch.


 ❓ Where is Dow Theory used?

The Dow Theory is widely recognized as a prominent and effective analysis method in the financial world. This theory can be applied efficiently in various 📊financial markets, including stocks, commodities, currencies, and cryptocurrencies, relying on historical price data. At its core, the Dow Theory revolves around price movements and technical analysis, providing investors with a valuable tool in these diverse markets. The primary objective of the theory is to identify the market's direction and determine the trends forming in the stock market. By disregarding short-term price fluctuations, the main goal is to capture the existing trend in the market. This approach enables investors to balance their cash or stock positions according to the signals given by the trend, leading to a better understanding of potential investment opportunities and risks, and the development of appropriate strategies. By focusing on the long-term movements of the stock market, the Dow Theory offers a perspective that is free from emotional fluctuations and short-term noise in identifying market trends. 💪The strength of the Dow Theory is its ability to utilize all types of data from the markets. Charts, moving averages, volume analysis and other technical analysis tools help traders examine past price movements and identify potential future trends.


Dow Theory is an analytical method with 6(six) core principles that guide investors in financial markets. These principles include: 1. Market Indices Must Confirm Each Other, 2. Market Trends Should Be Reliable, 3. Volume Should Confirm the Trend, 4. Trends Must Be Valid in the Long Run, 5. Markets Should Confirm Each Other, and 6. Tracking Uptrends and Downtrends in the Markets
The 6 Core Principles of Dow Theory

 ❓ What are the Main Principles of Dow Theory?

The Dow Theory includes 6(six) basic principles, which are essential for understanding market movements from a Dow Theory perspective. The principles of Dow Theory are as follows:

  • 1.        Market reflects everything
  • 2.       There are 3 types of Trends in the Markets
  • 3.        Primary Trends consist of 3 Phases
  • 4.       Indexes must confirm each other
  • 5.       Trading Volume should confirm the Trend
  • 6.       Trends continue until reversal is confirmed.


  1️⃣   Market reflects everything:

The Dow Theory, a prominent and effective analysis method in financial markets, believes that prices in the market reflect all available information and emotions. In other words, market developments, investor expectations, and risk factors are already reflected in prices, making prices the ultimate and conclusive data at the end of the day. According to this theory, the current state of the market or the value of a financial asset includes all instant or potential news and sentiments about that asset. It is believed that news and information influence other investors' decisions and determine price movements. Particularly, it is expected that positive or negative news will impact prices. It is assumed that the information currently available in the market is already priced in, and as soon as new information becomes known, it will be reflected in prices. This mechanism ensures the efficient functioning of an effective market.

This image explains how Dow Theory affects price changes in financial markets due to unexpected events and market developments. The image illustrates that significant events occurring in the markets can lead to sudden and substantial changes in prices. For instance, unexpected situations such as natural disasters, political crises, surprising alterations in economic data, or announcements from major companies can trigger emotional reactions from investors and traders, influencing decision-making that impacts prices.
Reflection of news and events on the market

The Dow Theory embraces the idea that information and news are priced into the market as one of the fundamental assumptions of technical analysis. However, it is important not just whether everyone knows this information, but rather that what is known has already been reflected in prices, and what is unknown will be reflected when it becomes known. It is believed that one can understand what is happening in the market through the averages of market indexes. However, it should also be noted that verified information may not always produce the expected reaction. For instance, a piece of news expected to be positive might lead to an opposite price response. Moreover, unexpected and unpredictable events, 🌋such as natural disasters, political developments, or terrorism, can also be exceptions and swiftly impact the market, causing price changes. As a result, the Dow Theory offers a perspective that prices in the markets reflect all information and emotions in a complex manner. This approach helps us make informed investment decisions by evaluating information and news while considering the constantly changing and unpredictable nature of the market.


   2️⃣  There are 3 types of Trends in the Markets:

The Dow Theory has a significant impact in financial markets, and according to this theory, market trends are divided into three different categories: Primary trend, Secondary trend, and Tertiary trend.

The Dow Theory categorizes financial market trends into primary, secondary, and tertiary trends, explaining their respective characteristics and effects. The primary trend represents the longest-lasting trend in the market and can often extend for a year or more, signifying bull or bear markets. Secondary trends are short-term corrections that typically last from a few weeks to a few months, retracing about 1/3 or 2/3 of the preceding move. Tertiary trends, on the other hand, are the shortest and usually occur within secondary trends, lasting only a few days. These different trends showcase market changes over varying timeframes and magnitudes.
Dow Theory's Trend Classification

 🔵 The Primary trend represents the longest-lasting trend in the market. Lasting for over a year, this trend can represent either bull or bear markets. Within the Primary trend, there are Secondary trends that occur over several weeks to a few months. These Secondary trends are short-term retracements or advances that move in the opposite direction of the Primary trend.

 🟢 Secondary trends can last from a few weeks to a few months and are often seen as reaction trends that retrace about one-third to two-thirds of the preceding move. Also known as reactions to the Primary trend, these Secondary trends are a part of revealing the clear direction of the Primary trend.

 🔴 Tertiary trends are the shortest in duration and occur within the Secondary trends. Lasting only a few days, these price movements are considered insignificant according to the Dow Theory and may be susceptible to manipulation.

This picture explains the critical tools used to identify market trends in the Dow Theory and discusses in detail the importance of the terms Higher Highs (HH), Higher Lows (HL), Lower Lows (LL) and Lower Highs (LH). With the information contained in this picture, traders and market participants can better understand the process of determining the direction of markets and gain a new perspective on trend analysis. With the guidance offered by the Dow Theory, traders can make more informed decisions and better capitalize on market opportunities.
The structure of rising and falling Trends

The Dow Theory holds a fundamental basis in identifying market trends. The formation of higher highs and higher lows in price movements constitutes one of its key principles. If each successive trough and peak in price forms above the previous troughs and peaks, it indicates the presence of an uptrend. This means that prices are in an upward trajectory, presenting buying opportunities. On the other hand, if the troughs and peaks in price form below the previous troughs and peaks, it indicates a downtrend. This signifies that selling pressure persists on prices, and it may be a signal to consider selling positions. The Dow Theory analyzes prices based on closing prices and disregards intraday price movements. As a result, the closing prices have a significant impact on determining the primary trend, secondary trend, and tertiary trends. The closing prices of an index are considered a reflection of the market and are utilized in identifying trends.


    3️⃣  Primary Trends consist of 3 Phases:

Stages of the Uptrend (Bull Market)

Stages of the Downtrend (Bear Market)

Accumulation (Recovery) Phase

Distribution (Surplus) Phase

Participation (Rising) Phase

Panic (Collapse) Phase

Excess (Exaggeration) Phase

Despair Phase






 🐮 The stages of an uptrend (Bull Market):

1.The first stage of the uptrend, called the Accumulation Phase, represents a period in the market where the prices of financial assets have reached their lowest levels, and the downtrend comes to an end. During this phase, the impact of negative news diminishes or becomes exhausted. Positive news and signals become more frequent, indicating a tendency for the market to start rising. In the Accumulation Phase, successful investors make their purchases and then adopt a wait-and-see approach. Investors considering short-term positions wait for a correction or pullback, while long-term investors do not plan to sell their assets during the rising trend period. Since this stage occurs immediately after a bear market, prices are still at low levels. During this period, investor interest increases, and assets gradually start to accumulate.

2.The Participation Phase is a lively and exciting period in the market. Prices rise rapidly, and investors actively participate in the market to seize increasing opportunities. This phase lasts longer compared to the previous accumulation period and involves a broader range of investors in the market. During this period, increases in companies' profitability are anticipated, growth targets are raised, and positive forecasts are made for stock prices. These positive expectations lead to significant upward movements in the market. In the Participation Phase, a much larger number of investors take long positions compared to the accumulation period. This stage is the longest among the three stages of the uptrend and covers the widest range of prices.

3. The Excess Phase signals that bull markets are approaching their end. Promising economic expectations and high corporate profits supported by the media create a belief that the trend will move even higher or at least continue to rise. High earnings attract everyone's attention, regardless of their relevance, and trading volumes reach record levels. However, at this stage, the situation is characterized by excessive speculation, and prices start to deviate from their true values, similar to the initial phase of a bear market. Prices become exaggerated, and during this excess phase, a smaller but well-capitalized group of investors begins to sell a significant portion of their assets. This situation, often observed as the bull market nears its end and the bear market begins, does not offer a favorable opportunity even for many small investors who buy the product at its highest level.


This visualization explains in detail the market phases of the Dow Theory, Accumulation, Participation, Excess, Distribution, Collapse and Despair. Traders and market participants can use this guide to better understand market movements. They can confirm the information gathered by traders in the Accumulation phase, the lively and exciting market movements in the Participation phase, the signs of the end of bull markets in the Excess phase, the first signs of a downtrend in the Distribution phase, and the hopelessness and uncertainty in the market in the Collapse phase.
Evolution of Trends as per Dow Theory

 🐻 The stages of a downtrend (Bear Market):

1.The first stage of the downtrend, known as the Distribution Phase, is a period in the financial markets where the prices of an asset start to decline from high levels, and investors begin to sell their holdings. During this phase, those who believe the uptrend is coming to an end realize that asset prices will no longer rise significantly and start to liquidate their current positions. In the Distribution Phase, trading volumes in the market can still be high, and prices follow an uncertain course. Some investors may perceive declines as short-term buying opportunities, but later realize that this notion is misleading. The bear market advances quietly and deeply during this stage, and prices gradually begin to decline. Demand decreases while supply increases, indicating the beginning of the downtrend. The Distribution Phase signals the start of the downtrend and indicates that the market is beginning to follow a negative trajectory.

2. The second stage of the downtrend, known as the Collapse Phase, bewilders the market. All prices rapidly move downward, and expectations are quickly revised to reflect a decline. This stage is both longer and encompasses wider price ranges compared to the other two phases of the downtrend. With the participation of trend followers, prices deepen further, and the downward momentum increases. Economic indicators and corporate earnings also paint a negative picture during this stage. Uncertainty prevails in the market, and there is apprehension in the face of collapsing prices, with little hope of a recovery. Any positive news or signals prove insufficient to halt the overall downward trend. During this stage of the downtrend, everyone tends to develop protection strategies. Confidence in stocks decreases, while there is an increase in the inclination towards safe-haven assets.

3. In the Despair Phase, the market is filled with uncertainty, and a sense of hopelessness prevails about the future. Prices continue to fall, and stocks and other assets reach low values. During this period, there is uncertainty about when the market decline will come to an end, and everyone is anxiously waiting. However, at this stage, some investors start to believe that the downturn is nearing its end and begin to make purchases. With these purchases, prices start to recover from the bottoms, and the market enters a period of improvement. Despair slowly gives way to optimism, and hopes for the beginning of a new uptrend increase.

With Dow Theory Phases, you can see the Accumulation, Mark Up and Distribution Phases live, like an example in EUR/USD Parity
The Stages of Uptrend in EUR/USD pair

   4️⃣  Indexes must confirm each other:

The principle of confirmation between indexes states that for a new trend to form, different indexes in various markets need to confirm each other. Charles Dow illustrated this principle by using the example of the relationship between the Dow Jones Transportation Average and the Dow Jones Industrial Average. According to this principle, a strong condition in the 🚛transportation market usually implies that the 🏭industrial market is also in good shape. If one index is rising while another is falling, it wouldn't be accurate to conclude that a rising trend has emerged based solely on the ascent of one index. A rising trend becomes stronger and more sustainable when indexes in different markets confirm each other's movements. If different indexes are moving in different directions, it may indicate uncertainty and indecisiveness in the market.

   5️⃣  Trading Volume should confirm the Trend:

According to the Dow Theory, volume plays a critical role during trend movements. If prices are moving in the direction of the primary trend, volume should also increase. On the other hand, if prices are moving against the primary trend, volume should decrease. For instance, in a bull market where prices are in an uptrend, the rising candles should be supported by high volume, while the falling candles should have lower volume. If during the uptrend, the volume decreases gradually, or during the downtrend, there is high volume, this may indicate that the trend is weakening and could potentially reverse.

According to the Dow Theory, Volume plays a major role in Trend Confirmation. It is necessary to use trading volume to confirm trends in the markets. If prices are moving in a certain direction and volume is increasing in the same direction, this indicates that the trend is strong and may continue.
Trend relationship with trading Volume

   6️⃣  Trends continue until reversal is confirmed:

It is generally accepted that as long as the trend is valid, it will continue until a confirmation of a reversal is obtained. Charles Dow emphasized the significance of turning points, as he previously mentioned in the stages of the primary trend. For instance, an uptrend can end when the previous peak is not surpassed, and then a reaction occurs with prices falling below the previous dip level. Similarly, a downtrend can come to an end when prices fail to fall below the previous dip level, and then a reaction takes prices higher, surpassing the previous peak. However, if such situations do not occur, it is assumed that the current trend will continue.

According to Dow Theory, the trend continuation principle emphasizes that while a trend is considered valid, that trend will continue until confirmation of a reversal is received. Dow noted that turning points are of paramount importance in the phases of the main trend. For example, an uptrend may end as a result of not exceeding the previous high and falling below the previous low with the ensuing reaction. Similarly, a downtrend can end with failure to break below the previous low and then break above the previous high in the ensuing backlash. However, when such situations do not occur, the current trend is considered to continue.
Confirmation of Trend Reversals


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