The Dow Theory – What Does the Dow Truly Mean?

People who invest in the stock market know all about the Dow Theory. This is what helps determine stock price. The sustainability of a publicly traded company and its futures depends heavily on what the theory determines for it. The theory is named after Charles H. Dow who was a journalist. He founded the Wall Street Journal and served as its first editor. During his time as editor of the Wall Street Journal, he wrote several editorials that served as the basis for the theory. Contrary to what some might believe, he never used the terminology himself nor did he think of the editorials as a theory of any kind. Instead, it was after his death that three other men collected the editorials and used them to base the theory on.

There are six aspects of the Dow Theory:

  1. The market has three movements – The first movement may last only less than a year, but then again it could last several years. The second movement is called the medium swing and lasts generally from 10 days to a few months. The third movement is called the short swing. It can vary by the hour, day or even by the month. All three movements can be going on at the same time.
  2. There are three phases to market trends – There is an accumulation phase, which is when investors who are considered to be in the know are buying and selling stock that goes against what the market determines. This phase generally has no change in stock price. The next phase is the public participation phase. This is when the public gets wind of what is going on and begins to buy and sell the same stocks. This causes the price to change significantly. The third phase is the distribution phase. This is when the initial investors sell their stocks back to the market.
  3. The stock market discounts news – Stock prices change on a regular basis because of new news that is made available.
  4. Stock market averages confirm one another – Profits and production/shipping values should be going in the same direction. If they are not, then that means there is change coming to that company and it is not safe to invest.
  5. Market trends are confirmed by volume – In the Dow Theory, it is believed that market trends depend on volume. If price movements come right along with high volume, this is believed to be the actual market value.
  6.  Market trends will exist until there are definite signals that they have ended – Just because a trend may move in an opposite direction for a short period of time, the Dow Theory suggests that it will eventually go back to its initial path. Of course, it is not easy to determine what a temporary trend is and what a permanent trend is.

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