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Explained: Dow Theory
Source: | Author:finance-102 | Date2023-04-07 | 325 Views | Share:
Dow Theory is a method of technical analysis developed by Charles Dow, the founder of the Wall Street Journal, in the late 19th century. It is a framework for understanding the behavior of the stock market, and its principles can also be applied to other financial markets, including the forex market.

Dow Theory is a method of technical analysis developed by Charles Dow, the founder of the Wall Street Journal, in the late 19th century. It is a framework for understanding the behavior of the stock market, and its principles can also be applied to other financial markets, including the forex market.


The theory is based on the observation that the stock market moves in distinct trends or phases, and these trends can be identified and analyzed to make trading decisions. According to Dow Theory, there are three types of market trends - primary, secondary, and minor.


The primary trend is the most important and can last for several years. It is the long-term trend of the market, and it represents the overall direction in which the market is moving. The primary trend can be bullish (upward), bearish (downward), or sideways (no clear direction).


Once the primary trend has been identified, traders can look for secondary corrections or pullbacks in price. These are temporary moves against the primary trend and can provide opportunities for traders to enter the market at a more favorable price.


Dow Theory also emphasizes the importance of volume in confirming the direction of the trend. If trading volume is increasing as prices move in the direction of the trend, it is a sign that the trend is strong. On the other hand, if trading volume is decreasing as prices move in the direction of the trend, it could be a sign that the trend is weakening.


One of the key principles of Dow Theory is patience. Traders should wait for confirmation of the trend before making trading decisions. This means waiting for the trend to be established and avoiding the temptation to jump in and out of the market based on short-term fluctuations.


While Dow Theory was originally developed for analyzing the stock market, its principles can be applied to the forex market as well. However, it's important to note that the forex market operates differently from the stock market, and some of the Dow Theory principles may not apply as well.


For example, trading volume in the forex market is decentralized and not as reliable an indicator as it is in the stock market. Additionally, economic and political events can have a significant impact on currency prices, and traders need to keep an eye on market news and events that could potentially affect the forex market.


In conclusion, Dow Theory is a valuable tool for traders looking to understand and analyze market trends. By identifying the primary trend, looking for secondary corrections, and using volume to confirm the trend, traders can make informed trading decisions and manage their risk effectively. However, it's important to remember that Dow Theory is just one tool in a trader's arsenal, and it should be used in conjunction with other technical and fundamental analysis techniques.


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