Dow theory is a market analysis methodology that was developed by Charles Dow, co-founder of Dow Jones & Company and creator of the Dow Jones Industrial Average. The theory is based on the idea that the stock market consists of three distinct movements, or trends, that can be identified and used to predict future price movements.
According to Dow theory, these three trends are the primary trend, the secondary trend, and the minor trend. The primary trend is the overall direction of the market and is typically measured in months or years. The secondary trend, on the other hand, is a temporary reversal of the primary trend and is usually measured in weeks or months. The minor trend is the most short-term movement of the market and is typically measured in days or weeks.
Dow theory also states that the stock market moves in cycles, with each cycle consisting of four phases: accumulation, markup, distribution, and markdown. In the accumulation phase, investors are buying stocks but the market hasn’t yet recognized the increased demand, leading to a rise in prices. In the markup phase, the market begins to recognize the increased demand and prices continue to rise. In the distribution phase, investors start to sell off their stocks and prices begin to decline. Finally, in the markdown phase, selling continues and prices fall further.
Dow theory is often used by investors and analysts as a way to identify potential entry and exit points in the market, as well as to identify overall market trends. While the theory has its critics, it remains a popular approach to market analysis and is still widely used today.