Prediction With The Dow Theory
Technical analysts rely on the assumption that stock prices have predictable patterns. This assumption is based on the Dow Theory, named after Charles H. Dow, who founded the forerunner of the Dow Jones Industrial Average. According to the Dow Theory, the stock market averages reflect everything known by the investment community, and their trends can be predicted. The theory describes three basic trends in stock price movements.
Primary movements are relatively long in duration and are generally known to investors as bull and bear markets.
Secondary movements frequently move against the primary trend and make up intermediate corrections during bull markets and recoveries during bear markets.
Daily movements have no importance in and of themselves, but collectively they make up secondary trends.
Although simplistic, the Dow Theory forms the foundation of modern technical analysis. However, today’s technician goes much deeper into trend technical analysis, as you will see in the sections that follow.
The Dow Theory
Primary movements in stocks are analogous to a tide, with secondary movements akin to the waves and daily movements like ripples.
In technical analysis, technical analysts are most concerned with primary and secondary trends.
According to the original theory, a primary trend is not officially recognized until it has been confirmed by
(1) like movements in both the industrials and rail averages, and
(2) breaking out.
The second occurs when, after fluctuating within a narrow range over an extended period, the market average penetrates the upper level of the range.
A bull or bear market may be under way for some time before it is confirmed