Dow Theory Every Trader Must Know - Making Profit from Reading Charts Easier

Dow Theory is considered the foundation of technical analysis that has been accepted for over 100 years. Anyone unfamiliar with Dow Theory may miss important opportunities to predict market trends. Today, we will explain how this theory is useful in trading and investing.

How does Dow Theory work - Simple explanation

Dow Theory originated from the ideas of Charles H. Dow and William Peter Hamilton in the early 20th century. The basic concept of this theory is comparing market price movements to the flow of ocean currents.

When the market is in an uptrend (Uptrend), prices will continuously make new highs, and the next lows will be higher than the previous lows. Conversely, in a downtrend (Downtrend), new lows will be lower than previous lows, and new highs will be lower than previous highs. Sometimes, in uncertain market conditions, prices will fluctuate back and forth (Sideway) without forming clear new highs or lows.

Why investors need to understand Dow Theory

Dow Theory helps traders to:

• Read the market more accurately - Know whether the market is rising or falling, not guesswork
• Plan trades clearly - Buy during uptrends, sell during downtrends
• Reduce risks - Recognize when the market changes direction, allowing timely stop-loss

Learning Dow Theory can improve your trading skills, but only through practical application, not just reading the theory.

The 3 trend levels in Dow Theory - Choose according to your trading timing

According to Dow Theory, prices move in three trend levels, each differing in duration:

( 1. Primary Trend ) - Long-term This trend lasts for a year or more, sometimes up to 4 years. It is crucial for long-term investors as it indicates the overall market direction in the long run.

2. Intermediate Trend ( - Medium-term

This trend lasts from 3 weeks to 3 months, often representing temporary adjustments within the primary trend. If the primary trend is down, there may be a short-term rally )Intermediate Trend### before the trend resumes.

( 3. Minor Trend ) - Short-term Duration is up to 3 weeks. It involves short-term market movements, suitable for short-term traders to speculate.

6 main principles of Dow Theory that traders must remember

( 1. The market discounts all information The current stock prices on the chart reflect all available information, including company profits, news, or other factors. Therefore, price analysis alone is sufficient for trading.

) 2. Prices move in three main patterns Uptrend, downtrend, and sideways. Each pattern has different signals:

• Uptrend ###Uptrend( - Making new highs and higher lows
• Downtrend )Downtrend### - Making new lows and lower highs
• Sideway ###Sideway( - Indecisive, no clear new highs or lows

) 3. All trends consist of three phases

Phase 1: Accumulation (Accumulation) Prices are low, beginning to rise, but the trend is not yet clear. Fundamental investors (Fundamental Investors) are encouraged to buy, while technical traders wait.

Phase 2: Public Participation ###Public Participation( Prices rise clearly, and the asset gains general attention. Trading volume increases, allowing traders to profit fully.

Phase 3: Distribution )Distribution( Prices approach the peak, filled with general money. Large investors start selling to lock in profits. Confidence is high, but a decline often follows.

) 4. Everything must be consistent Charles Dow originally used the Dow Jones Industrial Average and the Dow Jones Transportation Average to confirm each other’s trends. If one index is rising, the other should also be rising to confirm a genuine market uptrend.

( 5. Volume should confirm the trend In an uptrend )Uptrend(, trading volume should increase accordingly. In a downtrend, volume should also increase on selling. Consistency between price and volume indicates a strong trend.

) 6. Trends continue until clear signals of reversal An uptrend continues until a new lower high ###Lower High### or a new lower low (Lower Low) appears. When these signals occur, Dow Theory indicates the trend has ended.

Double Bottom and Double Top - Trend reversal signals

Double Bottom ( - Two lows forming ) - A bullish signal

When prices form two similar lows (W or U shape), it indicates the decline is over, and the market is building a strong base. The next move should be a recovery.

( Double Top ) - Two highs forming ### - A warning signal Conversely, when prices form two similar highs (M shape), it suggests the rally is over, and the market is creating a ceiling. A decline is likely, and buying at this stage carries high risk.

Pros and cons of using Dow Theory

( Advantages ✅

• Simple fundamental system - Clear principles, not complicated
• Good at identifying trends - Helps improve trading decision-making
• Applicable to all asset classes - Stocks, gold, crypto, etc.
• Does not rely on economic data - Uses only price charts and volume

) Disadvantages ❌

• Confirmation lag - Must wait for trends to be clear, sometimes missing fast moves
• Ignores fundamental factors - Such as corporate earnings announcements or major news, which may not immediately reflect in charts

How to use Dow Theory for profitable trading

Bullish market ( - Uptrend )

When prices continue to rise, making new highs and higher lows, do the following:

• Place Buy orders - Enter or plan to buy
• Target - Set profit-taking points (Take Profit) at the next resistance level
• Protection - Use stop-loss ###Stop Loss### below the latest low

Bearish market ( - Downtrend )

When prices continue to fall, making new lows and lower highs, do the following:

• Place Sell orders - Enter or plan to sell
• Target - Set profit points (Take Profit) at the next support level
• Protection - Use stop-loss (Stop Loss) above the latest high

When the market moves sideways

In this situation, it is best to wait and not fight the market until the trend becomes clearer.

Dow Theory and CFD trading

The CFD (Contract for Difference) trading style is highly suitable for applying Dow Theory because it offers flexibility:

• Profiting from uptrends - Use buy orders to go long
• Profiting from downtrends - Use sell orders to go short
• Trade across various assets - Stocks, crypto, gold, indices within a single account

Summary and mastering Dow Theory

Dow Theory (Dow Theory) may seem simple, but it is a fundamental basis of technical analysis. Understanding and mastering it can boost your confidence in trading because you know where the market is heading and what actions to take. However, it requires practice, not just reading the theory.

Investing involves risks. Consult with professionals or try demo accounts before trading with real money for the best results.