What is Dow Theory and the Market Cycle?

What is Dow Theory and the Market Cycle?

Firstly, what is Dow Theory?

The Dow Theory is a theory used in market analysis and was invented over a century ago. Since then, it has become the standard for numerous technical analysis techniques. 

Principles of Dow Theory

1. Price indicates everything

It is stated that prices that rise and fall are partly due to current news and economic or financial states.

2. Relation of amounts of trades to market prediction

If the price is heading uptrend, the demand or buying volume should also be heading upwards. The contrasting manner applies to downtrend markets. However, if the two are not in relation, a reversal is stated to be plausibly incoming.

In a situation where a price is heading uptrend, but the volume is increasing, it can be an indication of a false signal, wherein the price may not be heading upwards very long. The contrasting direction applies to downtrend markets.

3. Price confirmation

The theory states that the price of assets in similar categories will always travel in unison, such as the correlation between a new all-time high price of both public utility and transportation groups’ stocks.

In cryptocurrency, this particular principle is not yet applicable as the premise is largely digitally-based, along with how there is little to no connection between the services of each platform.

4. Continuous movement until change

Prices are indicated to continuously travel in a certain direction until a certain occurrence stops the movement, reversing its trajectory, awaiting another occurrence to revert it back.

5. The three market trend variations:

5.1 Primary Trend - the movements of price over the span of a year or more, displaying the various uptrend and downtrend movements.

5.2 Intermediate Trend - the movements of a price over the period of 1 month or less, indicating high volatility through support-resistance lines.

5.3 Minor Trend - the movements of a price over the time frame of less than a month, also displaying high volatility. The support-resistance lines can be examined to find an entry or exit point in the market.

6. The three market phases

6.1 The accumulation phase - the lowest point of a price, or lower than usual, allowing investors an entry point.

6.2 The public participation phase - indicates clear market projection, allowing investors an entry point.

6.3 The distribution phase - after buying in the initial phases, investors have been found to sell and take profit, mitigating risks for long-term holding of their assets.

Primary trend’s relation to market cycles

By being able to study market trajectories in primary trends, when there are numerous occurrences, market cycles can take precedence, allowing investors insight into their investment strategies.

Primary trends are divided into uptrend and downtrend phases. The uptrend category can be further separated as such:

1. Accumulation Phase - a phase initiated after a previous downtrend market occurrence, wherein investors have been found to collectively buy assets due to its low price point. In this phase, news may not be present and technical analysis investors may experience unclear signals from the market.

2. Participation Phase - investors tend to buy in this phase as well after appearances of influential news, TA investors are also included.

3. Excess Phase - after continuous upward movements and influential news and word-of-mouth, prices may have skyrocketed to a point suitable for selling. Some may experience FOMO and also participate.

As for downtrend markets, they can be divided as follows:

1. Distribution Phase - a phase wherein new investors have little to no space for movement, the market may face slight depression and price dips. TA investors may also sell due to market indications to cut losses.

2. Participation Phase - investors may start heavily cutting loss after clearer signals, further worsening the price dip. Influential news may also arise, leading some groups to buy due to the low price point, causing small and brief price spikes and rebounds.

3. Panic Phase - after continuous dips and glimpses of hope through brief rebound periods, some investors may start entirely selling while some groups may continue to hold their assets. When reaching a certain point, the graph would display a reversal back into the market cycle, initiating the phases once more.

In clarification of the early-mentioned matter, investors that are observant of the market cycle can easily find entry and exit points, as well as apply certain theories to their technical and fundamental analysis strategies, as well as their risk management methods.


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