What is Dow Theory?

What is Dow Theory?

The ‘Dow Theory’ was founded over a century ago, yet in today’s technology-driven markets, the basic components of Dow Theory still remain valid and play a vital role. Developed by Charles Dow, polished by William Hamilton, then expressed by Robert Rhea, the Theory states not only technical analysis and price action, but also market philosophy.

‘The Dow Theory’ – The Book.

On Dow’s death in 1902, William Hamilton continued Dow’s work, writing editorials of his own until 1929. Robert Rhea then collected works of both of these men and used it as a basis to publish The Dow Theory in 1932.


The theory has experienced further changes in its 100-plus year history, including contributions by William Hamilton and S.A. Nelson in1920s, then Robert Rhea in the 1930s, and finally Richard Russell and E. George Shaefer were the latest  in the 1960s.

Charles Dow developed the theory in the late 19th century. Awaiting his death in 1902, Dow was a part owner as well as editor of The Wall Street Journal.

 S.A. Nelson and William Hamilton later polished the theory into what it is today.

Finally, in 1932, Robert Rhea further refined the analysis of Dow and Hamilton in The Dow Theory.


Some Accepted Definitions–

  • The Dow Theory is simply a method of trading.
  • The Dow Theory  is a form of technical analysis that includes some features of sector rotation.
  • Dow Theory is an analysis which combines the two Dow averages – Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA). When one of these averages hikes to an intermediate high, then the other is likely to follow suit within a reasonable amount of time. Otherwise, the averages possess “divergence” and the market is responsible to reverse course.

How it works –

At Dow’s time, the two averages were Industry and rails, the logic behind the theory is simple: The Industrial companies did the manufacturing of goods and the rails shipped them. When one average noted a new secondary or intermediate high, the other average was required to do the same in order for the signal to be considered effective.

Now, if the two averages acted in coordination — with both reaching new highs and lows around the same time period — then the price action of each was said to be confirming.

However, if one of the averages went to a new high, while the other was left behind, then bearish divergence was found. In the contrary case, with one average, reaching a new low while the other held above a previous bottom, then the divergence was bullish in marketing terms.

How is it of use in today’s world?

Dow Theorists claim that the principle remains valid still. They repel that the activity of the Industrials and Transports provides a filter which detects whether the stock market is in a healthy or bad state.

By understanding the Dow Theory, traders are better able to spot unseen trends that more expert investors may be noting. This allows them to make more informed decisions regarding their open positions.


  1. Three movements of the Market –
  • The Primary movement or major trend may last for less than a year for quite a few years. Can be bullish or bearish.
  • The Secondary reaction or intermediate reaction may last from ten days to three months and generally repeats from 33% to 66% of the primary price change since the previous medium swing or the start of the main movement.
  • The Minor movement differs with opinion from hours to a month or more.

         2. Three phases of Market trends –

  • Accumulation Phase, is the period when investors are actively selling stock in contradiction of the general opinion of the market. During this phase, the stock price does not alter much.
  • Absorption Phase, Eventually, the market catches on to these wise investors and a rapid price change occurs.
  • Distribution Phase, Absorption Phase continues until rampant speculation occurs. At this point, the wise investors begin to distribute their holdings to the market
  1. The stock market discounts everything.

     4. Stock prices instantly incorporate new information as soon as it becomes available.Stock market averages must confirm each other, as explained above.

     5. Volume confirms the trend – Volume should increase if the price is moving in the direction of the primary trend, and decrease if it is moving against it.

    6. Trends Exist until there is a clear end – Markets might momentarily move in the direction opposite to the trend, but they will soon continue the prior move. The trend should be given the benefit of the doubt during these reversals.

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