Dow Theory

Financial markets
Bond market
Fixed income
Corporate bond
Government bond
Municipal bond
Bond valuation
High-yield debt
Stock market
Preferred stock
Common stock
Stock exchange
Foreign exchange market
Retail forex
Derivative market
Credit derivative
Hybrid security
Other Markets
Commodity market
OTC market
Real estate market
Spot market

Finance series
Financial market
Financial market participants
Corporate finance
Personal finance
Public finance
Banks and Banking
Financial regulation
Dow Theory is a theory on stock price movements that provides a basis for technical analysis. The theory was derived from 255 Wall Street Journal editorials written by Charles H. Dow (18511902), journalist, founder and first editor of the Wall Street Journal and co-founder of Dow Jones and Company. Following Dow's death, William P. Hamilton, Robert Rhea and E. George Schaefer organized and collectively represented "Dow Theory," based on Dow's editorials. Dow himself never used the term "Dow Theory," though.

The six basic tenets of Dow Theory as summarized by Hamilton, Rhea, and Schaefer are described below.

Six basic tenets of Dow Theory

  1. Markets have three trends
  2. : Dow defined an uptrend (trend 1) as a time when successive rallies in a security price close at levels higher than those achieved in previous rallies and when lows occur at levels higher than previous lows. Downtrends (trend 2) occur when markets make lower lows and lower highs. It is this concept of Dow Theory that provides the basis of technical analysis' definition of a price trend. Dow described what he saw as a recurring theme in the market: that prices would move sharply in one direction, recede briefly in the opposite direction, and then continue in their original direction (trend 3).
  3. Trends have three phases
  4. : Dow Theory asserts that major market trends are composed of three phases: an accumulation phase, a public participation phase, and a distribution phase. The accumulation phase (phase 1) is when investors "in the know" are actively buying (selling) stock against the general opinion of the market. During this phase, the stock price does not change much because these investors are in the minority absorbing (releasing) stock that the market at large is supplying (demanding). Eventually, the market catches on to these astute investors and a rapid price change occurs (phase 2). This is when trend followers and other technically oriented investors participate. This phase continues until rampant speculation occurs. At this point, the astute investors begin to distribute their holdings to the market (phase 3).
  5. The stock market discounts all news
  6. : Stock prices quickly incorporate new information as soon as it becomes available. Once news is released, stock prices will change to reflect this new information. On this point, Dow Theory agrees with one of the premises of the efficient market hypothesis.
  7. Stock market averages must confirm each other
  8. : In Dow's time, the US was a growing industrial power. The US had population centers but factories were scattered throughout the country. Factories had to ship their goods to market, usually by rail. Dow's first stock averages were an index of industrial (manufacturing) companies and rail companies. To Dow, a bull market in industrials could not occur unless the railway average rallied as well, usually first. According to this logic, if manufacturers' profits are rising, it follows that they are producing more. If they produce more, then they have to ship more goods to consumers. Hence, if an investor is looking for signs of health in manufacturers, he or she should look at the performance of the companies that ship the output of them to market, the railroads. The two averages should be moving in the same direction. When the performance of the averages diverge, it is a warning that change is in the air.
  9. : Both Barron's Magazine and the Wall Street Journal still publish the daily performance of the Dow Jones Transportation Index in chart form. The index contains major railroads, shipping companies, and air freight carriers in the US.
  10. Trends are confirmed by volume
  11. : Dow believed that volume confirmed price trends. When prices move on low volume, there could be many different explanations why. An overly aggressive seller could be present for example. But when price movements are accompanied by high volume, Dow believed this represented the "true" market view. If many participants are active in a particular security, and the price moves significantly in one direction, Dow maintained that this was the direction in which the market anticipated continued movement. To him, it was a signal that a trend is developing.
  12. Trends exist until definitive signals prove that they have ended
  13. : Dow believed that trends existed despite "market noise". Markets might temporarily move in the direction opposite the trend, but they will soon resume the prior move. The trend should be given the benefit of the doubt during these reversals. Determining whether a reversal is the start of a new trend or a temporary movement in the current trend is not easy. Dow Theorists often disagree in this determination. Technical analysis tools attempt to clarify this but they can be interpreted differently by different investors.


As with many investment theories, there is conflicting evidence in support and opposition of Dow Theory. Alfred Cowles in a study in Econometrica in 1934 showed that trading based upon the editorial advice would have resulted in earning less than a buy-and-hold strategy using a well diversified portfolio. Cowles concluded that a buy-and-hold strategy produced 15.5% annualized returns from 1902-1929 while the Dow Theory strategy produced annualized returns of 12%. After numerous studies supported Cowles over the following years, many academics stopped studying Dow Theory believing Cowles's results were conclusive.

In recent years however, some in the academic community have revisited Dow Theory and question Cowles' conclusions. William Goetzmann, Stephen Brown, and Priyank kumar believe that Cowles' study was incomplete [1] and that Dow Theory produces excess risk-adjusted returns. Specifically, the absolute return of a buy-and-hold strategy was higher than that of a Dow Theory portfolio by 2%, but the riskiness and volatility of the Dow Theory portfolio was so much lower that the Dow Theory portfolio produced higher risk-adjusted returns according to their study. The Chicago Board of Trade also notes that there is growing interest in market timing strategies such as Dow Theory. [2]

One key problem with any analysis of Dow Theory is that the editorials of Charles Dow did not contain explicitly defined investing "rules" so some assumptions and interpretations are necessary. And as with many academic studies of investing strategies, practitioners often disagree with academics.

Many technical analysts consider Dow Theory's definition of a trend and its insistence on studying price action as the main premises of modern technical analysis.


  • J. M. Hurst: The Profit Magic of Stock Transaction Timing. Englewood Cliffs, N.J.: Prentice-Hall, 1977. [ISBN 0-13-726000-8] (Analysis of the empirical character of US stock market movements prior to 1973) {NB: Also, [ISBN 0-934380-62-7]}
  • John Murphy: Technical Analysis of Futures Markets. New York, N.Y.: New York Inst. of Finance, 1986. [ISBN 0-13-898008-X]

External links

Stock Market
Types of Stocks
Stock | Common stock | Preferred stock | Outstanding stock | Treasury stock
Trading Stock
Participants:Market maker
Exchanges:Stock exchange | List of stock exchanges | New York Stock Exchange | NASDAQ
colspan="4" align="left"| Toronto Stock Exchange | London Stock Exchange | Euronext | Frankfurt Stock Exchange
colspan="4" align="left"| Tokyo Stock Exchange | Hong Kong Stock Exchange | Australian Securities Exchange
colspan="4" align="left"| Warsaw Stock Exchange | Botswana Stock Exchange | Zimbabwe Stock Exchange
colspan="4" align="left"| Palestine Securities Exchange | Kyrgyz Stock Exchange | Chittagong Stock Exchange Nairobi Stock Exchange | Uganda Securities Exchange
Stock Valuation
Trading Theories:Dow Theory | Elliott Wave Theory | Fundamental analysis | Technical analysis
colspan="4" align="left"| Mark Twain effect | January effect | Efficient market hypothesis Arbitrage_pricing_theory
Stock Pricing:Dividend yield | Gordon model | Income per share | Book value | Earnings yield | Beta coefficient
Ratios:Financial ratio | P/CF ratio | PE ratio | PEG ratio | Price/sales ratio | P/B ratio
Stock Related Terms
Dividend | Stock split | Growth stock | Investment | Speculation | Trade | Day trading
In economics, a financial market is a mechanism that allows people to easily buy and sell (trade) financial securities (such as stocks and bonds), commodities (such as precious metals or agricultural goods), and other fungible items of value at low transaction costs and at prices
..... Click the link for more information.
The bond market, also known as the debt, credit, or fixed income market, is a financial market where participants buy and sell debt securities usually in the form of bonds. The size of the international bond market is an estimated $45 trillion of which the size of outstanding U.S.
..... Click the link for more information.
worldwide view.
Fixed income refers to any type of investment that yields a regular (or fixed) return.

For example, if you borrow money and have to pay interest once a month, you have issued a fixed-income security.
..... Click the link for more information.
A corporate bond is a bond issued by a corporation. The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date. (The term "commercial paper" is sometimes used for instruments with a shorter maturity.
..... Click the link for more information.
A government bond is a bond issued by a national government denominated in the country's own currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds.
..... Click the link for more information.
In the United States, a municipal bond (or muni) is a bond issued by a state, city or other local government, or their agencies. Potential issuers of municipal bonds include cities, counties, redevelopment agencies, school districts, publicly owned airports and seaports,
..... Click the link for more information.
Bond valuation is the process of determining the fair price of a bond. As with any security or capital investment, the fair value of a bond is the present value of the stream of cash flows it is expected to generate.
..... Click the link for more information.
In finance, a high yield bond (non-investment grade bond, speculative grade bond or junk bond) is a bond that is rated below investment grade at the time of purchase.
..... Click the link for more information.
A stock market is a market for the trading of company stock, and derivatives of same; both of these are securities listed on a stock exchange as well as those only traded privately.
..... Click the link for more information.
In financial markets, the stock capital of a corporation or a joint-stock company is the capital raised through the issuance, sale and distribution of shares. A person or organization that holds at least a partial share of stock is called a shareholder.
..... Click the link for more information.
Preferred stock, also called preferred shares or preference shares, is typically a higher ranking stock than common stock, and its terms are negotiated between the corporation and the investor.
..... Click the link for more information.
A stock exchange, share market or bourse is a corporation or mutual organization which provides facilities for stock brokers and traders, to trade company stocks and other securities.
..... Click the link for more information.
The foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another. It is by far the largest financial market in the world, and includes trading between large banks, central banks, currency speculators,
..... Click the link for more information.
The Retail forex (Retail Currency Trading or Retail Forex or Retail FX) market is a subset of the larger Foreign exchange market.


Retail trading is more structured than the forex market as a whole.
..... Click the link for more information.
The derivatives markets are the financial markets for derivatives. The market can be divided into two, that for exchange traded derivatives and that for over-the-counter derivatives.
..... Click the link for more information.
In finance, a credit derivative is a financial instrument or derivative whose price and value derives from the creditworthiness of the obligations of a third party, which is isolated and traded.
..... Click the link for more information.
    Returns: Predictable dividend, often franked therefore possible tax advantage to the holder
  • Capital price:
*Price moves in line with share price (fixed conversion terms e.g.

..... Click the link for more information.
Options are financial instruments that convey the right, but not the obligation, to engage in a future transaction on some underlying security. For example, buying a call option provides the right to buy a specified quantity of a security at a set strike price at some time on or
..... Click the link for more information.
In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. The future date is called the delivery date or final settlement date.
..... Click the link for more information.
A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time. Therefore, the trade date and delivery date are separated.
..... Click the link for more information.
swap is a derivative in which two counterparties agree to exchange one stream of cash flows against another stream. These streams are called the legs of the swap.
..... Click the link for more information.
Commodity markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized contracts.
..... Click the link for more information.
Over-the-counter (OTC) trading is to trade financial instruments such as stocks, bonds, commodities or derivatives directly between two parties. It is the opposite of exchange trading which occurs on futures exchanges or stock exchanges.
..... Click the link for more information.
Property law
Part of the common law series
Acquisition of property
Gift  · Adverse possession  · Deed
Lost, mislaid, and abandoned property
Alienation  · Bailment  · License
Estates in land
..... Click the link for more information.
The Spot Market or Cash Market is a commodities or securities market in which goods are sold for cash and delivered immediately. Contracts bought and sold on these markets are immediately effective.
..... Click the link for more information.
Finance studies and addresses the ways in which individuals, businesses, and organizations raise, allocate, and use monetary resources over time, taking into account the risks entailed in their projects.
..... Click the link for more information.
In economics, a financial market is a mechanism that allows people to easily buy and sell (trade) financial securities (such as stocks and bonds), commodities (such as precious metals or agricultural goods), and other fungible items of value at low transaction costs and at prices
..... Click the link for more information.
financial market participant categories, Investor vs. Speculator and Institutional vs. Retail. Action in financial market by Central banks is usually regarded as intervention rather than participation, although evidence exists in the Sprott '"Visible Hand of Uncle Sam"' report that
..... Click the link for more information.
Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to enhance corporate value while reducing the firm's financial risks.
..... Click the link for more information.
Personal finance is the application of the principles of finance to the monetary decisions of an individual or family unit. It addresses the ways in which individuals or families obtain, budget, save and spend monetary resources over time, taking into account various financial
..... Click the link for more information.

This article is copied from an article on - the free encyclopedia created and edited by online user community. The text was not checked or edited by anyone on our staff. Although the vast majority of the wikipedia encyclopedia articles provide accurate and timely information please do not assume the accuracy of any particular article. This article is distributed under the terms of GNU Free Documentation License.