The Dow Theory and its six basic tenets.

The Dow Theory is a theory of market analysis developed by Charles H. Dow, one of the founders of Dow Jones & Company and the Wall Street Journal. Although it was developed in the late 19th and early 20th centuries, the Dow Theory is still widely followed and considered an important framework for understanding market trends.

The Dow Theory is primarily concerned with analyzing the stock market through the use of price movements and volume. It is based on the analysis of two major stock market indices: the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA). According to the theory, the movements of these two indices can provide valuable insights into the overall direction of the market.

The Dow Theory is based on six basic tenets:

1. The market discounts everything: The theory assumes that all available information about a stock or the market is reflected in its price. Therefore, the analysis focuses on price movements rather than specific fundamental factors.

2. The market has three trends: The Dow Theory identifies three types of market trends: primary, secondary, and minor. The primary trend can last from months to years and represents the overall direction of the market. Secondary trends are corrections within the primary trend, typically lasting weeks to months. Minor trends are short-term fluctuations that are less significant.

3. The primary trend has three phases: The primary trend is divided into three phases: accumulation (smart money buying), public participation (general investors joining the trend), and distribution (smart money selling). These phases can help identify potential turning points in the market.

4. Confirming indices: The Dow Theory suggests that the primary trend is confirmed when both the DJIA and DJTA move in the same direction. If one index reaches a new high or low while the other does not, it may signal a divergence and a potential warning sign.

5. Volume confirmation: The theory emphasizes that volume should confirm the direction of price movements. Increasing volume during an upward trend is seen as a sign of strength, while decreasing volume during a rally may indicate weakness.

6. Trend remains in effect until proven otherwise: According to the Dow Theory, the current trend remains intact until there is sufficient evidence to suggest a reversal. Traders and investors should avoid making premature judgments and wait for clear confirmation of a trend change.

The Dow Theory provides a framework for understanding the overall direction of the stock market and can help traders and investors make informed decisions. However, it is important to note that market analysis involves a range of factors, and the Dow Theory is just one tool among many that can be used to assess market trends and conditions.