Dow Theory

Question 1

What are the three premises of the technical approach?

Answer 1

1. Market action discounts everything
2. Prices move in trends
3. History repeats itself

Murphy, John J.. Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications (New York Institute of Finance) (p. 2). Penguin Publishing Group. Kindle Edition.

Question 2

What are the 6 basic tenents of the DOW Theory?

Answer 2

1. The Averages Discount Everything
2. The Market Has 3 Trends (primary, secondary & minor)
3. Major Trends Have 3 Phases (accumulation, public & distribution)
4. The Averages Must Confirm Each Other
5. Volume Must Confirm the Trend
6. A Trend Is Assumed to Be in Effect Until It Gives Definite Signals That It Has Reversed.

Murphy, John J.. Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications (New York Institute of Finance) (p. 24). Penguin Publishing Group. Kindle Edition.

Question 3

Dow focused his attention on primary or major trends, which he felt usually take place in three distinct phases:

• Accumulation
• Public participation
• Distribution

How are the 3 phases defined?

Answer 3

Accumulation Phase: represents informed buying by the most astute investors

Public Participation Phase: where most technical trend-followers begin to participate, occurs when prices begin to advance rapidly, and business news improves.

Distribution Phase: increasingly bullish media and when speculative volume and public participation increase. The same informed investors who began to “accumulate” near the bear market bottom begin to “distribute” before anyone else starts selling.

Murphy, John J.. Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications (New York Institute of Finance) (p. 26). Penguin Publishing Group. Kindle Edition.

Question 4

Is this statement true or false?

“The most difficult task for a Dow theorist, or any trend-follower for that matter, is being able to distinguish between a normal secondary correction in an existing trend and the first leg of a new trend in the opposite direction”

Answer 4

The statement is True.

Murphy, John J.. Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications (New York Institute of Finance) (p. 29). Penguin Publishing Group. Kindle Edition.

Question 5

In context of Dow theory what is the significance of closing prices?

Answer 5

Dow relied exclusively on closing prices. He believed that averages had to close higher than a previous peak or lower than a previous trough to have significance. Dow did not consider intraday penetrations valid.

Murphy, John J.. Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications (New York Institute of Finance) (pp. 30-31). Penguin Publishing Group. Kindle Edition.