I present to you here the Basic Tenets of Dow Theory, which many of my future posts will be based upon, (as well as some more modern methods such as Elliott Wave, algorithm trading, etc.). The cryptocurrency market is new and in some ways different than the Dow, such as the ability to manipulate small ventures with pump and dumps and FUD etc., In that regard please refer to Basic Tenet 1. I also understand that in the crypto market we do not as of yet have an Averages vehicle such as the Dow Jones Industrial Average, in this case I monitor the top ten coins to get a feel of the entire market and do simple comparisons for reference. Please be aware, this is a new market and things happen pretty fast, none of these differences take away the effectiveness of the Dow Theory just a different perspective of time is appropriate.
ps. I am a student of the market and I am sharing my studies. This is not required reading as I posted it here for reference purposes.
Basic Tenets
Dow Theory basic tenets:
The Averages Discount Everything (except “Acts of God”)
Because they reflect the combined market activities of thousands of investors, including those possessed of the greatest foresight and the best information on trends and events, the Averages in their day-to-day fluctuations discount everything known, everything foreseeable, and every condition which can affect the supply of or the demand for corporate securities. Even unpredictable natural calamities, when they happen, are quickly appraised and their possible effects discounted.
The Three Trends
The “market,” meaning the price of stocks in general, swings in trends, of which the most important are its
Major or Primary Trends. These are the extensive up or down movements which usually last for a year or more and result in general appreciation or depreciation in value of more than 20%. Movements in the direction of the Primary Trend are interrupted at intervals by Secondary Swings in the opposite direction — reactions or “corrections” that occur when the Primary Move has temporarily “gotten ahead of itself.” (Both Secondaries and the intervening segments of the Primary Trend are frequently lumped together as Intermediate Movements — a term which we shall find useful in subsequent discussions.) Finally, the Secondary Trends are composed of Minor Trends or day-to-day fluctuations which are unimportant to Dow Theory.
The Primary Trends
These, as aforesaid, are the broad, overall, up and down movements which usually (but not invariably) last for more than a year and may run for several years. So long as each successive rally (price advance) reaches a higher level than the one before it, and each Secondary Reaction stops (i.e., the price trend reverses from down to up) at a higher level than the previous reaction, the Primary Trend is Up. This is called a Bull Market. Conversely, when each Intermediate Decline carries prices to successively lower levels and each intervening rally fails to bring them back up to the top level of the preceding rally, the Primary Trend is Down and that is called a Bear Market. (The terms Bull and Bear are frequently used loosely with reference, respectively, to any sort of up or down movements, but we shall use them in this book only in connection with the Major or Primary Movements of the market in the Dow sense.) Ordinarily — theoretically, at least — the Primary is the only one of the three trends with which the true long-term investor is concerned. His aim is to buy stocks as early as possible in a Bull Market — just as soon as he can be sure that one has started — and then hold them until (and only until) it becomes evident that it has ended and a Bear
Market has started. He knows that he can safely disregard all the intervening Secondary Reactions and Minor Fluctuations. The trader, however, may well concern himself also with the Secondary Swings, and it will appear later on in this book that he can do so with profit.
The Secondary Trends
These are the important reactions that interrupt the progress of prices in the Primary Direction. They are the Intermediate Declines or “corrections” which occur during Bull Markets, the Intermediate Rallies or “recoveries” which occur in Bear Markets. Normally, they last for 3 weeks to many months, and rarely longer. Normally, they retrace from one third to two thirds of the gain (or loss, as the case may be) in prices registered in the preceding swing in the Primary Direction. Thus, in a Bull Market, prices in terms of the Industrial Average might rise steadily, or with only brief and minor interruptions, for a total gain of 30 (or 300) points before a Secondary Correction occurred. That correction might then be expected to produce a decline of not less than 10 points and not more than 20 points before a new Intermediate Advance in the Primary Bull Trend developed. Note, however, that the one third/two thirds rule is not an unbreakable law; it is simply a statement of probabilities. Most Secondaries are confined within these limits; many of them stop very close to the halfway mark, retracing 50% of the preceding Primary Swing. They seldom run less than one third, but some of them cancel nearly all of it. Thus we have two criteria by which to recognize a Secondary Trend. Any price movement contrary in direction to the Primary Trend that lasts for at least 3 weeks and retraces at least one third of the preceding net move in the Primary Direction (from the end of the preceding Secondary to the beginning of this one, disregarding Minor Fluctuations) is labeled as of Intermediate Rank, i.e., a true Secondary. Despite these criteria, however, the Secondary Trend is often confusing; its recognition, its correct appraisal at the time it develops and while it is in process, poses the Dow theorist’s most difficult problem. We shall have more to say about this later.
The Minor Trends
These are the brief (rarely as long as 3 weeks — usually less than 6 days) fluctuations which are, so far as the Dow Theory is concerned, meaningless in themselves, but which, in total, make up the Intermediate Trends. Usually, but not always, an Intermediate Swing, whether a Secondary or the segment of a Primary between successive Secondaries, is made up of a series of three or more distinguishable Minor Waves. Inferences drawn from these day- to-day fluctuations are quite apt to be misleading. The Minor Trend is the only one of the three trends which can be “manipulated” (although it is, in fact, doubtful if under present conditions even that can be purposely manipulated to any important extent). Primary and Secondary Trends cannot be manipulated; it would strain the resources of the U.S. Treasury to do so.
The Bull Market
Primary Uptrends are usually (but not invariably) divisible into three phases. The first is the phase of
accumulation during which farsighted investors, sensing that business, although now depressed, is due to turn up, are willing to pick up all the shares offered by discouraged and distressed sellers, and to raise their bids gradually as such selling diminishes in volume. Financial reports are still bad — in fact, often at their worst — during this phase. The “public” is completely disgusted with the stock market — out of it entirely. Activity is only moderate but beginning to increase on the rallies (Minor Advances). The second phase is one of fairly steady advance and increasing activity as the improved tone of business and a rising trend in corporate earnings begin to attract attention. It is during this phase that the “technical” trader normally is able to reap his best harvest of profits. Finally, comes the third phase when the market boils with activity as the “public” flocks to the boardrooms. All the financial news is good, price advances are spectacular and frequently “make the front page” of the daily papers, and new issues are brought out in increasing numbers. It is during this phase that one of your friends will call up and blithely remark, “Say, I see the market is going up. What’s a good buy?” — all oblivious to the fact that it has been going up for perhaps two years, has already gone up a long ways, and is now reaching the stage where it might be more appropriate to ask, “What’s a good thing to sell?” In the last stage of this phase, with speculation rampant, volume continues to rise, but “air pockets” appear with increasing frequency; the “cats and dogs” (low-priced stocks of no investment value) are whirled up, but more and more of the top-grade issues refuse to follow.
The Bear Market
Primary Downtrends are also usually (but again, not invariably) characterized by three phases. The first is the
distribution period (which really starts in the later stages of the preceding Bull Market). During this phase, farsighted investors sense the fact that business earnings have reached an abnormal height and unload their holdings at an increasing pace. Trading volume is still high, though tending to diminish on rallies, and the “public” is still active but beginning to show signs of frustration as hoped-for profits fade away. The second phase is the Panic Phase. Buyers begin to thin out and sellers become more urgent; the downward trend of prices suddenly accelerates into an almost vertical drop, while volume mounts to climactic proportions. After the Panic Phase (which usually runs too far relative to then-existing business conditions), there may be a fairly long Secondary Recovery or a sideways movement, and then the third phase begins.
This is characterized by discouraged selling on the part of those investors who held on through the Panic or, perhaps, bought during it because stocks looked cheap in comparison with prices which had ruled a few months earlier. The business news now begins to deteriorate. As the third phase proceeds, the downward movement is less rapid, but is maintained by more and more distress selling from those who have to raise cash for other needs. The “cats and dogs” may lose practically all their previous Bull Advance in the first two phases. Better-grade stocks decline more gradually, because their owners cling to them to the last. And, the final stage of a Bear Market, in consequence, is frequently concentrated in such issues. The Bear Market ends when everything in the way of possible bad news, the worst to be expected, has been discounted, and it is usually over before all the bad news is “out.” The three Bear Market phases described in the preceding paragraph are not the same as those named by others who have discussed this subject, but the writers of this study feel that they represent a more accurate and realistic division of the Primary down moves of the past 30 years. The reader should be warned, however, that no two Bear Markets are exactly alike, and neither are any two Bull Markets. Some may lack one or another of the three typical phases. A few Major Advances have passed from the first to the third stage with only a very brief and rapid intervening markup. A few short Bear Markets have developed no marked Panic Phase and others have ended with it, as in April 1939. No time limits can be set for any phase; the third stage of a Bull Market, for example, the phase of excited speculation and great public activity, may last for more than a year or run out in a month or two. The Panic Phase of a Bear Market is usually exhausted in a very few weeks if not in days, but the 1929 through 1932 decline was interspersed with at least five Panic Waves of major proportions. Nevertheless, the typical characteristics of Primary Trends are well worth keeping in mind. If you know the symptoms which normally accompany the last stage of a Bull Market, for example, you are less likely to be deluded by its exciting atmosphere.
Principle of Confirmation
The Two Averages Must Confirm
This is the most-often questioned and the most difficult to rationalize of all the Dow principles. Yet it has stood the test of time; the fact that it has “worked” is not disputed by any who have carefully examined the records. Those who have disregarded it in practice have, more often than not, had occasion to regret their apostasy. What it means is that no valid signal of a change in trend can be produced by the action of one Average
“Volume Goes with the Trend”
Those words, which you may often hear spoken with ritual solemnity but little understanding, are the colloquial expression for the general truth that trading activity tends to expand as prices move in the direction of the prevailing Primary Trend. Thus, in a Bull Market, volume increases when prices rise and dwindles as prices decline; in Bear Markets, turnover increases when prices drop and dries up as they recover. To a lesser degree, this holds for Secondary Trends also, especially in the early stages of an extended Secondary Recovery within a Bear Market, when activity may show a tendency to pick up on the Minor Rallies and diminish on the Minor Set-backs. But to this rule, again, there are exceptions, and useful conclusions can seldom be drawn from the volume manifestations of a few days, much less a single trading session; it is only the overall and relative volume trend over a period of time that may produce helpful indications. Moreover, in Dow Theory, conclusive signals as to the market’s trend are produced in the final analysis only by price movement. Volume simply affords collateral evidence which may aid interpretation of otherwise doubtful situations.
“Lines” May Substitute for Secondary's
A Line in Dow Theory parlance is a sideways movement (as it appears on the charts) in one or both of the Averages, which lasts for 2 or 3 weeks or, sometimes, for as many months, in the course of which prices fluctuate within a range of approximately 5% or less (of their mean figure). The formation of a Line signifies that pressure of buying and selling is more or less in balance. Eventually, of course, either the offerings within that price range are exhausted and those who want to buy stocks have to raise their bids to induce owners to sell, or else those who are eager to sell at the “Line” price range find that buyers have vanished and that, in consequence, they must cut their prices in order to dispose of their shares. Hence, an advance in prices through the upper limits of an established Line is a Bullish Signal and, conversely, a break down through its lower limits is a Bearish Signal. Generally speaking, the longer the Line (in duration) and the narrower or more compact its price range, the greater the significance of its ultimate breakout. Lines occur often enough to make their recognition essential to followers of Dow’s principles. They may develop at important Tops or Bottoms, signaling periods of distribution or of accumulation, respectively, but they come more frequently as interludes of rest or Consolidation in the progress of established Major Trends. Under those circumstances, they take the place of normal Secondary Waves. A Line may develop in one Average while the other is going through a typical Secondary Reaction. It is worth noting that a price movement out of a Line, either up or down, is usually followed by a more extensive additional move in the same direction than can be counted on to follow the “signal” produced when a new wave pushes beyond the limits set by a preceding Primary Wave. The direction in which prices will break out of a Line cannot be determined in advance of the actual movement. The 5% limit ordinarily assigned to a Line is arbitrarily based on experience; there have been a few slightly wider sideways movements which, by virtue of their compactness and well defined boundaries, could be construed as true Lines.
Only Closing Prices Used
Dow Theory pays no attention to any extreme highs or lows which may be registered during a day and before the market closes, but takes into account only the closing figures, i.e., the average of the day’s final sale prices for the component issues. We have discussed the psychological importance of the end-of-day prices under the subject of chart construction and need not deal with it further here, except to say that this is another Dow rule which has stood the test of time. It works thus: suppose an Intermediate Advance in a Primary Uptrend reaches its peak on a certain day at 11 a.m., at which hour the Industrial Average figures at, say, 152.45, and then falls back to close at 150.70. All that the next advance will have to do in order to indicate that the Primary Trend is still up is register a daily close above 150.70. The previous intraday high of 152.45 does not count. Conversely, using the same figures for our first advance, if the next upswing carries prices to an intraday high at, say, 152.60, but fails to register a closing price above 150.70, the continuation of the Primary Bull Trend is still in doubt. In recent years, differences of opinion have arisen among market students as to the extent to which an Average should push beyond a previous limit (Top or Bottom figure) in order to signal (or confirm or reaffirm, as the case may be) a market trend. Dow and Hamilton evidently regarded any penetration, even as little as 0.01, in closing price as a valid signal, but some modern commentators have required penetration by a full point (1.00). We think that the original view has the best of the argument, that the record shows little or nothing in practical results to favor any of the proposed modifications. One incident in June of 1946, to which we shall refer in the following chapter, shows a decided advantage for the orthodox “any-penetration-whatever” rule.
A Trend Should Be Assumed to Continue in Effect Until Such Time as Its Reversal Has Been Definitely Signaled
This Dow Theory tenet is one which, perhaps more than any other, has evoked criticism. Yet, when correctly understood, it, like all the others we have enumerated, stands up under practical test. What it states is really a
probability. It is a warning against changing one’s market position too soon, against “jumping the gun.” It does not imply that one should delay action by one unnecessary minute once a signal of change in trend has appeared. But it expresses the experience that the odds are in favor of the man who waits until he is sure, and against the other fellow who buys (or sells) prematurely. These odds cannot be stated in mathematical language such as 2–1 or 3–1; as a matter of fact, they are constantly changing. Bull Markets do not climb forever and Bear Markets always reach a Bottom sooner or later. When a new Primary Trend is first definitely signaled by the action of the two Averages, the odds that it will be continued, despite any near-term reactions or interruptions, are at their greatest. But as this Primary Trend carries on, the odds in favor of its further extension grow smaller. Thus, each successive reaffirmation of a Bull Market (new Intermediate high in one average confirmed by a new Intermediate high in the other) carries relatively less weight. The incentive to buy, the prospect of selling new purchases at a profit, is smaller after a Bull Market has been in existence for several months than it was when the Primary Uptrend was first recognized, but this twelfth Dow tenet says, “Hold your position pending contrary orders.” A corollary to this tenet, which is not so contradictory as it may at first seem, is: a Reversal in trend can occur any time after that trend has been confirmed. This can be taken simply as a warning that the Dow Theory investor must watch the market constantly if he has any commitment in it.
rev. Technical Analysis of Stock Trends
