Meet the Dow Theory with 100+ years of history

As investors, you see the famous Dow Jones Industrial Average index every day and it pretty much reflects how the market is performing. But do you know there's a Dow theory developed by Charles H. Dow, the founder of Dow Jones & Company?

In fact, the Dow theory has undergone further developments in its 100-plus-year history by many well-known traders, analysts and scholars. Now let's dive into the theory together to see what it tell us and how useful it can be.

The Dow Theory is a technical framework that predicts the market is in an upward trend if one of its averages advances above a previous important high, accompanied or followed by a similar advance in the other average. For example, if the DJI hits record, the DJUSAF is expected to follow and rise within a time period. Thus, different market indexes should confirm each other until the market trend reverses.

The market has already taken all available information into consideration and all factors have been priced into asset prices.

These primary trends last for 1 year or more. However, there could be secondary trends within these broader trends, such as corrections in a bull market. These secondary trends normally last less than 3 months.

Just like every new product has a life cycle, the primary trends also have 3 stages. A bull market would experience the accumulation phase, the big move phase and the excess phase. Similarly, a bear market would observe the distribution phase, the participation phase, and the panic phase.

For a trend to be established, all indexes should perform the same in terms of price actions.

Trading volumes should reflect the direction of trends. Increasing volumes signal price movements in the direction of the primary trend, while decreasing volumes mean prices are moving against the trend.

Prices move in trends and a trend is believed to be in action unless definitive proofs of reversal emerge. But traders could sometimes be confused whether a price change is short-term or long-term.