Dow Theory

Charles H. Dow, in 1884 created two averages or sectorial indices for stock-market of New York, one called Dow Industrial Jones Average (Index of Industrial Sector or DJIA) and Dow Jones Transport Average (Index of the Sector Transports or DJTA).

This way Dow tried to establish an indicator of the economic activity, using for it an average of the evolution of certain sectors in the stock market.

Dow thought that the rise of economic activity implied a greater industrial production, than when increasing its benefits the companies would see increased the demand of its stocks and therefore the quotation of these companies would raise.

As a result, this would affect the rest of the sectors, whose businesses would benefit and consequently the price of its shares rise. Based on these indexes, Charles Dow formulate his theory that today is the base of modern technical analysis and therefore of the chartism (analytical study of the evolutionary graphs of the price of a particular company).

The basic principles of the Dow theory are:

1. - The averages emphasize everything

As we said Dow created two averages, and therefore any event side affected in the quotations, the news, data, and inclusively misfortunes or wars. Leaving to us a clear tendency of the market.

2. - The markets move in tendencies

Every market has a tendency, with these three types, primary, secondary or tertiary.

Primary Trend: This trend usually lasts more than a year, and movements are extensive and constant.

Secondary Trend: This trend can last months, but fluctuations of this trend is included in the Primary Trend. Any corrections that might have might be of the 1/3 or 2/3 of the previous section and are usually 50%

Tertiary or Minor Trend: There are variations within the Secondary Trend.

3 .- Principle of Confirmation

The two averages would have to confirm a possible change of tendency, as much to the rise as to the loss. The movement in one of the averages does not confirm, in if, a change of effective tendency.

But ahead we can see how using two Moving Averages we can confirm a possible change.

4. - The volume moves with the Tendency

The movements in favor of the trend always will be accompanied by an volume greater than the potential correction.

If we are in a bull market phase, the volume will be increased by uploading, and lessen the descents. If we are in a bearish market phase, the volume went up in the fall and decline in raises.

5. - The tendency will be effective while there is not a change confirmation.

This is intended to avoid premature exits of a trend. A trend will continue effective if there is no change in the averages. This gives good advice "Leave run gains, avoiding losses."

A lateral trend or a possible correction does not indicate a change in trend.

6 .- The trends have three phases

Phases of a Bullish Trend

Phase of Accumulation: This phase the investors who think that an economic recovery is possible, enter the market aggressively considering that this has an raise potential. These investors who usually are better informed enter very aggressively when that currency does not have the attention of mass media. Even so, the feeling is of discourage and pessimistic therefore. The buying positions are accumulated by those investors better informed, until the demand presses making raise the quotation. These movements can be considered by the public in general like a bounce of the bearish tendency.

Phase of Tendency or Fundamental: : In this phase it is characterized by an improvement in the economic conditions, where the buys on the part of the traders are growing. In this phase many traders realize that it has happened a change in the main tendency and they enter progressively. The movements of this phase usually are ample.

Phase Distribution or Speculation: At this stage the economic conditions are usually very good. In this phase a large number of traders will incorporate to the market. Strong rises in the currency makes it appear in the media. Operators who have entered the first phase begin to sell their positions, as they believe that the currency has already gone too far in anticipation of a fall.

These are the phases of an uptrend.

Fases de una Tendencia Bajista

Fase de Distribución: Los operadores que han estado en la fase alcista desde la primera fase, se comienzan a deshacer de sus posiciones. En estos momentos las noticias son aun buenas y la corrección que ocurre es considerada por el público general menor o intermedia dentro de la tendencia alcista. En esta fase muchos operadores aun esperan por un fuerte movimiento alcista.

Fase de Pánico: En esta fase la fuerza de venta es muy superior a la compradora y las depreciaciones se acumulan, se suelen producir ventas de pánico.

Los operadores suelen vender fuertes posiciones al mercado, provocando una caída muy vertical en la cual muchos operadores pierden dinero. Después de esta fase suele producirse una corrección lateral o una recuperación en la tendencia bajista la cual suele ser mínima.

En esta fase suele haber un fuerte volumen en la bajada que suele ser inferior a los volúmenes que hubo en la fase alcista.

Fase de Desanimo o Tercera: En esta fase las noticias sobre la divisa comienzan a empeorar o bien no influyen en los precios. Los operadores que se encuentran en esta fase suelen ser los operadores que aguantaron en la fase de Pánico o bien aquellos que compraron considerando que los precios se encontraban bajos.

Los medios de comunicación dejan de prestar atención a dicha divisa y las caídas se van haciendo más suaves.

Estas son las fases en una tendencia bajista.