Trends, Dow Theory and Drawing Support and Resistance

2.1Dow Theory: Defining a Trend

Dow theory is a body of ideas that later analysts organised from the newspaper editorials of Charles Dow, co-founder of Dow Jones & Company, in the late nineteenth century. Much of modern technical analysis builds on it, and its definition of what a trend is matters most.

Dow theory defines an uptrend as a market whose highs and lows are both rising, and a downtrend as one whose highs and lows are both falling. In the first half of the diagram, higher highs (HH) and higher lows (HL) follow one another.

A trend is assumed to continue until a clear reversal signal appears. In an uptrend, a break below the most recent pullback low (the last HL in the diagram) is the classic signal. In the second half of the diagram, the price fails to make a new high, prints a lower high (LH) and then breaks the pullback low with a lower low (LL), so the uptrend definition no longer holds.

• The averages discount everything
• There are three kinds of trend: primary, secondary and minor
• Primary trends pass through three phases (accumulation, public participation, distribution)
• The averages (originally industrials and railroads) must confirm each other
• Volume must confirm the trend
• A trend persists until a clear reversal signal appears