Each trader has their own, unique strategy for dealing with the markets. Although there is a perceived myth about some traders having a market edge, this very rarely turns out to be the case and, although you can have good market intuition, nobody is born to be a trader. Some people merely strike it lucky in the trading world, after finding a strategy that works for them. Finding the right trade at the right time takes practice and regular education. One of the most useful strategies involved in trading is the Dow Theory. Here, we look at how it could help you improve your trades.
A System To Suit All Traders
The principals behind trading using the Dow Theory are (in trading terms at least) relatively straightforward and, as a result, the method is accessible for traders of all levels of skill and experience. Ultimately, the sentiments behind Dow Theory equate to the belief that any factor that would influence the market has already been factored into the offer price. Sometimes, prospective buyers- and even potentially sellers- are unaware of what these factors might be, but they are factored in nonetheless.
Using Dow Theory to Map Market Trends Through Technical Analysis
The Dow Theory states that you can spot underlying patterns in any chart by looking for three specific market trends that occur over a number of timescales, these are:
- The Primary Trend: a broad, long lasting trend that can occur over a number of years
- The Secondary Trend: not as long lasting as the primary trend, but this will generally occur over weeks and months rather than days. Usually, this acts to correct and fluctuations in the primary trend, keeping it on its intended course.
- The Daily Trend: A trend that only lasts a maximum of one month. The daily trend will show short, volatile movements in the market and it is very unusual that these will affect the primary trend in the long term.
Although discussed separately here to show you how they occur, it is important to understand that all three trends act simultaneously, with a technical analysis chart giving you a visual representation of the shapes they take.
Interpreting Charts Using The Dow Theory
Dow Theory is useful because it takes the emotion out of trading. Remember, the principal behind Dow Theory states that all factors are already included in the price, and this includes the emotional aspect of all participants. Such emotions cause fluctuations in short term trends, but will never affect the primary trend. This means that, even if the unexpected happens, only the short term trend will fluctuate, and you can trust the primary trend to gauge your options. Long term, strategic thinking will always take place using the Dow Theory and, to back up your beliefs on why the daily trend is affected and whether (in extreme circumstances) it will spread to the secondary trend, you’ll have to maximise the use of educational material.
To conclude, Dow Theory is based around the principal that all prices are currently factored into markets. Once you understand these trends and how they’re manipulated, you should be able to read charts more accurately.