Dow Theory

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Trading with Dow Theory

There are many times in a bear market when people (especially the media) start getting excited. The market starts to rally, and before you know it we have truck loads of market experts calling a new bull market. But how do you look through all the news and noise and really tell if a new bull market has really started?

Here is one way that has been very successful in keeping out of bad trades and staying in good ones over the last 50 – 100 years. Originally coined from Charles Dow’s own writings (if his name sounds familiar, it’s because it is one half of the “Dow Jones Index”) Dow Theory, as it is now called, is simple and quick to use. But why would we use Dow Theory?

Here are the main benefits:
1: Dow Theory is an easy and measurable way to recognise when the market is heading up, and when the market is heading down (and likely to continue).

2: As Dow Theory is viewed on a weekly chart, you only need to scan the market once a week. This means you can work full time and still trade successfully.

3: Being a weekly strategy, you get to capture the longer weekly trends. These will usually range from 5% to 30%, but can stretch out to 50%, 100% or more.

4: Dow Theory is easy to recognise. You do not need to have any fancy indicators, volume, or astrological charts on your screen to recognise a Dow Theory signal.

Now, according to Dow Theory, to have a bear market we must see a peak in price, followed by a trough, then followed by a lower peak. Once price trades through or closes below the previous trough, this is our signal to sell.

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By the same token, to have a bull market we must see a trough, followed by a peak, then followed by a higher trough. Once price trades through or closes above the previous peak, this is our signal to buy. If this all seems confusing,

I found the above picture which says a thousand words
Graph Source > http://www.asxmarketwatch.com/wp-content/uploads/2009/06/dow-theory1.jpg