Dow Theory: The Foundation of Technical Analysis

Dow Theory is the cornerstone of technical analysis and a major topic on the CMT Level 1 exam. Developed by Charles Dow in the late 1800s, it provides the philosophical foundation for chart-based market analysis.

The Six Tenets of Dow Theory

1. The Market Discounts Everything

All known information — fundamental, political, psychological — is already reflected in market prices.

2. The Market Has Three Trends

  • Primary trend: Major trend lasting months to years
  • Secondary trend: Corrections within the primary trend (3 weeks to 3 months)
  • Minor trend: Short-term fluctuations (less than 3 weeks)

3. Major Trends Have Three Phases

  • Accumulation: Smart money buying
  • Public participation: Trend followers join
  • Distribution: Smart money selling

4. Averages Must Confirm Each Other

Originally the Industrials and Rails (now Transports) must both confirm a trend for it to be valid.

5. Volume Must Confirm the Trend

Volume should expand in the direction of the primary trend.

6. A Trend Persists Until Definitively Reversed

Trends remain in effect until clear reversal signals appear.

Modern Applications

While developed over a century ago, Dow Theory principles remain relevant:

  • Trend identification frameworks
  • Intermarket confirmation concepts
  • Volume analysis fundamentals