Dow theory: six principles and the confirmation between averages

Dow theory on the two real indices

School · Charles Dow and William Peter Hamilton · Wall Street Journal, 1900-1929 · Dow Jones Industrials and Transports

Dow theory

Weekly closes of the two indices, 1998-2002

Industrials+4.7%Transports−28.7%Industrials highJanuary 14, 2000Transports highMay 7, 1999

Rebased to 100 at the first week; the circles mark the high of each.

InteractiveConfirmation or non-confirmation? Click a week on the chart above: I tell you where the two indices stood relative to their highs.

14weeks of non-confirmationbetween July 17, 1998 and January 14, 2000

The three trends of Dow theory

Fig. 1 · Primary, secondary, minor

Primary: lasts from one to several years. It is the tide.
Secondary: corrects the primary for weeks or months. It is the wave.
Minor: a few days. It is the ripple, and it does not count.

The three phases of a primary trend

Fig. 2 · Accumulation, participation, distribution

Accumulation: the best informed buy, the news is still bad.
Participation: earnings improve, trend followers come in.
Distribution: the news is excellent, the public buys; the early buyers sell.

Confirmation, non-confirmation, reversal and volume

Fig. 3 · Confirmation

Both indices make a new high.
Goods are made and shipped: the economy is pulling.
The trend is confirmed.

Fig. 4 · Non-confirmation

The Industrials make a new high.
The Transports do not: their high is lower than the previous one.
The rise is not confirmed: it is a warning, not a signal.

Fig. 5 · The reversal signal

First clue: a high lower than the previous one.
Signal: the decline below the previous low.
Until then the trend is considered intact.

Fig. 6 · Volume

In an uptrend volume grows when the price rises.
In corrections it falls.
If the opposite happens, the trend is weakening.

The six principles

1The averages discount everything

what is known is already in the prices
the news arrives when the move is already done

2The market has three trends

primary, secondary, minor
the tide, the waves, the ripples (fig. 1)

3The primary trend has three phases

accumulation, participation, distribution
who buys first, who follows, who comes last (fig. 2)

4The averages must confirm each other

Industrials and Transports in the same direction
a high by one alone is not enough (fig. 3 and 4)

5Volume confirms the trend

it grows in the direction of the trend
it falls in corrections (fig. 6)

6A trend holds until it reverses

you wait for the signal, you do not anticipate it
a lower high, then below the previous low (fig. 5)

Confirmation in the two periods

choose the period above the chart

Industrials highJanuary 14, 2000in the period

Transports highMay 7, 1999in the period

Weeks of non-confirmation14Industrials at a high, Transports more than 5% below

Outcomenon-confirmation

In 14 weeks the Industrials close at a new high with the Transports more than 5% below theirs, down to −22.8% (December 24, 1999). Confirmation never came in the period.

Where to go from here

The schools

The other lessons in the guide

What is technical analysis

the study of price and volume to recognise the trend and the levels
three premises: price discounts everything, trends, history repeats
exercise: uptrend, downtrend or sideways on three real charts

Candlestick chart

the four prices of a session: body and shadows
green and red, long and short bodies, long shadows, the doji
find the candle on a real chart: the judge says yes or no with the numbers

Uptrend: higher highs and higher lows

higher highs and higher lows: how to recognize an uptrend
swing points, and the two signals that end a trend
mark the higher lows yourself on a real chart

Support and resistance

the level where the decline stopped, and the one where the rise stopped
touches, time and volume: how much a level counts; once broken, it switches roles
find the level yourself on a real chart: the judge counts the touches

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Frequently asked questions

What is Dow theory?

The first organic theory of technical analysis, born from Charles Dow’s editorials in the Wall Street Journal between 1900 and 1902: three trends, three phases, and a trend counts only if the Dow Jones Industrials and Transports confirm it.

What are the six principles of Dow theory?

The averages discount everything; the market has three trends; the primary trend has three phases; the averages must confirm each other; volume confirms the trend; a trend holds until it gives clear signals of reversal.

Why compare the Dow Jones Industrials and the Transports?

For Dow, the goods produced must be shipped: if industrial stocks rise and transport stocks do not, the rise is not confirmed.

Does Dow theory still work?

As a method for reading the trend, yes; the limit is that the signals come late, and today’s indices are different from Dow’s.

Method and sources

The sources of this page: the books are cited, the text is ours
Source
John J. Murphy, Technical Analysis of the Financial Markets: chapter 2, Dow theory.
Robert D. Edwards, John Magee, W.H.C. Bassetti, Technical Analysis of Stock Trends, 9th ed.: chapters 3-5.
Charles D. Kirkpatrick and Julie R. Dahlquist, Technical Analysis (CMT curriculum): chapter 6.
William Peter Hamilton, The Stock Market Barometer, 1922; Robert Rhea, The Dow Theory, 1932.

Official weekly closes of the Dow Jones Industrial Average and the Dow Jones Transportation Average from our archive, in the periods 1998-2002 and 2021-2024. The numbered figures are diagrams drawn to explain, not prices. This guide explains how the tools work: it does not contain investment recommendations and promises no returns. Our method · licence · report an error.