A Handbook of Technical Analysis: The Practitioner's Comprehensive Guide to Technical Analysis

CHAPTER 2

Introduction to Dow Theory

LEARNING OBJECTIVES

After studying this chapter, you should be able to:

• Understand the basic concepts and assumptions of Dow Theory
• Apply the concepts of Dow Theory to forecast potential entry and exit points in the market
• Identify the strengths and weaknesses of applying Dow Theory
• Explain the importance of price and volume confirmation as a basis for determining potential market action
• Highlight the current challenges to Dow Theory

Dow Theory lays the basic foundation for modern day technical analysis. Its premises underpin the very study of market action analysis and have withstood the test of time. In this chapter, we shall be discussing the basic assumptions of Dow Theory and its relevance in today's markets.

2.1 ORIGINS AND PROPONENTS OF DOW THEORY

Charles H. Dow is credited for much of the early work that led to what is known today as Dow Theory. Dow's successor, William P. Hamilton, carried on developing and organizing much of Dow's original early writings, which included the Wall Street Journal editorials that were published around the beginning of the twentieth century. Hamilton's work culminated in his book The Stock Market Barometer. A close acquaintance of Dow's, S. A. Nelson, published a book about Dow's work entitled The ABC of Stock Speculation and was the first person to refer to Dow's concepts and ideas as the “Dow Theory.”

Robert Rhea, a student of Hamilton, was later responsible for much of the categorizing, refining, ...