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The Dow theory on Stock price movement is a form of technical analysis that includes some aspects of rotation. The theory was derived from Wall Street editorials written by Charles H. Dow, Journalist, Founder and first Editor of The Wall Street Journal and CoFounder of Dow Jones and Company. There are 6 basic tenets of Dow Theory.
1. The market has 3 movements.
Primary movement: A major trend may last from year to several years. It can be bullish or bearish.
Medium swing: It may last from 10 days to 3 months.
Short swing: It is a minor movement lasting from hours to a month or more.
2. Market trends have 3 phases.
Dow theory asserts that major market trends are composed of 3 phases — accumulation phase, public participation phase and distribution phase. The accumulation phase is a period when investors are actively buying stocks against general opinion of the market. The stock price does not change much. Eventually a rapid price change occurs and this phase continues until rampant speculation occurs.
3. The Stock market discounts on news
The Stock prices incorporate news as soon as it becomes available and prices will change.
4. Stock market averages must confirm each other
When there is a divergence in averages its seen as a warning.
5. Trends are confirmed by volume
Dow believes volume is confirmed by trends. If many participants are active in a particular security and price move signficantly in one direction Dow maintained that this was the direction in which the market anticipated continued movement. To him it was the signal that a trend is developing.
6. Trends exist until definitive signals prove that trends exist despite market noise
Markets move temporarily move in the direction opposite to the trend but they will resume soon the prior move.