Doe Theory or How Technical Analysis Appeared
In order to fully reflect on the progress made, it is sometimes useful to return to the very foundations. Today, technical analysis is taken for granted, and few people wonder what really lies behind well-known market terms. Doe 's theory, and Charles Doe himself in particular, can be said to have been at those very foundations. At the same time, at the moment the postulates of theory have not lost their relevance.
Postulates of the Theory of Dow
The price considers everything
Of course, the market cannot take into account events that by definition cannot be predicted. However, the price already takes into account the emotions of the participants, economic data of individual companies and states, including readings of inflation and interest rates, and even possible risks in case of unforeseen developments.
In no case does this mean that the market itself or its participants know absolutely everything, and even future events. This only means that all that has happened has already been captured in the price, and any new information will also be taken into account.
A huge number of technical indicators have been created on this base, and today you can find an indicator to analyze literally anything. But while indicators are often used mindlessly, Dow analyzed the market entirely, relying on the natural segmentation of market players.
The extreme reflection of his work is indices of industry and transport. The composition of the index itself has an important role. It is not fixed and is periodically revised to take into account the changing market situation. The essence is that shares of enterprises operating in the same area are analyzed. As a result, the index is in some way a closed system in which most of the funds are distributed among the participants and do not go beyond the portfolio.
Market of three trends
The straight market movement is science fiction. In fact, the price almost always moves zigzag, forming characteristic rising/decreasing highs/lows. In other words, forming an uptrend or a downtrend.
There is a major initial trend in the market. It is most important to define it, as it is the original trend that reflects the actual direction of price movement when all underlying trend levels are dependent on the original. The duration of the reference trend ranges from 1 year to 3 years.
The most important thing is to determine the direction of the original trend and trade in agreement with it. The trend remains in place until there was confirmation of its reversal. The prerequisite for a reversal, for example, may be the closing of the price below the previous extreme.
So, the original trend determines the main direction of the market. In turn, the secondary trend is moving towards the opposite of the main trend. In fact, these are corrections to the main trend. The secondary trend has one interesting characteristic - its volatility is usually higher than the original movement.
The latter, the smallest trend, is nothing short of a secondary trend rollback. Such movement continues no longer than one week. The classical presentation pays the least attention to it. It is believed that there is too much price noise in a given time period, and cycling on the slightest movements can lead to irrational trade solutions.
Three phases of a trend
The following postulate of Dow theory is the stages of trend formation:
The first phase is usually characterized by price consolidation. This is a period of market hesitation when the previous trend is on the drain. In other words, this period is marked by an accumulation of forces before breaking and is also the most attractive entry point (though risky);
Once the new direction has been confirmed, the participation phase begins. It is the main phase of the trend, the longest of the three, which is also marked by a large price movement;
When the motivating conditions have been exhausted, the suppression phase begins. During this period, intelligent players begin to withdraw from positions as soon as there are signs of instability, such as increased corrections. This phase can be described as "irrational optimism" when the price can continue to rise by inertia, despite the absence of clear prerequisites.