The Handbook of Technical Analysis + Test Bank_ The Practitioner\'s Comprehensive Guide to Technical Analysis ( PDFDrive )

Introduction to Dow Theory

barometer for investment decisions. It is sometimes referred to as the tides of the

oceans. Although the primary trend usually lasts from months to years, Rhea com-

mented that is it very difficult to forecast the extent or duration of a primary trend.

There are two types of primary trends, namely:

1. Primary bull trend (bull market)


2. Primary bear trend (bear market)

In Dow Theory, an uptrend is defined primarily as successively higher peaks

and troughs. A downtrend is defined as successively lower peaks and troughs. No-

tice in Figure 2.4 that the appearance of a lower high in an uptrend may represent

an early indication that the uptrend may be coming to an end.

In Dow Theory, an indication of a trend continuation or reversal is signaled by

the penetration of a previous peak or trough. As such, one of the main criticisms

of Dow Theory is that buy and sell signals arrive too late, usually missing out on

one‐third or more of the entire trend. According to Dow, it is more important to

participate in a primary bull or bear trend once it has been confirmed or once it

proves that it has the strength to penetrate old peaks or troughs. Dow believes that

losing out on some potential profit for the added safety of participating in a con-

firmed trend is well worth the sacrifice. It should also be noted that all investment

and trading decisions are based strictly on the primary trend alone, with the excep-

tion of trading lines that may form from the daily price fluctuations. See Figure 2.5.

Figure 2.6 depicts a primary bull trend in gold that lasted approximately

12 years.

Figure 2.7 depicts a primary bear trend in the 30‐year Treasury bond yield

that lasted approximately 23 years.

It should be noted that if trends are defined via trendline violations rather

than by the successive sequence of rising or falling peaks and troughs, there

may be some discrepancies between exactly when a change in trend actually

occurs, especially when different chart scaling is employed. Logarithmically

fIgure 2.4 An Uptrend in Terms of Successively Higher Highs and Lows.