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Whale Trading

Dow Theory: The Classic Framework Behind Modern Trend Analysis

In this chapter we look at Dow Theory.

In one sentence:

“Markets move in multiple overlapping trends,
trends are defined by highs and lows,
and they are assumed to continue
until clearly reversed.”

We will cover:

  • what Dow Theory is,
  • the six basic principles,
  • the idea of primary, secondary, and minor trends,
  • the three phases of a major trend,
  • and how to apply this framework in modern chart analysis
    without treating it as a rigid “signal system.”

The diagram below visualizes how:

  • a primary (long-term) trend,
  • a secondary (intermediate) trend,
  • and minor (short-term) swings

can all coexist on the same chart.

1. What Is Dow Theory?

Originally, Dow Theory came from:

  • Charles Dow’s editorials on the behavior of the Dow indices, and
  • later work that 整理 ed his ideas into
    a more systematic trend and structure framework.

Many concepts we now take for granted come straight from Dow Theory:

  • trend as a core idea,
  • defining trend via high/low structure,
  • thinking in terms of multiple timeframes.

It’s more of a language for reading markets
than a ready-made trading system.

2. The Six Basic Principles of Dow Theory

Different books phrase them slightly differently,
but they usually boil down to six key ideas.

2-1. The market discounts everything

“The market discounts all known information.”

Price is assumed to reflect:

  • economic data,
  • interest rates,
  • politics, wars, expectations, fear, and hope—

not perfectly, but well enough that
we can analyze price directly.

This is the same starting point as
technical analysis in general.

2-2. The market has three trends

  • Primary trend – months to years,
  • Secondary (intermediate) trend – weeks to months,
  • Minor trend – days to weeks.

This lines up with our discussion in:

about multiple timeframe structure.

2-3. Each primary trend has three phases

  • Accumulation,
  • Participation (or public participation),
  • Distribution.

We’ll come back to these phases in Section 4.

2-4. Trends are confirmed by high/low structure

  • Uptrend:
    higher highs and higher lows (HH/HL).
  • Downtrend:
    lower highs and lower lows (LH/LL).

This matches our support/resistance view
in s-r.

2-5. Volume should confirm the trend

  • In a healthy uptrend:
    • volume tends to be higher on rallies,
    • and lighter on pullbacks.
  • In a strong downtrend:
    • heavy volume often appears on sell-offs,
    • with lighter volume on reactions.

This ties in with
volume.

2-6. A trend is assumed to continue until clearly reversed

“A trend in motion is assumed to continue
until there is a clear signal of reversal.”

In practice, that “clear signal”
often means a change in:

  • the sequence of highs and lows, and
  • key levels being broken and not reclaimed.

This is the same idea we use when analyzing:

3. Three Trends: Primary, Secondary, and Minor

A key insight of Dow Theory is:

“Different trends coexist on the same chart.”

The diagram below shows:

  • a rising primary trend,
  • several secondary corrections,
  • and many minor swings nested inside.

Practically:

  • Investors:
    • focus on the primary trend,
    • and use secondary reactions as opportunities to build or reduce positions.
  • Traders:
    • must know which “trend level”
      their timeframe lives in,
    • and often choose to align entries
      with the direction of the higher timeframe trend.

4. Three Phases: Accumulation, Participation, Distribution

Dow Theory also divides the primary trend
into three phases.

  1. Accumulation phase

    • News still looks bad or mixed,
    • but informed participants quietly start building positions.
    • Price often stops making new lows
      and begins forming a base.

  2. Participation (public) phase

    • The trend becomes visible;
      technical signals start to align.
    • Patterns like:
    • Many trend-following strategies aim to capture this middle part.

  3. Distribution phase

    • News may still be positive,
    • but price stops making convincing new highs.
    • Bigger players gradually distribute (reduce) positions.
    • Patterns like:

These phases are conceptually close to
the psychology cycles discussed in
elliott.

5. Defining Trend with Highs and Lows

Dow Theory defines trend via
the sequence of highs and lows:

  • Uptrend:
    • each high is higher than the last (HH),
    • and each low is higher than the last (HL).
  • Downtrend:
    • highs fall (LH),
    • lows also fall (LL).

The diagram below shows:

  • left: a clean HH/HL uptrend,
  • right: an example where
    • highs fail to make new highs (LH),
    • a key low breaks (LL),
    • and the structure shifts into a downtrend.

This idea underlies many reversal patterns:

6. Volume and Dow Theory

In Dow Theory, volume is treated as a confirmation tool.

  • In a healthy uptrend:
    • volume tends to expand on rallies,
    • and contract on pullbacks.
  • In a strong downtrend:
    • heavy volume often appears on sell-offs,
    • with weaker volume on bounces.

This aligns with
volume,
where we look at:

  • whether volume supports the current move, and
  • whether spikes near highs or lows
    suggest exhaustion or aggressive participation.

7. Using Dow Theory in Modern Trading

You don’t need to turn Dow Theory
into a mechanical trading system.

Instead, it works well as a structural framework:

  1. Big-picture filter

    • On higher timeframes:
      • ask “What is the primary trend?”
      • and “Where are we: accumulation, participation, or distribution?”
    • This can guide whether you prefer to trade with or against the dominant tide.

  2. Context for reversal patterns

    • When you see a double top/bottom or head and shoulders:
      • don’t just memorize the shape,
      • check whether the high/low structure
        truly shifts from HH/HL to LH/LL (or the opposite).

  3. Linking to risk management

    • A “trend reversal” in Dow Theory terms often aligns with an invalidation level:
      • the point where a prior structural low/high is broken and not reclaimed.
    • This naturally connects to
      risk-management
      as a candidate stop area for trend trades.

8. What to Read Next

Because Dow Theory is a foundational language
for trend and structure,
it combines well with these chapters:

Seen this way, Dow Theory is not an “old theory”
but a still useful backbone for how we talk about trend,
structure, and reversal in modern markets.