TradeCityPro Academy | Dow Theory Part 2👋 Welcome to TradeCityPro Channel!
Welcome to the Educational Content Section of Our Channel Technical Analysis Training
We aim to produce educational content in playlist format that will teach you technical analysis from A to Z. We will cover topics such as risk and capital management, Dow Theory, support and resistance, trends, market cycles, and more. These lessons are based on our experiences and the book The Handbook of Technical Analysis.
🎨 What is Technical Analysis?
Technical Analysis (TA) is a method used to predict price movements in financial markets by analyzing past data, especially price and trading volume. This approach is based on the idea that historical price patterns tend to repeat and can help traders identify profitable opportunities.
🔹 Why is Technical Analysis Important?
Technical analysis helps traders and investors predict future price movements based on past price action. Its importance comes from several key benefits:
Faster Decision-Making: No need to analyze financial reports or complex news—just focus on price patterns and trading volume.
Better Risk Management: Tools like support & resistance, indicators, and chart patterns help traders find the best entry and exit points.
Applicable to All Markets: Technical analysis can be used in Forex, stocks, cryptocurrencies, commodities, and even real estate.
📚 Recap of the Previous Session
In the previous session, we explained the first two principles of Dow Theory. Make sure to review and study them, and if you have any questions, feel free to reach out to us in the comments.
📑 Principles of Dow Theory
1 - The Averages Discount Everything (Not applicable to crypto)
2 - The Market Has Three Trends
3 - Trends Have Three Phases
4 - Trend Continues Until a Reversal is Confirmed
5 - The Averages Must Confirm Each Other
6 - Volume Confirms the Trend
🌟 Principle 3: Trends Have Three Phases
In Dow Theory, the primary trend (which can be a Bull Market or Bear Market) is divided into three distinct phases. These phases reflect market behavior and investor psychology over time. Here’s a detailed explanation:
📉 Accumulation Phase
Definition: This phase begins when the market is at its lowest point (in a bull trend after a bear market) or when general pessimism prevails. Smart investors, professionals, and those with a long-term vision (like large funds or experienced traders) start buying.
Characteristics:
Prices are still low, and economic news is typically negative (e.g., recession, high unemployment).
Trading volume is low because the general public lacks confidence and doesn’t participate.
Price changes are small and gradual, making the market seem "lifeless" or directionless.
Psychology: This phase marks a transition from despair to hope. Smart investors recognize that the worst is over and that the real value of assets exceeds their current price.
Example: Imagine after a major crash like 2008, some big companies stabilize their prices, but the media still talks about "collapse." Professionals step in here. Or with Bitcoin at $16K, most people thought it was heading to zero and were hopeless!
📈 Public Participation Phase
Definition: This phase occurs when the primary trend is clearly established, and the market starts moving more strongly. Economic news improves, and the general public (retail investors) enters the market.
Characteristics:
Prices rise quickly (in a bull market) or fall sharply (in a bear market).
Trading volume increases significantly as participation grows.
Analysts and media begin confirming the trend with positive reports.
Psychology: Confidence in the market grows, and greed (in a bull market) or fear (in a bear market) gradually takes over. This is where market momentum accelerates.
Example: In a bull market, you might see indices like the Dow Jones hitting new records weekly, with ordinary people buying tech or industrial stocks.
💰 Distribution Phase
Definition: This is the end of the primary trend. In a bull market, smart investors who bought during accumulation start selling to take profits. In a bear market, panic selling subsides, and some buy in hopes of a recovery.
Characteristics:
Prices may still be high, but volatility increases, and signs of weakness emerge.
Trading volume might remain high, but discrepancies between volume and price (e.g., price drops with high volume) appear.
News is still positive, but professionals know the market is overvalued.
Psychology: In a bull market, excessive optimism (Euphoria) dominates; in a bear market, complete despair sets in. This is where the trend reverses.
Example: At the peak of the dot-com bubble (2000), tech stocks kept rising, but professionals began exiting, and then the crash followed.
Key Note: These three phases occur in sequence, and understanding them helps analysts identify the market’s position in the larger cycle. In a bear market, the phases reverse: panic selling (like distribution), temporary recovery (like participation), and final capitulation (like accumulation).
🔍 Principle 4: The Averages Must Confirm Each Other
Charles Dow believed that for a primary trend to be confirmed, two key market indices—the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA)—must move in the same direction. This principle stems from economic and logical significance in Dow’s time and is still considered a key metric. Here’s the full explanation:
📊 Economic Logic:
Industry and Transportation: In Dow’s era (late 19th and early 20th centuries), the U.S. economy relied heavily on industrial production and transportation (e.g., railroads). If industrial companies (producers of goods) were growing, demand for transportation (moving goods) should also rise.
Thus, aligned movement in these indices signaled a healthy economy.
Mutual Confirmation: If only one average rises (e.g., industrials go up but transportation doesn’t), Dow saw it as a sign of weakness or an unsustainable trend.
🤑 Practical Application:
Bullish Trend: In a bull market, both averages should reach new highs (Higher Highs). If the DJIA hits a new record but the DJTA fails to confirm and stays lower, the uptrend is questionable.
Bearish Trend: In a bear market, both should hit new lows (Lower Lows). Lack of confirmation (e.g., industrials fall but transportation doesn’t) might signal the end of the downtrend.
Divergence: If the averages diverge (one rises while the other doesn’t), Dow viewed it as a warning of a potential trend change.
⚖️ Technical Details:
Timing: Confirmation doesn’t need to be simultaneous but should occur within a reasonable timeframe (e.g., weeks or months).
Volume: Though not directly mentioned in this principle, handbooks emphasize that high volume during confirmation adds credibility to the trend.
Classic Example: In 1929, the industrial average began falling, but transportation initially resisted. When transportation also dropped, the bearish trend was confirmed, leading to the Great Depression.
🎉 Conclusion
We’ve reached the end of today’s educational segment! We’ll start by explaining all of Dow Theory’s principles, and in the future, we’ll move on to chart analysis and the strategy I personally use for trading with Dow Theory. So, make sure you fully grasp these concepts first so we can progress together in this learning journey!
💡 Final Thoughts for Today
This is the end of this part, and I must say we have a long journey ahead. We will continually strive to produce better content every day, steering clear of sensationalized content that promises unrealistic profits, and instead, focusing on the proper learning path of technical analysis.
⚠️ Please remember that these lessons represent our personal view of the market and should not be considered financial advice for investment.
