A hundred years ago it was about understanding. In general, a secondary, or intermediate, trend typically lasts between three weeks and three months, while the retracement of the secondary trend generally ranges between one-third to two-thirds of the primary trend's movement.
ABOUT DOW JONES
Traders who identify the primary trend and continue to trade in its direction till it lasts are handsomely rewarded. It is easy to identify the primary trend in this chart. A series of higher highs and higher lows are marked on the chart.
Price on the left side of the chart was in a downtrend. The trend changed from down to up at the point marked by the thick arrow. At this point, the sequence of lower highs and lower lows were broken with price making a new high. Once trend changed, it remained in force for almost a year.
An example of a downtrend is shown in the next chart. Now we shall see how we can identify a primary trend in a bearish market. The following chart shows how an uptrend changed to a downtrend. As seen in the chart, after a brief consolidation trend changed from bullish to bearish. A sequence of higher highs and higher lows were broken when a series of lower highs were formed. These are marked on the chart using multiple arrows, the break below the previous higher low confirmed a trend change.
The new bearish trend remained in force for almost a year. A secondary trend is a correction in the ongoing primary trend. The secondary trend continues for three weeks to three months after which the primary trend resumes.
The secondary trend is marked on the chart above with thin arrows; the primary trend which is down is shown with a thicker arrow. The secondary trend is sharp and violent. After a sharp countertrend move, the primary trend resumes.
Minor trend lasts a few hours to a few days, but not more than three weeks. It is random in nature and is not profitable to trade; it should be ignored according to Dow Theory. An attempt to trade the minor trends can lead to stop-loss hits, frustration, a string of losing trades and loss of confidence. It is therefore advised to always trade in the direction of the primary trend.
According to the Dow Theory, a primary bull trend consists of three phases. An accumulation phase where informed buyers start accumulating, followed by a steady phase where most of the trend followers enter the trend. And it ends with a blowout phase when everyone is into the trade.
A bearish trend starts with a distribution phase where informed investors sell their positions when everyone else is buying, trend followers start selling in the steady phase, despair grips most of the market participants and the blowout phase ends with a steep decline. The left side of the chart shows the blowout phase for the downtrend. The accumulation starts after the downtrend, followed by steady and blowout phase which ends the uptrend. Dow Theory gives importance to volume and suggests a trend backed by volume is likely to be strong and continues for a longer duration compared to a trend which lacks volume.
Some traders criticize the Dow theory for this reason. But it is important to note that only a handful of traders profit by identifying and trading the top and bottom turning points. Most successful traders are those who follow trends and earn decent profits by identifying the larger trends and staying with it.
Dow theory was primarily designed for the equity markets. It has proved its mettle successfully over the last century in the equity markets. Its principles can be utilized in the Forex markets by combining the trend identification methods of Dow Theory with Trendlines and Moving Averages.
Point 1 is the beginning of an uptrend and a buy can be initiated at this point. We have already explained how to identify an uptrend. Traders can also use moving averages for entries. Point 2 on the chart shows an entry using moving averages. As the trend is up, we are looking only for buy signals. After the secondary trend is completed, price resumes in the direction of the main trend. We wait for both the 20 and 50 EMAs to turn up, and price to break above both the moving averages.
It retraces to point 2, where the 50 EMA provides support. A buy can be initiated when the price moves above the 20 EMA again. The trend lines in this chart cannot be used for generating buy signals, but they can be used to take profits on the long positions.
Knowledge and anticipation of how markets move is hard to come by and in truth, it is more of a natural talent than a learnt skill. In spite of this, natural talent alone is not enough and being successful in the markets requires hard work and dedication above all else.
Regular forex education is essential if you want to improve the success rate of your trades. One simple way to boost your knowledge is to adopt a trading strategy. Here, we look at the Dow Theory and show how it can help you improve your trades.
The principles behind the Dow Theory are relatively simplistic and, because of this, it is a great tool for new traders. The fundamental belief behind the Dow Theory is that any factor that would influence the market will have already been factored into the offer price.
It may be the case that such factors cannot be predicted, but, even so, they are already factored in. Why Use Technical Analysis? Put simply, technical analysis uses charts and graphs to predict price movements. By showing the events of the past, it is believed that future developments can be predicted.