Dow Theory Explained - Part 3

Dow theory does not specify a time period beyond which a confirmation of one average by the other becomes invalid. Generally, the closer the confirmation, the stronger the following move is likely to be.

One of the major criticisms of Dow theory is that many of its signals have proved to be late, often 20 to 25 percent after a peak or trough in the averages has occurred.

Dow theorists would not necessarily use these levels as actual buying or selling points, but would probably consider altering the percentage of their equity exposure if a significant non confirmation developed between the Industrial Average and the Transportation Average when the yield on the Dow reached these extremes.

This strategy would help to improve the investment return of the Dow theory, but would not always result in a superior performance.

Dow 'theory tell nothing about the trend duration or size of the trend, it main focus is on the primary trend of the market. Once confirmed by both averages, the new trend is assumed to be in existence until an offsetting confirmation by both averages takes place.

Major bull and bear markets each have three distinct phases. Both the identification of these phases and the appearance of any divergence in the normal volume/price relationship offer useful indications that a reversal in the major trend is about to take place. Such supplementary evidence is particularly useful when the action of the price averages is inconclusive.