Dow Theory

When it comes to investing in the stock market, understanding market trends is crucial. One of the most influential theories in this regard is the Dow Theory. Developed by Charles H. Dow, the founder of the Wall Street Journal, this theory has stood the test of time and continues to be a valuable tool for investors. In this article, we will delve into the intricacies of the Dow Theory, its key principles, and how it can help you make informed investment decisions.

Introduction to the Dow Theory

The Dow Theory is based on the analysis of the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA). These two indices are considered to be representative of the overall market trend. According to the Dow Theory, the movement of these averages can provide valuable insights into the direction of the market.

The Dow Theory identifies three distinct phases in market trends: the accumulation phase, the public participation phase, and the distribution phase.

1. Accumulation Phase

In the accumulation phase, smart money investors start buying stocks when prices are low. This phase is characterized by low trading volumes and a lack of public interest. Prices may fluctuate within a range, but overall, they remain relatively stable. This phase is an indication that the market is bottoming out, and a new uptrend may be on the horizon.

2. Public Participation Phase

As the market starts to recover, the public participation phase begins. This phase is marked by increasing trading volumes and growing public interest in stocks. Prices start to rise steadily, and investors who missed the accumulation phase begin to enter the market. This phase is often the longest and most profitable for investors.

3. Distribution Phase

The distribution phase occurs when the market reaches its peak. Prices may become volatile, and trading volumes start to decline. Smart money investors begin to sell their holdings, taking profits from the previous phases. The general public, however, remains optimistic and continues to buy stocks. This phase is a warning sign that the market may be nearing a downturn.

Confirmation and Non-Confirmation

Another important aspect of the Dow Theory is the concept of confirmation and non-confirmation. According to this theory, for a trend to be considered valid, both the DJIA and the DJTA must confirm each other's movements. If one average reaches a new high or low, the other should follow suit. If there is a non-confirmation, it suggests a potential reversal in the market trend.

Case Study: The Great Recession

A notable example of the Dow Theory in action is the Great Recession of 2008. In the accumulation phase, which began in 2007, the DJIA and DJTA both experienced significant declines. This was an indication that the market was bottoming out and a new uptrend could be expected.

During the public participation phase, which started in early 2009, both averages began to rise steadily. Trading volumes increased, and investor confidence started to return. This phase lasted for several years, with the market reaching new highs.

In the distribution phase, which began in 2015, the DJIA continued to rise, reaching new highs, while the DJTA failed to confirm these movements. This non-confirmation signaled a potential reversal in the market trend. In 2016, the market experienced a significant downturn, leading to a correction.

Using the Dow Theory in Your Investment Strategy

Now that we understand the key principles of the Dow Theory, let's explore how you can incorporate it into your investment strategy.

1. Analyze the DJIA and DJTA

Start by analyzing the movements of the DJIA and DJTA. Look for confirmation or non-confirmation between the two averages. If they are confirming each other's movements, it suggests a strong and valid trend. If there is a non-confirmation, it may be a warning sign of a potential reversal.

2. Identify the Market Phase

Based on the movements of the averages, determine which phase of the market trend you are in. Are we in the accumulation phase, public participation phase, or distribution phase? Understanding the current phase can help you make informed decisions about buying or selling stocks.

3. Consider Other Indicators

While the Dow Theory is a powerful tool, it is not the only indicator you should rely on. Consider other technical and fundamental indicators to validate your analysis. This can include factors such as earnings reports, economic data, and industry trends.


The Dow Theory provides a valuable framework for understanding market trends and making informed investment decisions. By analyzing the movements of the DJIA and DJTA, investors can identify the three phases of market trends and determine whether a trend is valid or potentially reversing. Incorporating the Dow Theory into your investment strategy can help you navigate the complexities of the stock market and increase your chances of success.

Remember, the Dow Theory is just one tool in your investment toolbox. It should be used in conjunction with other indicators and thorough research. By combining multiple sources of information, you can develop a well-rounded investment strategy that takes into account both the macroeconomic environment and the specific dynamics of individual stocks and sectors.

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