Trading with Dow Theory
There are many times in a bear market when people (especially the media) start getting excited. The market starts to rally, and before you know it we have truck loads of market experts calling a new bull market. But how do you look through all the news and noise and really tell if a new bull market has really started?
Here is one way that has been very successful in keeping out of bad trades and staying in good ones over the last 50 – 100 years. Originally coined from Charles Dow’s own writings (if his name sounds familiar, it’s because it is one half of the “Dow Jones Index”) Dow Theory, as it is now called, is simple and quick to use. But why would we use Dow Theory?
Here are the main benefits:
1: Dow Theory is an easy and measurable way to recognise when the market is heading up, and when the market is heading down (and likely to continue).
2: As Dow Theory is viewed on a weekly chart, you only need to scan the market once a week. This means you can work full time and still trade successfully.
3: Being a weekly strategy, you get to capture the longer weekly trends. These will usually range from 5% to 30%, but can stretch out to 50%, 100% or more.
4: Dow Theory is easy to recognise. You do not need to have any fancy indicators, volume, or astrological charts on your screen to recognise a Dow Theory signal.
Now, according to Dow Theory, to have a bear market we must see a peak in price, followed by a trough, then followed by a lower peak. Once price trades through or closes below the previous trough, this is our signal to sell.
By the same token, to have a bull market we must see a trough, followed by a peak, then followed by a higher trough. Once price trades through or closes above the previous peak, this is our signal to buy. If this all seems confusing, I find a picture says a thousand words:
Click the picture for a visual idea of Dow Theory.
When you combine this with a good stop loss and solid trade management, Dow Theory can be a great trading strategy. But please – don’t take my word for it, go out and backtest it for yourself. If you find it works for you, then that’s great! You might just save yourself some money.
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June 11, 2009
Tags: Enter and Exit Posted in: Free Trading Course Lesson Backlog
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2 Responses
Ask Dave | ASX Market Watch - March 29, 2010
[...] advice. I respect the powers that be – but I CAN tell you that with MQG you would see a Dow Theory Exit signal with a price close below $44.85, and that using Dow Theory in this way you would have won 81% of [...]
ASX CANSLIM Current Growth Stocks | ASX Market Watch - April 12, 2010
[...] – it might be a good idea to put them on your watchlist and look for a Trend Line entry or Dow Theory entry signal, and always keep a solid stop loss in place once you enter. Check them out [...]
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