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You may find yourself wondering what Dow theory has to do with trading on the Forex (Foreign Exchange market—where nations, corporations, and now retail traders go to exchange currencies). Well, before Charles Dow began writing his theory over a century ago, the idea of speculating on the markets was considered rather foolish. However, the Dow Theory is still considered to be one of the leading authorities on basic market philosophy and is relevant to traders on the Forex exchange or Wall Street.
Indeed, Dow Theory is a basic market philosophy that stresses technical analysis and keeping an eye on price action can help determine the presence of three primary movements within the market, including:
· Primary Movement
· Secondary Movement
· Daily Fluctuations
The primary movement would be what most investors commonly identify as the “bull” or “bear” market. In other words, the primary movement is the general trend of the entire market and can last from several months or stretch into years. In an upward trend, or bull market, the price will continue to climb and establish new historical highs with a succession of higher lows. There may be temporary fluctuations in pricing, and these are known as Secondary Movements.
The Secondary Movements are really known by different names according to when they are identified but the rule is that they will be shorter and in the opposite direction as the Primary Movement. If it occurs during a “bull” market, the secondary movement would commonly be referred to as a market correction. Were it to occur during a “bear” market, the secondary movement is known as a rally.
Daily fluctuations vary greatly and can be caused by a number of factors, including world events. As with the secondary movements, the daily fluctuations may buck the primary movement temporarily, but the market will continue going in the same overall direction until it is time for a primary trend change.
At the end of the day, Charles Dow believed that trends existed, could be identified, and that technical analysis was the best method for perceiving them. Dow and his followers were not necessarily concerned with identifying the exact point where a trend change would occur—just that they existed and could be capitalized upon once identified—and the earlier the trend was spotted, the greater the potential for profit. Some technical indicators used to help identify trends include:
· Moving Average
· Simple Moving Average
· Exponential Moving Average
· Moving Average Convergence Divergence Indicator (MACD)
Although varying aspects of Dow's comprehensive theory have been disputed, the fact remains that the overall philosophy remains sound. The same principles that govern the equities markets also govern the Forex—namely, that trends exist and tend to persist over time and can be identified through technical analysis.
Indeed, technical traders tend to be the most successful on the Forex market because they are constantly testing their investment strategies using the most accurate analysis available making it far more likely for them to identify and capitalize upon the long term trends first identified by Charles Dow.