Dow Theory is about how to build wealth from the nature of movements in the Stock Market. Charles Dow (1851-1902) was a journalist, the first editor of the Wall Street Journal, and a co-founder of the Dow-Jones Company, and his theory was taken from editorials that he wrote.

Dow Theory was later refined by William P. Hamilton and others.

But Dow himself never used the term "Dow Theory."

The Theory does not just look at Technical Analysis and price action, but also at Market philosophy.

Many ideas put forward by Dow and Hamilton became axioms in the Stock Market.

Lot's of people think: "it will be different this time," but Dow Theory has proven that the Stock Market behaves the same today as it did 100 years ago.

Charles Dow developed his Theory from the analysis of Market price action late in the 1800s.

Dow never actually wrote a book on his Theory, but he did, as the editor of the Wall Street Journal, write editorials on his views. And it wasn't until later that William Hamilton refined Dow's Theory through a series of articles, and later in his book: The Stock Market Barometer, that the Theory was explained in detail.

But before you can understand Dow Theory, there are three assumptions that must be accepted.

The first of these is that the Primary trend of any Market cannot be manipulated.

And Hamilton agreed with this. He asserted that intra-day, day-to-day, and even Secondary movements could be prone to manipulation as these were just short movements of a few hours or even a few days. Hamilton also referred to the possibilities of individual stocks being manipulated.

The Primary, long-term trend of the Market would always keep intact, even if stocks were manipulatedin the shorter term. Manipulating a Market was virtually impossible according to Hamilton. Any Marketis just too large for manipulation to happen.

In the early 90s the UK Government tried to hold the British Pound against other currencies but even the fourth largest industrial country in the world could not influence things. The currency markets are huge. And in 1979/80 there was an attempt by the Hunt Brothers to manipulate the price of silver. Silver did skyrocket (temporarily) but only for it to come back down and continue its bear trend (after the attempt to corner the market was discovered).

Secondly, Dow Theory assumes that everything is reflected in the Markets. The price in the Market represents the sum total of all the hopes, the fears, and expectations of everyone in it.

Also, interest rate movements, earnings, elections, and anything else are already priced into the markeet.

Unexpected events will happen - but they only usually affect the short term trend. The Primary trend stays intact.

Hamilton observed that the Markets could sometimes act negatively on good news. He argued that the Market acts as a barometer of current events. When news comes out, that is already shown in the price - the Market has already acted.

This explains very nicely the Stock Market axiom: "Buy the rumor, sell the news!"

And the third assumption to be taken into account when studying the Theory of Dow is that it's not perfect. No theory can be.

Dow and Hamilton both knew this.

Dow Theory, like any other theory, is just a set of guidelines, albeit, fairly reliable ones.

But the Theory does provide a mechanism that removes a lot of emotion from your trading. And emotion is the number one reason most people fail.

By taking emotion out of trading helps you see what is actually there, NOT what you want to see that is there. And Dow's Theory eliminates the ambiguity.

Dow Theory is extremely efficient at identifying the Primary trend of any Market. It is not intended as a short term indicator.

Neither Hamilton nor Dow intended for the Theory to predict short-term movements beause they admitted that such movements could be manipulated. but in no way could Primary Market movements be manipulated.

They were not interested in predicting the exact tops or bottoms of a Market, in fact, nobody can reliably do that, they were interested in establishing the main (Primary) trend and capitalizing on the big moves. Even if these were to take months, or in some cases, years.

It is human nature to get caught up in sudden price movements, or forget the main trend. But once identified, this is where the big profits are.

In the next article I will get into the heart of Dow Theory - daily fluctuations, Secondary movements, and Primary movements,and the three phass of Bull and Bear Markets.

Understand Dow Theory and you will have a good overall picture of what is going on in your chosen Market.