It’s no secret that many of the technical analysis foundations used in crypto today were initially developed for the stock market – and the Dow Theory is a prime example.
As a concept, The Dow Theory is one of the oldest forms of technical analysis you can use today, and it’s relatively simple for both new and experienced crypto traders to follow and understand.
The Dow Theory can be applied in both a bull and bear market – Now, let’s take a little trip into history to understand the origins of the dow jones theory technical analysis tool.
What Is The Dow Theory?
The Dow Jones Theory or simply dow theory is made up of six basic principles (or tenets), which assists traders in analysing the market:
- The market reflects everything
- There are three trends in the market (primary, secondary and minor trends)
- Each trend includes 3 phases: Accumulation, public participation, and distribution.
- Volume is Key.
- Existing trends end only when there are no apparent signs of reversal present.
- Market Indexes confirm each other.
Let’s have a closer look into each of these tenets and how they assist in analysing the cryptocurrency market.
The Market Reflects Everything
A principle still valid for many traders; today, Dow observed that all available information is reflected within an asset’s current price. This means what it states. Whether it’s public information or not, all information is already reflected in the available data crypto traders see on the charts.
However, a difference between cryptocurrency and the stock market (whilst still relevant in stocks, too) is that cryptocurrency can be heavily affected by sentiment, which affects prices. So the first rule can often be held with a grain of salt when analysing charts.
There Are 3 Market Trends: Main, Secondary & Minor
The Dow jones Theory states that there are three main market trends, and traders can trace their movements in the following:
- Primary Trend – The significant movement in the market, lasting months to several years
- Secondary Trend – A secondary trend lasting a week to several months
- Minor Trend – A slight trend that can last a few minutes, to a total of 10 days.
Eagle-eyed traders can take advantage of all three market trends, benefiting from analysing small movements in a bear/bull market to make a good exit or entry strategy.
Each Trend Includes 3 Phases: Accumulation, Public Participation & Distribution
Whether it’s a bullish or bearish trend, the Dow Theory states three clear phases within a specific trend.
Let’s apply this principle to a bullish market with BTC as an example.
- Accumulation – BTC value is low, and the market is currently experiencing low sentimental interest and average trader confidence. Smart crypto traders will identify this trend, which slowly grows as an entry point for buying coins.
- Public Participation – The wider general audience identifies this opportunity and begins rapid purchasing BTC at a very quick rate. This sends the price of BTC upwards; however, traders who jump in at this moment will not see their returns as profitable as those who bought in at the accumulation phase.
- Distribution – Speculation is rife in this phase, with accumulation phase investors identifying the loss of power in the trend and plan their exit by selling at the peak of the trend. After doing so, the market begins to correct itself – leaving traders who jumped in later with a smaller profit or none if they do not exit at the correct time.
For a bear market, crypto traders can apply the Dow Theory in reverse:
- Distribution – The decline begins as traders identify the loss of power in the market and begin selling their BTC. The wider public is still involved within the market and is unaware of the trend decline, as sentiment is currently not reflecting this. During this time, BTC begins to lose some value.
- Public Participation – Negative sentiment increases as the trend is identified. The wider public begin to follow the steps of the traders who exited earlier and sell their BTC. This drives down the value of BTC, imposing losses for those unable to leave at the right time.
- “Panic Phase” – You can probably tell what happens in this phase. The value of BTC is low and is heavily impacted by outside noise such as media coverage, panicking influencers and overall, downbeat outlook. As a result, BTC value will continue to plummet until the market reflects all sentiment and the worst outcome – which gives life to a new bull trend. Volume Is Key This is one of Dow’s principles vital in cryptocurrency – volume. It’s easy to follow.
Dow theorized that high volume is a necessary secondary identifier for a trend. Thus, the higher the BTC volume being traded, the more chances that the current trend is valid. Conversely, if BTC is sold to a low volume, the market needs to be watched closely.
Cryptocurrency traders can apply this to any of the phases outlined above.
Existing Trends End Only When There Are No Clear Signs Of Reversal Present
There will always be temporary noise that affects the movement of a trend in the opposite direction.
This principle of the Dow Theory states that, unless there is a definitive indicator that indicates a reversal in the market, expect no change with the current trend. Essentially, only the beginning of a new trend marks the end of the existing trend.
Market Indexes Confirm Each Other
An indicator of a strong trend in the market is additional market confirmation. So when Dow theorised these six basic tenets across 255 editorials, it’s important to note that America was facing a steep industrial growth at the time.
This principle initially followed the stock averages of the rail and industrial industries. Thus, if one rallied in a bull market, this could only happen if the other sector faced the same trending average.
It can be challenging to place this principle when looking at crypto markets, as assets are digital, and the inside market can only
match influence. For example, one of the numerous altcoins which now enter the cryptocurrency space will often trend similar to
BTC’s price. However, this doesn’t confirm that the markets ‘confirm’ each other.
Here are some other technical analysis articles I’ve made for you:
- How to use support and resistance when trading
- Eliott Wave Theory in technical analysis
- How to swing trade cryptocurrency
- What is the Bull Trap?
- How to trade the relative strength index (RSI)?
- What is the rising wedge?
- How to trade the head and shoulders pattern?
- How to be a Bitcoin millionaire
History of the Dow Jones Theory
The Dow Theory was developed after the death of American journalist Charles H Dow. Originally, Dow had written 255 articles for the Wall Street Journal, founded alongside fellow journalists Edward Jones and Charles Bergstresser.
These articles provided early investors with a new approach to analyzing markets. After his death in 1902, these ideas were collated and formed the Dow Theory, which is now widely used across stock and cryptocurrency markets.
You can apply the Dow Theory to your technical analysis toolkit by following the six principles.
In saying that, it’s important to remember the differences between the crypto and stock market when applying older technical analysis concepts to your trading strategy and to look at the market holistically.
Now that you’re familiar with the Dow Theory, do you think that all of these principles are important to apply when trading Bitcoin or any other cryptocurrency?