Hello again!
This is the part 2 of DOW THEORY: The Six Tenets
Let’s continue from the 4th tenet.
- 4 – Indices Must Confirm Each Other:
Well, some of you may find this tenet obvious, but let’s think about it for one second.
Dow not only studied the market to such degree that he was able to develop indexes, but he could understand the relationship between them. Also, he understood how this relationship can be affected by different economic phases.
The sectors are all connected in our economy, in some way. Understanding how the sectors behave and how they affect each other is a priceless tool for a trader and investor. Just by curiosity, Jesse Livermore explain this principle, on his own words, in his book.
In case you don’t know, Livermore was one of the greatest traders who ever lived, and he was very famous and influent.
- 5 – Volume Must Confirm the Trend:
The two most important things for a trader are the price and the volume. Let’s never forget that the market is the interaction between its players, and the volume indicates when an asset becomes “interesting”.
For instance, as more people heard good things about a certain stock, more people will buy it. Then, the volume will increase as the number of new participants buy the stock.
This is exactly how a bull trend is engaged. On the other hand, if the volume is low, it indicates the asset is no longer interesting, and this could lead to two different scenarios:
First, the asset is too expensive, and the players want the prices to drop because they want to buy it at a lower price.
In this scenario we will see a pullback, with the volume starting to increase again when the price is more acceptable.
Second, it could be the start of a bear market, and the asset’s price will sink to lower levels, until the price is attractive again.
- 6 – Trends Persist Until a Clear Reversal Occurs:
This tenet is one of the most overlooked by traders – by far! I always see people trying to predict exactly when the next top or bottom is going to happen. And they keep suffering unnecessary losses on their way. If they just follow the trend! Things are so simple, yet, traders always find a way to complicate it.
Trading is reactive, not predictive, and there’s a simple reason for that: We can’t predict the future. We don’t know what’s going to happen next, but the good news is that we don’t need to know. If you have a solid trading style, you’ll stay out from the traps the market will try to lure you into.
All tenets have their importance, but I think if you overlook this tenet, you’ll face serious problems for sure.
Personally, I have my own trading method that I use for some years now, but I was a complete mess in the beginning! It took me about 2 years to finally understand what it takes to be a real trader.
I invite you to follow me on Twitter and on TradingView for more information. Also, you can check this link if you are interested in learning my trading style.
I wish you well and stay safe.