Star Theory: A Market Analysis Guide for Traders

What is Dow Theory (

Dow Theory is a technical analysis approach that originated over 100 years ago and remains a fundamental basis for studying market behavior, especially analyzing price movements and identifying market trends.

Dow Theory was developed from an article by Charles H. Dow published in The Wall Street Journal in the early 20th century, with further development by William Peter Hamilton.

This core concept was created to help investors understand market cycles based on the rotation of economic sectors and the adjustment of securities prices.

The 6 Basic Principles of Dow Theory

) 1. The market discounts all information

Dow Theory assumes that all news, whether it’s earnings forecasts, competitive status, or fundamental factors of companies, is already reflected in security prices. Therefore, studying prices is an effective way to understand the market.

2. Trends are divided into 3 levels

Dow Theory categorizes price trends into three timeframes:

• Primary Trend: Long-term ###200 days or nearly 1 year to 4 years(
• Intermediate Trend: Medium-term )3 weeks to 3 months(
• Minor Trend: Short-term )up to 3 weeks(

) 3. The structure of each trend has three phases

(# Accumulation Phase ): The start of a new upward cycle. Prices do not show clear signals yet. Investors focusing on fundamentals begin accumulating this asset because it has low and reasonable value. Technical analysts often avoid participating because the trend is not yet clear.

(# Public Participation Phase ): Prices clearly rise, and trading volume increases rapidly. This asset becomes a topic of widespread discussion. Short-term traders seek opportunities here due to high profit potential and short holding periods.

(# Distribution Phase ): The final stage of the upward trend. Prices soar based on market optimism. Large investors start taking profits, while retail investors continue buying enthusiastically. Trading during this phase carries high risk; discipline and stop-loss management are essential.

4. Confirmation Principles

To establish a primary trend, Dow Theory requires confirmation from multiple indicators. For example, Charles Dow used the Dow Jones Industrial Average and the Dow Jones Transportation Average to confirm each other. If one index is trending upward, the other should do the same. If not, it’s too early to confirm a true bullish trend.

5. Volume must follow the trend

Trading volume should support the price trend. In an uptrend (Uptrend), volume should increase as prices rise. In a downtrend ###Downtrend(, volume should increase as prices fall. When volume and price trend align, it indicates a strong movement, not just a correction or sideways fluctuation.

) 6. Trends continue until clear signals of reversal appear

Prices will support the current trend until there are clear signs of a change. For example, gold is in an uptrend, but recent days show three consecutive days of selling pressure, unable to make new highs ###Lower High( but making new lows )Lower Low###. This signals that the uptrend has ended and a downtrend may begin.

Characteristics of the Three Types of Trends

Uptrend (Uptrend)

Charts show alternating higher highs and higher lows:

• Higher high (High) than previous = Higher High ###HH(
• Higher low )Low( than previous = Higher Low )HL###

( Downtrend )Downtrend(

Opposite to uptrend:

• Lower high )High( than previous = Lower High )LH(
• Lower low )Low( than previous = Lower Low )LL###

( Sideways )Sideways(

Prices lack a clear direction, with alternating HH, HL, LH, LL, unable to consistently set higher highs or lower lows.

Double Bottom and Double Top Patterns

) Double Bottom (Two lows)

A reversal pattern from a downtrend to an uptrend, characterized by a “W” shape formed when prices touch the same low twice. Between these lows, a peak (peak) forms, indicating buying momentum may be building up and a potential upward move.

( Double Top )Two highs###

Opposite of Double Bottom, indicating a reversal from an uptrend to a downtrend. It has an “M” shape formed when prices hit the same high twice. Between these highs, a trough (trough) appears, signaling increasing selling pressure and the possible end of the uptrend.

Applying Dow Theory to Trading

When investors analyze the market based on Dow Theory principles, they can:

For an uptrend (Uptrend)

• Choose Buy orders, expecting prices to continue rising
• Set appropriate Lot Sizes for effective capital management
• Use leverage aligned with acceptable risk levels
• Clearly define entry points, profit targets, and stop-loss levels

( For a downtrend )Downtrend###

• Choose Sell orders, expecting prices to decline
• Use the same data to determine leverage, volume, and risk controls
• Follow disciplined stop-loss rules

CFD (Contract for Difference) trading is well-suited for Dow Theory because it allows trading in both directions, providing flexibility to profit from all market conditions.

Strengths of Dow Theory

• Simple foundational system: The principles are straightforward and easy to understand, making them practical to apply.
• Clear trend identification: Helps investors recognize the current market state to plan trades purposefully.
• Volume as an indicator of importance: Considering trading volume enhances trend analysis.
• Not dependent on economic equations: Does not rely on potentially unstable economic figures, making it effective in volatile markets.

Limitations of Dow Theory

• Signal lag: Waiting for confirmation means signals appear after the trend has already moved significantly, risking missed opportunities.
• Ignoring fundamentals: Does not incorporate company or economic data, which may cause overlooking critical market changes.

Conclusion

Dow Theory remains a classic analytical system that is still practically applicable today. Its fundamental principles are straightforward and guiding. Users should understand that it’s not a perfect system but a tool to clarify market trends and movements. Combining it with good money management, risk control, and continuous practice can help investors use this tool effectively and deepen their understanding of stock and commodity market movements.