Dow Theory
Charles Dow's six-tenet framework: the market discounts everything, moves in primary, secondary and tertiary trends, must be confirmed by indices and volume, and trends persist until clearly reversed.
In plain language
Dow Theory is the foundation stone of technical analysis. Charles Dow set out the ideas in editorials between 1900 and 1902; William Hamilton and Robert Rhea organised them into a formal theory after his death.
Its picture of the market is like the sea: a tide that runs for a year or more, waves that run against it for weeks or months, and ripples that last days. Traders who confuse a wave for the tide sell at the bottom of a correction in a bull market.
How it works
The six tenets (section 15.3.1):
- The market discounts everything — economic, political and psychological information is already in the price.
- The market has three trends — primary, secondary and tertiary.
- Primary trends have three phases — accumulation (smart money enters quietly), public participation (the broader market joins as momentum builds), distribution (smart money exits while retail enters or exits late).
- Indices must confirm each other — a trend is valid when the major indices move in the same direction, for example Nifty and Sensex.
- Volume confirms the trend — volume should increase in the direction of the primary trend.
- Trends persist until a clear reversal — a trend is assumed to be in effect until there is a definite signal otherwise.
The three trends (section 15.4):
| Trend | Duration in the workbook | Character |
|---|---|---|
| Primary | Typically one year or more | Bull, bear or sideways |
| Secondary | A few weeks to several months; typically 3 weeks to 3 months | Correction in a bull market, rally in a bear market; retraces 1/3 to 2/3 of the prior primary move |
| Tertiary | A few days to a few weeks; typically under three weeks, some definitions up to six | Short-term noise for investors, opportunity for swing traders |
A worked example
Illustrative figures. The Nifty rises from 20,000 to 26,000 in a primary bull trend — a move of 6,000 points. Then it starts to fall.
Is this a secondary correction? Dow's retracement band is one-third to two-thirds of the prior primary move:
1/3 of 6,000 = 2,000 → 26,000 − 2,000 = 24,000
2/3 of 6,000 = 4,000 → 26,000 − 4,000 = 22,000
A fall that holds between 24,000 and 22,000 (7.7% to 15.4% off the top) and lasts a few weeks to a few months fits a secondary trend, with the primary uptrend still intact — especially if volume on the decline is lower than on the advance.
Confirmation. If the Nifty then makes a new high above 26,000 but the Sensex fails to exceed its own previous high, tenet 4 is not satisfied: the new high is unconfirmed.
The workbook's real case: the Nifty's roughly 7% fall in September–October 2020 was a secondary correction within the post-Covid primary bull trend, which resumed to new highs by early 2021.
Why NISM asks about it
Chapter 15 (Technical Analysis) lists "the six tenets of Dow Theory" among its learning objectives and covers the theory in section 15.3 and the three trends in section 15.4. The first sample question asks which statement is not a tenet — the market has four trends is the false one.
Common exam traps
- Three trends, not four, and three phases of a primary trend — the numbers are the question.
- The phases run accumulation → public participation → distribution. Smart money enters in the first and exits in the third.
- The workbook gives two ranges for secondary and tertiary trends — know both. Secondary: "a few weeks to several months" and "3 weeks to 3 months and sometimes more". Tertiary: "a few days to a few weeks", "typically less than three weeks, though some definitions extend this to up to six weeks".
- The correction size is quoted two ways. The bull-market table says a correction is "often 10–20%"; the Dow retracement rule is 1/3 to 2/3 of the prior primary move; the 2020 case example was about 7%. They measure different things — a percentage off the top versus a fraction of the preceding move.
- "Indices must confirm" means two major indices moving together, not an index confirming a single stock.
Check yourself
1.Which of the following is NOT a tenet of the Dow Theory?
- a)The market discounts everything
- b)The market has four trends
- c)The averages must confirm each other
- d)A trend remains in effect until a clear reversal occurs
Show the answer
Answer: (b) The market has four trends
Dow Theory says the market has three trends — primary, secondary and tertiary — not four. This is the workbook’s own sample question, and the number is the whole trick.
The other three options are genuine tenets. "The market discounts everything" is the first tenet; "indices must confirm each other" is the fourth, requiring both Nifty and Sensex to move in the same direction; and "trends persist until a clear reversal" is the sixth.
Keep the counts together: six tenets, three trends, three phases, five assumptions.
2.Which statement about the origin of the Dow Theory is consistent with the workbook?
- a)Charles Dow set out all six tenets as a formal theory in a single book published in 1902
- b)It was developed by William Hamilton, and Charles Dow later organised it into a formal theory
- c)It was developed in the 1950s and formalised by Robert Rhea during Dow’s lifetime
- d)Charles Dow developed it through a series of editorials between 1900 and 1902, and his successors William Hamilton and Robert Rhea organised it into a formal theory after his death
Show the answer
Answer: (d) Charles Dow developed it through a series of editorials between 1900 and 1902, and his successors William Hamilton and Robert Rhea organised it into a formal theory after his death
The workbook: "The Dow Theory was developed in the early 20th century by Charles Dow through a series of editorials between 1900 and 1902. His work was later organised into a formal theory by his successors, William Hamilton and Robert Rhea, after his death."
Option A turns editorials into a single formal book by Dow himself — the formalisation was done by others. Option B reverses the roles of Dow and Hamilton. Option C gets the period wrong (early 20th century, 1900–1902) and the timing of the formalisation (after Dow’s death, not during his lifetime).
The workbook adds that despite its age "its principles still remain relevant in modern market behavior" — it is adaptable to candlestick patterns, algorithmic trading and AI-driven sentiment analysis.
Where this is taught
Free preparation for NISM Series XVRelated terms
- Efficient Market HypothesisThe proposition that share prices already incorporate and reflect all relevant information — which, if true, leaves nothing for an analyst to find by studying that information.
- MACDMoving Average Convergence Divergence — the gap between the 12- and 26-period EMAs, read against its own 9-period EMA, to track shifts in momentum rather than price.
- Moving averageThe average price of a share over a rolling window, recalculated each session — it smooths away daily noise so that the underlying trend, and changes in it, become visible.
- Support and resistancePrice levels where a move tends to pause or reverse — support where demand concentrates and forms a floor, resistance where supply concentrates and forms a ceiling.
- Technical analysisForecasting price direction from past price and volume alone, on the assumption that everything worth knowing about a company is already in its price.
- Primary trendThe dominant, long-term direction of a market or stock — bull, bear or sideways — typically lasting a year or more, driven by macro-economic forces and investor sentiment.
- Secondary trendAn intermediate correction or rally that runs counter to the dominant primary trend, typically lasting a few weeks to a few months, before the primary trend resumes.
- Tertiary trendThe smallest of Dow Theory's three trends — a short-term move of a few days to a few weeks, often running against the primary or secondary trend.