We can learn a lot from investors and traders past – even those who dealt exclusively with asset classes outside of foreign exchange rates. Perhaps one theory that many currency traders are less familiar with is that of Dow Theory, which extends way back to 1884. In this article we examine the basics behind the Dow Theory and see how it may help currency traders make better sense of the foreign exchange rates.
What The Dow Theory Teaches Us About Foreign Exchange Rates Trading
1. The Current Price Is Fair Value (Markets Discount Everything). When you see the quote on any foreign exchange rates, that is the current and fair value. While we know that the price will move in either direction at some point, markets are on the whole efficient and discount everything in forming a price. This is quite consistent with the behavior displayed within the foreign exchange rates – while price may see saw up and down, it takes something really epic to propel prices beyond their standard trading range.
2. The Market Serves Up Three Types Of Trends. These trends are known as primary trends, secondary trends and minor trends. The primary trend is the predominant trend in which the currency pair is heading by enlarge. Therefore during a bull run, the predominant direction will be for the foreign exchange rates to head higher. This will be depicted by a combination of rising tops and/or bottoms. During a deep and clawing bear run, the general price direction will be downwards, and can easily be substantiated by drawing trendlines which will reveal sinking tops and/or bottoms.
3. Trends Display Three Stages. These stages have a stark impact upon how the trend behaves. The three stages that Dow identified were the accumulation stage, public participation and finally distribution.
4. Volume And Trend Should Be Linear. Down believed that any trend should be accompanied by a spike in volume. A trend that gathers strength should see a pickup in volume to substantiate that trend. A surge in price would need to have a sufficient tidal wave of volume behind it to make it genuine.
5. Trends Are In Tact Until There Is A Trend Ending Event. Trends really do last until something major happens to knock them off their perch. Trends are often self fueling – as the price rises (in the event of an uptrend) it will scale past previous resistance areas which in turn will attract more traders placing long positions. Currency traders in particular should pay heed to this market fact since all too often, traders are overly hasty in predicting market tops or bottoms. The problem of course becomes that they do so prematurely, and the trend just goes on and on to flick away all stops in its path, like you would ants off a dinner table. A trend ending event will be something major – events that will change the very composition of market sentiment. In fact, one of the baser and more important skills that the trader can develop is in knowing when trends are forming and stuttering. There are plenty of trend trading indicators about, but if in doubt always start from a position of assuming that the current trend is still in tact.