The Concept of Trend
Charles Dow is probably best known as the founder of the Dow Jones Industrial Average. However, it was during his time as editor of the Wall Street Journal that he produced a series of articles examining stock market behaviour, and it was from these editorials that “Dow Theory” evolved.
Dow theory provides us with a clear definition of trend. Dow described how prices did not rise or fall in a straight line but moved in a series of zigzags which resembled waves and it was the relative positioning of the peaks and troughs in these waves that defined the trend.
For a stock to be in an uptrend, it must make successive higher peaks (highs) and higher troughs (lows). For a stock to be in a downtrend, it must make lower peaks (highs) and lower troughs (lows).
|Uptrend - higher highs and higher lows|
|Downtrend - lower highs and lower lows|
By identifying these peaks and troughs, we can not only describe the current trend and put it in its historic context but, just as importantly, determine when it is changing. We do this by looking at the patterns formed by the peaks and troughs and this is covered in the next section (Major Reversal Patterns).