Stock Market Masters – 21st Century Use of the Charles Dow Theory, Part 6

This is part 6 in our series on Dow Theory. In the last article we focused on the fourth tenet of Dow Theory, The Averages Must Confirm Each Other. In this article we are going to focus on the fifth tenet which says Volume Must Confirm The Trend.

As a quick refresher the 6 tenets of Dow Theory are:

1. The price discounts everything.
2. The market has 3 trends.
3. Major trends have 3 phases.
4. The averages must confirm each other.
5. Volume must confirm the trend.
6. A trend is assumed to be in effect until it gives definite signals that it has reversed.

Volume Must Confirm The Trend

The fifth tenet of Dow Theory plays in tightly with the third tenet. If you remember the third tenet of Dow Theory states that a trend has 3 phases, those the Accumulation, Public Participation, and Distribution phases. The middle phase, public participation, is tightly connection with this tenet surrounding volume.

When a group of investors begin to accumulate a new position they are generally working on contrary opinion. Consequently they are all alone. This is the time when most of the money has been pulled out of a stock and there are few people left to trade it. But as the accumulators begin to take their position and the price of the stock rises, it grabs the attention of the public. As the public takes note of the rising prices and begins to enter their own positions, the volume of shares traded begins to rise.

Dow theorized that a rising price without rising volume was not a confirmation of public participation. Since the public participation phase is when the largest moves are garnered, the ideal scenario is to get in at the beginning of the public’s participation and get out at or near the end. But if volume does not rise as well, then the rising price may not be sustainable and it is a sign of a weak trend.

Volume is one of the easiest indicators to work with. It’s quite simple in that it merely reflects how many shares trade hands on that particular day. Whether the trend is rising or falling, volume should be rising to confirm the general public has jumped into the trade and is helping to perpetuate the move. If volume does not support the trend it does not mean the price will not move. It simply reflects that the number of people trading is low and the trend may be a weak trend.

If you would like to learn how to apply Dow Theory and the importance of volume to your own trading please visit our website and sign up for a free class http://tradesmartu.com/site/scholarships.php. In our next article we will look at the 6th and final tenet of Dow Theory and how you can use it to better time your trades and understand the next move of a stock.