Dow Theory: The Foundation
Charles Dow's original framework — the one nearly every later technical concept in the book traces back to.
Murphy treats Dow Theory, developed by Charles Dow around the turn of the 20th century and later formalized by others, as the direct ancestor of almost every concept covered later in the book — trend identification, the idea that averages must confirm each other, and the use of volume as a secondary confirming signal all trace back to it. The theory holds that the market moves in three simultaneous trends of different length: a primary trend lasting a year or more, a secondary (or intermediate) trend that corrects part of the primary trend and lasts weeks to months, and minor day-to-day fluctuations that Dow considered largely noise.
A second core Dow Theory tenet, confirmation, holds that a signal in one market average is only meaningful if a related average confirms it — originally, Dow required the Industrial and Rail averages to both make new highs (or both new lows) before a trend change was considered valid; a move in only one was treated as suspect. The theory also holds that volume should expand in the direction of the primary trend and contract on corrective moves against it — a thread Murphy picks back up in full in the volume chapter later in this course.
Dow's original insistence that two separate averages confirm each other before a signal is trusted is presented as the theory's most durable idea, independent of which specific averages a trader actually watches today. The logic doesn't depend on the Industrial and Rail averages specifically — it depends on the principle that a genuine, broad shift in market direction should show up in more than one place, while a move confined to a single narrow average is more likely to be a false signal, sector-specific noise, or an anomaly in that one index rather than a real trend change worth acting on.
A modern equivalent: a trader today might require both a broad index and a related sector or breadth measure to confirm a signal before trusting it, the same non-confirmation logic Dow applied to the Industrials and Rails a century earlier.
- Dow Theory identifies three simultaneous trend lengths — primary, secondary, and minor — with the primary trend as the dominant direction to trade with.
- Confirmation — requiring a related average or measure to agree before trusting a signal — is presented as the theory's most durable and still-relevant idea.
- Volume should expand with the primary trend and contract on corrections against it, a principle this course returns to directly in the volume chapter.