Criticisms of the Dow Theory

Although Dow Theory forms the building blocks for modern-day technical analysis, this theory is not without criticisms. One of the criticisms is that following the theory will result in an investor acting after rather than before or at market tops and bottoms. With Dow Theory, there is an inevitable lag between the actual turn in the primary trend and the recognition of the change in trend. The theory does not recognize a turn until long after it has occurred and has been confirmed.

On the other hand, the theory, if properly interpreted, will recognize that primary trend change and will, thus, never allow a large loss. Dow’s contention was that concentrating on any direction change of shorter duration than the primary trend increased the chances of having one’s portfolio whittled away by high turnover, many errors in judgment, and increased transaction costs. Therefore, Dow Theory is biased toward late recognition of a change in trend to minimize the costs of wrongly identifying a change in trend.

A second criticism of Dow Theory is that the different trends are not strictly defined. Often the interpretation of price swings is difficult to assign to a specific trend type. Secondary trend beginnings often appear like primary trend beginnings, for example. This makes the determination of the primary trend unclear at times and can incite investment in the wrong direction.

Others, however, criticize Dow Theory for being too specific about the requirements needed to identify a change in trend. Requiring that only closing prices be used or that any break to a new level no matter how small is significant often places too much emphasis on a small change in price.

…the Dow-Jones averages…have a discretion not shared by all prophets. They are not talking all the time. (December 17, 1925, in Rhea, 1932; pg. 224)

Source: Kirkpatrick II Charles D., Dahlquist Julie R. (2015), Technical Analysis: The Complete Resource for Financial Market Technicians, FT Press; 3rd edition.

One thought on “Criticisms of the Dow Theory

  1. Rosalia Goldsboro says:

    We’re a group of volunteers and starting a new scheme in our community. Your website offered us with valuable information to work on. You have done an impressive job and our entire community will be grateful to you.

Leave a Reply

Your email address will not be published. Required fields are marked *