Dow Theory: The Market Discounts Everything
AAA
  1. Dow Theory: Introduction
  2. Dow Theory: The Market Discounts Everything
  3. Dow Theory: The Three-Trend Market
  4. Dow Theory: The Three Phases Of Primary Trends
  5. Dow Theory: Market Indexes Must Confirm Each Other
  6. Dow Theory: Volume Must Confirm The Trend
  7. Dow Theory: Trend Remains In Effect Until Clear Reversal Occurs
  8. Dow Theory: Dow Theory Specifics
  9. Dow Theory: Current Relevance
  10. Dow Theory: Conclusion

Dow Theory: The Market Discounts Everything

By Chad Langager and Casey Murphy, senior analyst of ChartAdvisor.com

The first basic premise of Dow theory suggests that all information - past, current and even future - is discounted into the markets and reflected in the prices of stocks and indexes.


That information includes everything from the emotions of investors to inflation and interest-rate data, along with pending earnings announcements to be made by companies after the close. Based on this tenet, the only information excluded is that which is unknowable, such as a massive earthquake. But even then the risks of such an event are priced into the market.

It's important to note that this is not to suggest that market participants, or even the market itself, are all knowing, with the ability to predict future events. Rather, it means that over any period of time, all factors - those that have happened, are expected to happen and could happen - are priced into the market. As things change, such as market risks, the market adjusts along with the prices, reflecting that new information.

The idea that the market discounts everything is not new to technical traders, as this is a major premise of many of the tools used in this field of study. Accordingly, in technical analysis one need only look at price movements, and not at other factors such as the balance sheet. (For more on this, see The Basics Of Technical Analysis.)

Like mainstream technical analysis, Dow theory is mainly focused on price. However, the two differ in that Dow theory is concerned with the movements of the broad markets, rather than specific securities.

For example, a follower of Dow theory will look at the price movement of the major market indexes. Once they have an idea of the prevailing trend in the market, they will make an investment decision. If the prevailing trend is upward, it follows that an investor would buy individual stocks trading at a fair valuation. This is where a broad understanding of the fundamental factors that affect a company can be helpful.

It's important to note that while Dow theory itself is focused on price movements and index trends, implementation can also incorporate elements of fundamental analysis, including value- and fundamental-oriented strategies.

Having said that, Dow theory is much more suited to technical analysis.

Dow Theory: The Three-Trend Market

  1. Dow Theory: Introduction
  2. Dow Theory: The Market Discounts Everything
  3. Dow Theory: The Three-Trend Market
  4. Dow Theory: The Three Phases Of Primary Trends
  5. Dow Theory: Market Indexes Must Confirm Each Other
  6. Dow Theory: Volume Must Confirm The Trend
  7. Dow Theory: Trend Remains In Effect Until Clear Reversal Occurs
  8. Dow Theory: Dow Theory Specifics
  9. Dow Theory: Current Relevance
  10. Dow Theory: Conclusion
RELATED TERMS
  1. Endowment Effect

    The endowment effect describes a circumstance in which an individual ...
  2. Self-enhancement

    The self-enhancing bias is the tendency for individuals take ...
  3. Gamification

    Gamification describes the incentivization of people's engagement ...
  4. Anchoring and Adjustment

    Anchoring and adjustment is a cognitive error described by behavioral ...
  5. Sample Size Neglect

    Sample size neglect occurs when an individual infers too much ...
  6. Indicator

    Indicators are statistics used to measure current conditions ...
  1. Are small cap companies more risky investments than large cap companies?

    Learn about the risk of small cap companies compared to large cap companies. Compare the volatility of both and learn how ...
  2. What main factors affect share prices in the metals and mining sector?

    Discover the primary factors that influence share prices of companies in the metals and mining sector and how companies can ...
  3. Why do investors with minority interest receive a minority interest discount and ...

    Discover why investors with minority interest usually receive a discount to the fair value of their ownership share, and ...
  4. What does the efficient market hypothesis assume about fair value?

    Found out what the efficient market hypothesis says about the fair value of securities, and learn why technical and fundamental ...

You May Also Like

Related Tutorials
  1. Trading Strategies

    Basics Of Technical Analysis

  2. Fundamental Analysis

    Ethical Investing Tutorial

  3. Investing Basics

    Industry Handbook

  4. Bonds & Fixed Income

    Investing For Safety and Income Tutorial

  5. Fundamental Analysis

    Discounted Cash Flow Analysis

Trading Center