Closing prices, line ranges and identification of trends (part one)

One thing to bear in mind with Dow’s theory is that it relies solely on daily closing prices and does not take the intraday movements into account. According to this theory, for a trend signal to be confirmed, the closing price has to signal the trend, not the intraday one. In Dow theory the concept of line ranges, or “trading ranges” is fundamental. These sequence of sideways, horizontal price movements is seen as a consolidation sequence, and traders should wait for the price movement to break the trendline before supposing a change in the market direction. For example, if the EURUSD currency pair were to break above the line, it’s likely that it will trend up.

One of the most difficult things to do related to the Dow theory is the precise identification of trend reversals, or when the forex market changes direction. A trader who follows Dow theory trades with the overall direction of the market, so it is fundamental that he identifies the right levels at which the direction shifts. How is it possible to do that? One of the main techniques used by traders to discover trend reversals is the “peak-and-trough” (or “high-and-low”) analysis, where a peak is the highest price of a market movement, while a trough is the lowest. Dow theory does not assume that the market move in a straight line but that it swings from highs (peaks) to lows (troughs), with the overall moves of the market trending in a direction.

According to Dow theory, a bullish trend is defined as a series of consecutive higher peaks – higher troughs, while a bearish trend as a series of consecutive lower peaks – lower troughs.

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