Dow Theory bases the price trends of Dow Jones Industrial index (^DJI) and Dow Jones Transportation Index (^DJT)  to make decision on whether investing in the stock market.

 The Dow Theory has been around for almost 100 years, yet even in today’s volatile and technology-driven markets, the basic components of Dow theory still remain valid. Developed by Charles Dow, refined by William Hamilton and articulated by Robert Rhea, the Dow theory addresses not only technical analysis and price action, but also market philosophy. Many of the ideas and comments put forth by Dow and Hamilton became axioms of Wall Street.

There exist various kinds of interpretations to the original Dow Theory. The strategy here represents a typical version: all the buy and sell signals are confirmed by both the Dow Jones Industrial Averages and Dow Jones Transportation Averages. If we think of the Dow Jones Industrial Average as being the measure of the tide on one part of the beach, and the Dow Jones Transportation Average as a measure on another part of the beach, both used to determine that the tide is indeed coming in or going out all along the seashore, rather than rogue waves in one place or the other, we will understand what Dow was getting at.

The classic Buy signal is developed as follows: After the low point of a primary downtrend in a Bear market is established, a secondary uptrend (this is the most often debated part of the Theory) bounce will occur. After that, a pullback on one of the averages must exceed 3%, according to Robert Rhea, the great Dow theorist of the 1930’s, must then, ideally, hold above the prior lows on both the Industrial and the Transportation Averages. Finally, a breakout above the previous rally high by both constitutes a BUY Signal for the developing Bull market. A Bear market Sell signal is determined in much the same way, but opposite to a Buy Signal. When a Bull market tops and sets back, and the subsequent rally that goes back up (again, over 3%) and falls short of reaching the previous high and then penetrates the recent lows on the next decline as measured by both the Industrial and Transportation Averages, a SELL Signal is generated indicating a Bear market.

There are about 5 buy patterns and 3 sell patterns summarized in the www.thedowtheory.com.  For more details about the patterns, please go to the Reference [2].

Reference [3] lists the "official" buy and sell records from 1897 to 2003 based on various publications including Barrons. Since we can only access the Dow Jones Industrial Averages and Transportation Averages from 10/01/1928, we start our analysis from that day. We have found our strategy closely matches the records most of time, other than some minor signal difference. Some of the results in Reference [3]  are subjective and some of them seem to base on experience and "chart feeling". Users should note that this strategy is just one of many possible interpretations and thus should use it based on their own discretion.

Since using the daily price data are causing some noise, we use the weekly price data instead.

• Strategy P SMA 200 Days DJI DJT VFINX  uses simple moving average indicators on both ^DJI and ^DJT to decide whether to invest in VFINX. It has a very similar risk adjusted return compared the P Dow Theory VFINX: P Dow Theory VFINX achieves better overall annualized return while it has a higher standard deviation, thus lower Sharpe ratio compared with P SMA 200 Days DJI DJT VFINX.
• Investment newsletter  Dow Theory Letters by Richard Russell.
  
• Investment newsletter Dow Theory Forcasts by Richard Moroney,
  
• Investment newsletter The Dow Theory by Jack Schannep.
  

See Also

• Jack Schannep,  Dow Theory for the 21st Century: Technical Indicators for Improving Your Investment, John Wiley & Sons Publisher.June 30, 2008.
• Jack Schannep, "The Dow Theory", www.thedowtheory.com.
• Jack Schannep: "The Dow Theory Official Record", www.thedowtheory.com
  
• Mark Hulbert, "Something is Wrong", www.marketwatch.com, June 12, 2009. Comments on Dow Theory.