Three Phases of Major Trends
A trend represents a general direction of the market. Dow Theory asserts that major trends have three distinct phases: accumulation, public participation and distribution. The accumulation phase represents the first part of the trend in which those who are well-informed buy or sell. In other words, if the well-informed recognize that the recent downtrend is soon coming to an end, they would buy, and vice versa.
The public participation phase involves the masses following the major trend. This occurs as prices begin to accelerate rapidly and there is news supporting the trend.
The final distribution phase occurs as the news highly favors the current trend and speculative volume and public participation increase even further. At this point, the well-informed investors who accumulated when the market was at its peak (trough) begin to sell (buy) before other investors begin to follow suit.
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A Trend Is Assumed to Be in Effect Until It Gives Definite Signals That It Has Reversed
This is a major theory that essentially mirrors the physical law stating that an object in motion tends to continue in motion until some external force causes it to change direction. Relating that principle to price trends, a strong trend will tend to continue in its current direction unless there is a price reversal indication, as per technical or even fundamental analysis. The later articles will focus on learning to spot reversals in the market and how traders can place orders to take advantage of such reversals.
In Trending Markets
The existence of a trend in any market depends on a series of relative highs and lows. Two consecutive relative highs, each above the previous relative high, and two relative lows above the previous low would be constitute a tentative up-trend. A third relative high would confirm the trend.
The chart below illustrates a up-trend of EUR/USD:
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The continuation of a trend depends on the successive rallies reaching a greater price than the previous ones. Traders can buy at relative lows and profit from the rest of the trend. Or traders can speculate the reverse of the trend and sell at relative highs. If an up-trend establishes a relative high and the subsequent rally fails to break through to a higher price, then the up-trend is in doubt. A series of decreasing relative lows would be necessary to determine that the market trend had reversed to a downtrend. More likely, the market will be range bound for a period.
In Range Bound Markets
Markets do not always move in trends. They spend a lot of time in ranges, fluctuating between established highs and lows. Often a range bound market is considered to have a sideways trend, since it is neither moving upwards to new highs or down to new lows. If the short-term trend is that of a sideways market, it is sometimes called a consolidation range. The price during a consolidation period is simply building up support for a continued move in the original direction. See the following chart:
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