This is the seventh and final part in our series on Dow Theory.
In Part 6 we focused on the fifth tenet of Dow Theory: volume must confirm the trend.
In this article we are going to take a look at the last tenet: a trend is assumed to be in effect until it gives definite signals that it has reversed.
As a quick refresher the 6 tenets of Dow Theory are:

1. The price discounts everything.
   
2. The market has 3 trends.
   
3. Major trends have 3 phases.
   
4. The averages must confirm each other.
   
5. Volume must confirm the trend.
   
6. A trend is assumed to be in effect until it gives definite signals that it has reversed.
   

A Trend Is Assumed to Be in Effect Until It Gives Definite Signals That It Has Reversed This sixth and final tenet of Dow Theory is technically one of the simplest points.
It speaks to an underlying emotion that has cost many a trader quite a pretty penny.
When a person analyzes a trade, the real goal is to answer three small but essential questions:

1. At what price do I enter the trade?
2. At what price do I exit to take a profit?
3. At what price do I exit because the trade has gone against me?

These three questions are quite simple, yet few traders actually take the time to answer them before entering a trade.
Of these questions, it is the last one that is really tough to handle.
After all, no one ever wants to close a trade for a loss, much less plan before entering the trade what would be an acceptable level of loss.
In fact it's such a tough subject that most people choose to ignore it and focus instead on all the money they are going to make with the trade.
This is why Dow's point about a trend still being in effect is so important.
Understanding where the trends are and where a stock is trading in that trend is critical to being able to answer the three questions outlined above.
Dow's theories on market behavior make our job a lot easier.
If we know before we enter a trade where the trend is, which part of the trend we are in, and where the trend is likely going, then we can enter and exit the trade with more confidence.
Making educated decisions about entries and exits (as opposed to wild guesses) means we can more effectively plan our trades.
Applying the First Five Tenets of Dow Theory By taking into account the first five tenets of Dow Theory (specifically as it relates to trends), a smart trader can account for the next likely move.
If we know that the fundamental data is factored into the price already, we will not be swayed by the emotion of speculation as much (Tenet 1).
If we understand that the market (as well as an individual stock) moves in simultaneous trends (Primary, Intermediate, Minor), we can better lay out and organize those trends and then trade off of that knowledge (Tenet 2).
If we understand the development of a trend (Accumulation, Public Participation, Distribution), we can better understand the life cycle of that trend and where the stock is currently trading in that cycle (Tenet 3).
By confirming our analysis through indexes and indicators, we can feel more confident about our analysis and confirm our thoughts (Tenet 4).
And by understanding how the public feels about a trend through their participation (as measured by volume), we can measure the strength of a trend and the likelihood of it following through (Tenet 5).
With all of this information now before us, we are better prepared to answer the three key questions before we enter the trade.
Knowing When to Get Out The first five tenets help us understand the direction of the trend and how to get into the trade.
The sixth one tells us where to get out.
Generally speaking, it is okay to stay in a trade as long as the trend is continuing.
However, once the trend breaks its pattern, it is confirming that the trade is no longer valid.
And this is when you must close your trade.
If a stock's trend cannot be patterned, then it cannot be predictable, and you cannot trade it for profit.
You must step back, reanalyze, and find a better strategy to trade that stock or else move on to a less complicated trade.
So how do you use this tenet to know where to exit your trade? Technically you can't.
The theory in and of itself doesn't give you the specifics.
It just gives you a conceptual look at timing and when you should stop trading that move.
In order to time your trends and know when you should close the trade, you need to implement other levels of analysis.
Different traders may choose to follow different systems for that analysis.
As for me, I teach my students to follow multiple steps to confirm their moves.
They include:

• Support and Resistance Analysis
• Price Target Analysis
• Chart Pattern Analysis
• Candlestick Pattern Analysis
• Indicator Analysis (for final confirmation)

As a trader you can work with your own systems to determine what your personal triggers will be for confirmation that the trend has been broken.
The five-step system above works for me every time.
But no matter which way you choose to do your more detailed analysis, Dow's theory that we should close the trade once the trend has confirmed it is no longer in effect is certainly a lesson all traders can learn from.
After all, you can't logically buy and hold forever (despite what some financial planners would tell you).
Charles Dow's contributions to technical analysis have certainly changed the way equities are analyzed for trading.
Even though his theories are over one hundred years old, they are just as relevant today as they were when he first wrote them in the late 1800s.
If you would like to learn how to apply Dow Theory to your own trading, please visit our website and sign up for a free class http://tradesmartu.
com/site/scholarships.
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