Technical analysis is a method of analyzing and predicting market price trends. It mainly relies on data such as price and trading volume to judge the supply and demand relationship and psychological state of the market, and then formulate appropriate trading strategies.
Dow Theory, as an ancient and famous technical analysis method, was created by Charles Henry Dow, the founder of Dow Jones & Company in the United States. It is also known as the "Dow Jones Theory". It can be used to predict the trend of stock price changes. It believes that the market price trend is composed of three trends, namely the main trend, the secondary trend and the short-term trend.
In the stock market, Dow Theory, as the originator of most technical analysis methods, has been further enriched through continuous summary, supplement and improvement by successors.
These include some rules for judging trend changes, the most commonly used are the 123 rule and the 2B rule. Next we will introduce the meaning and usage of these two rules, as well as their role in technical analysis.
1. 123 Rule
Before using these rules, let's first understand what their prerequisites are.
K-line breaks through the trend line
No more new highs or lows
Breaking the previous low or breaking the previous high
These three conditions do not have a particular order as long as they are met. It can be that the K-line breaks through first, and then falls below the premise or breaks through the previous high. It can also be done in this order, in reverse, or at random.
Here are some derivatives of the 123 rule:
The 123 rule is mainly used to determine the end of a certain trend, such as the EUR/USD 1-hour line. The 123 rule is used to determine when the downward trend will end.
First, draw a trend line verified by three points based on the high point formed by the K-line, and then determine whether the conditions of the 123 rule are met. Obviously, the conditions of the 123 rule are met. After breaking through the previous high, the role of the trend line changes from a pressure line to a support line, and the market slowly changes from a decline to an increase.
Zooming in on the point where the trend line is broken, we can see that when the trend line is broken from bottom to top by the K-line at point A, it turns from a pressure line to a support line, indicating that the downward trend has ended and a new trend will be formed in the short term, but it does not mean that a bull market will form immediately.
2.2B Rule
2B means "break out" twice. If the market is rising, two consecutive K-lines break through the previous high and then fall rapidly. This is a false breakthrough, which means that the strength of the bulls is weakening and then turns to bears. In this case, the intersection of the trend line and the K-line can be used as a signal to short.
Similar to the 123 rule, it also requires the market to break through the trend line and fall below the lowest point. The difference is that the 2B rule changes the condition of "breaking new highs or new lows" into a "false breakthrough."
Taking the EUR/USD 1-hour line as an example, before the low point was raised, there was a false breakthrough, two consecutive large K-lines bottomed out, and then immediately rose. This is also a signal that the downward trend is about to end.
Point A is the intersection of the K-line and the trend line, which can be used as a signal to go long. According to the subsequent market conditions, it can be seen that this is not a good position to go long, so point A can be used as a signal to go long.
The above is our introduction to the 123 rule and 2B rule of Dow Theory. These are two very useful technical analysis tools that can help us detect trend changes in a timely manner and seize trading opportunities.
It should be noted that they are not iron rules. Sometimes errors or failures may occur. Before making a decision, other technical indicators should be combined to determine the true trend of the market.
Improve and establish your own trading system to adapt to market changes and your own characteristics, review your own transactions, draw lessons and experience from them, improve your trading capabilities, and then achieve stable profits in the stock market.
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