Dow Theory: Hamilton's Principles and a Test of the Trend Rule on the Dow Since 1992

Dow theory is a way of reading the stock market's primary trend from the averages, built from Charles Dow's editorials in The Wall Street Journal and set out by William Peter Hamilton, a later editor of the paper, in his 1922 book The Stock Market Barometer. Its core is short: the market moves in three kinds of movements at once, the primary trend lasts a year or more, a bull market makes higher highs and a bear market lower lows, and a primary move counts only when two averages confirm each other. This page quotes Hamilton's text, then tests the higher-high, lower-low rule on the Dow Jones Industrial Average since 1992, with every signal listed.

The principles, in Hamilton's words

Hamilton's book, copyright 1922 and read here in the Internet Archive's scan of a later printing (The Stock Market Barometer), opens the subject with "Dow's theory is fundamentally simple. He showed that there are, simultaneously, three movements in progress in the stock market."

• The primary movement is the bull or bear market. Hamilton writes that it "tends to run over a period of at least a year and is generally much longer."
• The secondary movement is "represented by sharp rallies in a primary bear market and sharp reactions in a primary bull market." Dow, quoted by Hamilton from 1902, put it at "ten days to sixty days, averaging probably between thirty and forty days."
• The daily fluctuation is the third. Dow described it as "the daily variation due to local causes and the balance of buying or selling at that particular time."

The definition of the trend comes from Dow himself, in the passage Hamilton calls a useful definition: "It is a bull period as long as the average of one high point exceeds that of previous high points. It is a bear period when the low point becomes lower than the previous low points."

The averages had to agree. Hamilton used "twenty active industrials and twenty active railroads," and wrote that "the two averages corroborate each other, and that there is never a primary movement, rarely a secondary movement, where they do not agree." When both traded in a narrow range for weeks, the market was "making a line," which in his experience "indicates a period either of distribution or of accumulation"; "When the two averages rise above the high point of the line, the indication is strongly bullish."

Two more principles from the book: "News known is news discounted": the averages already reflect what is known. Hamilton also called "unnecessary" the "attempts to combine the volume of sales and to read the average with reference to commodity index numbers," because the averages already take such things into account. He gave volume a minor role: he noted that trading "expands as prices go up and contracts as they decline," but judged volume "much less significant than is generally supposed," and he did not make it a condition for confirming a trend. Robert Rhea, whose The Dow Theory has its earliest listed edition dated 1932 (Open Library record), systematized the theory further; this page quotes Hamilton only, because it could check his text.

The three phases of a primary trend

The schematic is a teaching drawing of a primary trend in three phases; it is not in Hamilton's text, which links accumulation and distribution to "lines". The phases drawn are accumulation, when informed buyers take positions after a decline; public participation, the long middle of the advance; and excess, before distribution and the bear market's own phases. Read the drawing as a teaching scheme, not as a measured pattern. The market cycles page shows the same idea from the cycle point of view.

A test of the trend rule on the Dow since 1992

To turn Dow's definition into a rule that can be counted, we used the daily closes of the Dow Jones Industrial Average from January 2, 1992 to October 28, 2026. It is the price index, without dividends. The site has no transportation or railroad average, so this is a one-average test: it checks Dow's higher-high, lower-low definition, not the confirmation by a second average that Hamilton considered essential.

• A swing high is confirmed once the close falls 10% below the highest close since the last swing low; a swing low is confirmed once the close rises 10% above the lowest close since the last swing high.
• A bear signal is a close below the last confirmed swing low; a bull signal is a close above the last confirmed swing high. Each signal stays in force until the opposite one.
• Results are measured from the close of the signal day. A strategy version holds the Dow while a bull signal is in force and is out of the market, earning nothing, while a bear signal is.

The rule gave 17 signals, 9 bull and 8 bear, from February 10, 1998, when the first one appeared, to the end of the data. The last one, a bull signal on November 23, 2022, was still in force on October 28, 2026. Every signal is in the table, with the Dow's change 126 and 252 sessions later, about six months and a year.

Over all days from February 10, 1998, the control, the Dow was higher 126 sessions later 70% of the time with a median of +4.3%, and 252 sessions later 76% of the time with a median of +8.7%. After the 9 bull signals the median was +2.0% at 126 sessions and +10.6% at 252. After the 8 bear signals the Dow was higher, not lower: +14.0% at 126 sessions and +17.6% at 252, because several bear signals came late: a year after those of November 2008, February 2016, December 2018 and March 2020, the Dow was between 21.7% and 54.6% higher. Three signals were reversed by the opposite signal within 63 sessions: those of November 4, 2008, February 11, 2016 and September 23, 2022.

The strategy version was in the market 81% of the time from February 10, 1998 and gained +167%, against +533% for holding the Dow over the same dates, before dividends, which would add to holding, and before interest on cash, which would add to the strategy. Changing the threshold changes the answer but not its direction:

How Dow theory is used today

The theory's lasting ideas are the trend definition by highs and lows, the separation of the primary trend from the swings against it, and the demand for confirmation before acting. They are the base of much of technical analysis, of trend trading and of the bullish vs. bearish market vocabulary. Volume, to which Hamilton gave only a minor role, is covered in volume indicators. To test a version of the rule yourself, keep a written record of every signal and its result, as in tracking trading performance. More terms are on the trading concepts page.