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What is Dao theory and what is its role in technical analysis?

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What is Dao theory and what is its role in technical analysis?

What is Dao theory and what are its uses in technical analysis? In the continuation of technical analysis training, this time we will introduce Dao theory. Stay with Pooyan Music.

What is Dao theory?

The Dao Theory is a financial theory that states that the market is in an uptrend if one of its averages (such as industrials or transportation) is above a previous significant high and is accompanied or followed by a similar advance in another average. Takes. For example, if the Dao Jones Industrial Average (DJIA) rises to an average, an investor might watch the Dao Jones Transportation Average (DJTA) rise to confirm the uptrend.

Important Notes

The Dao Theory is a technical framework that predicts that the market is in an uptrend if one of its moving averages breaks above a previous significant high, accompanied or followed by a similar advance in another corresponding moving average.

This theory is based on the concept that the market will discount everything according to the efficient market hypothesis.

In such a paradigm, various market indicators should confirm each other in terms of price action and volume patterns (until the trends reverse).

Understanding Dao Theory

Understanding Dao Theory

The Dao Theory is an approach to trading developed by Charles H. Dao was created, who, along with Edward Jones and Charles Bergströsser, founded Dao Jones & Co. and developed the Dao Jones Industrial Average in 1896. Dao expressed this theory in a collection. From the editorials of the Wall Street Journal, which he was one of the founders of.

Charles Dao died in 1902, and because of his death, he never published his complete theory on the market. But several followers and colleagues published works that expanded into editorials. Some of the most important contributions to Dao’s theory include:

Stock Market Barometer by William P. Hamilton (1922)

Dao Theory by Robert Rea (1932)

Oh you. George Shaffer How I Helped Over 10,000 Investors Profit in Stocks (1960)

Richard Russell’s Dao Theory Today (1961)

Dao believed that the stock market as a whole is a reliable measure of the overall business conditions in the economy, and by analyzing the entire market, those conditions can be accurately measured and the direction of important market trends as well as the possible direction of each stock. Identified.

Aspects of this theory have lost their place. But Dao’s approach forms the core of modern technical analysis.

How does Dao theory work?

Dao’s theory has six main components:

The market measures everything by price

The Dao Theory is based on the Efficient Market Hypothesis (EMH). It means that the price of assets includes all available information.

Earnings potential, competitive advantage, management competence – all these factors and more are priced into the market, even if they don’t know all or any of these details. In more detailed readings of this theory, even future events are discounted as risk.

There are three main types of market trends

Markets experience initial trends that can last a year or more, such as a bull (up) or bear (Daon) market. In broader trends, secondary trends create smaller moves, such as a pullback in a bull market or a rally in a bear market. These secondary processes can last from several weeks to several months. Finally, partial processes can last from a few days to a few weeks. These small fluctuations are considered market noise.

The primary processes have 3 phases

According to Dao Theory, the initial bull and bear trend goes through three stages.

The stages of a bull market are:

Accumulation stage: prices increase with the increase in volume.

Public Participation (or Big Move) Phase: Small and medium-sized investors begin to notice and join the uptrend – generally, this is the longest phase.

Excess Phase: The market reaches a point where experienced investors and traders begin to exit their positions while the average investing population continues to add to their positions.

The phases of a bear market are:

Distribution phase: in which news of the decline is distributed throughout the investor community through various channels.

General participation stage: It is opposite to the participation stage in the bull market. Medium and retail investors sell shares and exit the position to cut losses. Again, this is generally the longest stage.

Panic (or desperation) stage: Investors have lost all hope of a correction or full reversal and continue to sell off the scale.

The horns must confirm each other

To create a trend, the hypothetical Dao indices or market averages must confirm each other. This means that the signals that occur in one indicator must match or match the signals of other indicators. If one index, such as the Dao Jones Industrial Average, shows a new early uptrend, but another remains in an early Daontrend, traders should not assume that a new trend has begun.

Dao used two indices he and his partners invented, the Dao Jones Industrial Average (DJIA) and the Dao Jones Transportation Average (DJTA). Assuming that business conditions were healthy – as the rising DJIA might indicate. Railways benefit from the movement of cargo required by this commercial activity. So, DJTA is also increasing.

The volume should confirm the trend

Trading volume generally increases when the price moves in the direction of the initial trend and decreases when it moves against it. Low volume is a sign of weakness in the trend. For example, in a bull market, buying volume should increase as price rises and falls during secondary pullbacks, as traders continue to believe in the initial uptrend. If selling volume increases during a pullback, it could be a sign that more market participants are bearish.

Trends continue until a clear reversal occurs

Reversals in primary trends can be confused with secondary trends. It is difficult to determine whether a rally in a bear market is a reversal or a short-term rally followed by a low. Dao theory advocates caution and insists that a possible reversal be confirmed by comparing indicators.

Special considerations

Special considerations

Here are some additional points about Dao Theory.

Closing prices and line ranges

Charles Dao relied only on the closing prices and did not worry about the daily movements of the index.

Another feature of the Dao theory is the idea of a line range, which is also called a trading range in other areas of technical analysis. These periods of lateral (or horizontal) price movement are considered periods of consolidation. Therefore, traders should wait for the price action to break the trend line before deciding which direction the market is headed. For example, if the price moves above the line, it is likely that the market is in an uptrend.

Signals and trend identification

One of the challenging aspects of implementing Dao Theory is accurately identifying trend reversals. Remember, a Dao follower trades with the general direction of the market, so it is very important to recognize the points where this direction changes.

One of the main techniques used to identify trend reversals in Dao theory is peak and trough analysis. A peak is defined as the highest price of a market move in a period, while the lowest price is a market move in a period. Note that the Dao theory assumes that the market does not move in a straight line, but that the price moves from highs (tops) to lows (troughs) as the market generally moves in one direction.

An uptrend in Dao theory is a series of successively higher peaks and troughs. A Daontrend is a series of successively lower peaks and troughs.

The sixth principle of Dao Theory states that a trend will remain strong until there is a clear indication that the trend will reverse. Similarly, the market will continue to move in the initial direction until a force such as a change in business conditions is strong enough to reverse the direction of this initial movement.

Reverse process

A reversal in the primary trend is indicated when the market fails to make consecutive peaks and troughs in the direction of the primary trend.

During an uptrend, a reversal occurs when the index fails to make consecutive highs and lows over a long period of time. Instead, the index moves through a series of lower highs followed by lower lows.

A reversal of the initial Daontrend occurs when the market is no longer falling to a new low and high. Consecutive highs and lows in a Daontrend market indicate a possible return to an uptrend.

It is important to remember that the initial trend change may take months to manifest itself. A change in price direction over a period of one month, two months, or even three months may just be a market correction.

Frequently Asked Questions

What is the Dao theory trend?

These three trends are primary, secondary and secondary. The primary trend is the long-term trend, which is called bull or bear. Secondary trends are smaller trends, such as market corrections. Finally, minor trends are daily price fluctuations in the market.

What is the purpose of Dao theory?

The overall goal of Dao Theory is to identify the initial trend of the market through confirmation and confirmation.

What factors affect Dao?

The Dao Jones Industrial Average, known as the Dao, is influenced by the prices of the stocks that make up this index. Stock prices are affected by many factors.


Dao theory tries to identify the initial trend of the market. This theory consists of three main processes, each of which consists of secondary and sub-processes. This theory assumes that the market has prior knowledge of every possible factor and that prices reflect current information. This suggests that there is no need to delve further into why assets are priced the way they are, but to act on price and volume movements and depend on signals and confirmation of trend reversals.