NISM-Series-XV: Research Analyst · Technical Analysis

Introduction to Technical Analysis and Dow Theory

Updated 11 October 2026 · Fact-checked

Technical analysis forecasts future price direction by studying past price and volume data, mainly on charts. It assumes price reflects all information, prices move in trends, and history repeats. Dow Theory is its foundation: it describes primary, secondary and minor trends and says the averages must confirm each other.

Understand Introduction to Technical Analysis and Dow Theory

Technical analysis studies price and volume history to judge where a price may go next. It does not ask what a company is worth. It asks what the market is doing and how buyers and sellers are behaving.

It rests on three assumptions:
- Market action discounts everything. Price already reflects fundamentals, news and sentiment.
- Prices move in trends. A trend is more likely to continue than to reverse.
- History tends to repeat itself. Human behaviour such as fear and greed produces similar chart patterns.

Fundamental analysis looks at the economy, industry and company to find intrinsic value, then compares it with market price. It is mostly used for long-term investing. Technical analysis uses charts and indicators and is mostly used for timing entries and exits over shorter periods. Fundamental analysts ask why and what; technical analysts ask when.

Dow Theory comes from Charles Dow's writings and is the base of trend analysis. Its main tenets are:
- The averages discount everything.
- The market has three trends: primary (major, lasting from about a year to several years), secondary (corrections against the primary trend, lasting weeks to months) and minor (short-term fluctuations, lasting days to weeks).
- Primary trends have three phases. In a bull market: accumulation, public participation, and excess or distribution. A bear market has the mirror phases.
- The averages must confirm each other. Dow used the Industrial and Rail averages. A signal from one is stronger if the other agrees.
- Volume must confirm the trend. It should rise in the direction of the trend.
- A trend is assumed to continue until a clear reversal signal appears.

Dow Theory does not predict how long a trend lasts. It identifies the trend after it has begun, so it lags.

Key formulas to remember

Three assumptions of technical analysis: Price discounts everything | Prices move in trends | History repeats; Learn the exact trio. Options claiming 'markets are always efficient' or 'earnings drive price' are traps.
Three trends in Dow Theory: Primary (major) > Secondary (intermediate correction) > Minor (short-term); Secondary moves are corrections against the primary trend. Minor moves are the shortest.
Phases of a primary bull market: Accumulation → Public participation → Excess (distribution); Smart money buys in phase 1, the public joins in phase 2, and euphoria marks phase 3.
Confirmation principle: Trend signal valid when both averages confirm; volume should support the trend; Dow originally used the Industrial and Rail averages.
Technical vs fundamental: Technical: price and volume, charts, timing | Fundamental: intrinsic value, financials, long-term; Know which approach answers 'when' and which answers 'what and why'.

How to solve Introduction to Technical Analysis and Dow Theory questions

Most questions on this topic ask you to identify an assumption, a Dow tenet, or a difference between the two approaches. Use this method.

1Read the stem and spot the keyword: assumption, trend type, phase, confirmation, or comparison.
2Decide whether the question is about technical analysis, fundamental analysis, or Dow Theory.
3For assumptions, match to the trio: price discounts everything, trends, history repeats.
4For trend questions, link the duration and role: primary is major, secondary is a correction, minor is short-term noise.
5For comparison questions, check the input (price and volume vs financials) and the purpose (timing vs valuation).
6Eliminate options with absolutes such as 'always' or 'guarantees', or ones that mix the two approaches.
7Pick the option that fits the textbook definition exactly.

Quickest way: Keyword matching

When to use it: Use it for definition and 'which of the following' questions when time is short.

Price or volume data, charts, timing: technical analysis.
Intrinsic value, earnings, balance sheet, economy: fundamental analysis.
Correction against the major trend: secondary trend.
Two averages agreeing: confirmation.
Accumulation, public participation, excess: three phases of a primary trend.
Reject any option that claims certainty of prediction.

Common mistakes in Introduction to Technical Analysis and Dow Theory

Treating a secondary trend as a change in the primary trend.
A sharp fall in a bull market looks like a reversal.
Fix: A secondary trend is a correction within the primary trend. Only a clear reversal signal ends the primary trend.
Listing 'fundamentals drive price' as an assumption of technical analysis.
Students mix the two approaches.
Fix: Technical analysis assumes price already reflects everything, so it need not study fundamentals separately.
Saying Dow Theory predicts how long a trend will last.
Trend durations are quoted, so they look like forecasts.
Fix: Durations are only rough guides. Dow Theory identifies a trend once it is under way and does not time its end.
Confusing confirmation with volume confirmation.
Both use the word confirm.
Fix: Averages must confirm each other, and separately volume should expand in the direction of the trend.
Assuming technical analysis suits only short-term and fundamental only long-term as a strict rule.
Textbooks give this as the usual pattern.
Fix: Treat it as the typical use, not a rigid rule. Pick the option that says 'generally' or 'mostly' over one that says 'only'.
Mixing up the order of bull market phases.
Students memorise names without the logic.
Fix: Remember the story: informed buyers first, then the public, then euphoria and distribution.

Worked examples

Example 1

Which of the following is NOT an assumption of technical analysis? (A) Market action discounts everything (B) Prices move in trends (C) History tends to repeat itself (D) Intrinsic value always determines the market price in the short run

Show the solution

List the three assumptions: price discounts everything, trends, history repeats.
Options A, B and C match them exactly.
Option D is a fundamental analysis idea and is stated as an absolute.
So D is not an assumption of technical analysis.

Answer: (D)

Example 2

In a long-running bull market, the index falls for three weeks and then resumes rising to new highs. In Dow Theory, the three-week fall is best described as: (A) A primary trend (B) A secondary trend (C) A bear market phase (D) A distribution phase

Show the solution

The long-running bull market is the primary trend.
A fall against the primary trend lasting weeks is a correction.
Dow Theory calls such a correction a secondary trend.
The index then resumed rising, so no reversal occurred and it was not a bear market or distribution phase.

Answer: (B) A secondary trend

Exam tips

Memorise the three assumptions word for word. They are a frequent question source.
Practise telling primary, secondary and minor trends apart by their role, not just their duration.
For comparison questions, anchor on input data and purpose: price and volume for timing versus financials for valuation.
Beware of options with 'always', 'guarantees' or 'only'. Dow Theory and technical analysis deal in probabilities.
With negative marking of 25% of the marks on each question, skip a question only if you cannot eliminate at least two options.

Practice questions from Technical Analysis

Introduction to Technical Analysis and Dow Theory in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Introduction to Technical Analysis and Dow Theory: frequently asked questions

What are the assumptions of technical analysis?

There are three: market action discounts everything, prices move in trends, and history tends to repeat itself. Together they justify using past price and volume to judge future direction.

What is the difference between technical and fundamental analysis?

Fundamental analysis estimates intrinsic value from the economy, industry and company financials. Technical analysis studies price and volume charts to judge trend and timing. Fundamental analysis asks what to buy and why; technical analysis asks when.

What are the principles of Dow Theory?

The averages discount everything, the market has primary, secondary and minor trends, primary trends have three phases, averages must confirm each other, volume must confirm the trend, and a trend continues until a clear reversal signal appears.

Does Dow Theory give early signals?

No. It tends to confirm a trend after it has begun, so it lags. Its value is in helping you stay with the primary trend and avoid mistaking a correction for a reversal.