A Lesson in Dow Theory

Attached is a chart of the Dow Transports and then the Dow Industrials in order to show how the 100 year old Dow Theory works. On the chart I have two captions pointing out two different timeframes. The black lettering is the shorter time frame and shows both the Dow Jones Industrials and Transports printing a high, a low, and then a new high. Because both of these resulted in new highs above the previous high (in Novemeber and December 2010), they confirmed a shorter term Dow Theory buy signal.

On the longest time frame, however, neither index has made a new high above the previous high (2007) and thus neither index has confirmed the long term buy signal.

The Transports are getting close to making a new high. If that occurs then we will look toward the Industrials to confirm the hew high by surpassing its 2007 high. Obviously this has a long way to go and will leave a lot on the table, but that's the way a trend following technique works.

If the Industrials fail to confirm the new high, and go on to post a high, a low, a lower high, and then a lower low (all below the 2007 top), that will be a Dow Theory Non-Confirmation and a pending sale signal. If that occurs and then the Transports do the same, that will be a Dow Theory all out sell signal, on the shorter black time frame.

Dow Theory can work at all time frames, but for this analysis I have just used the 2 longest time frames.

For more on Dow Theory and how it helped foreshadow the 2008 bear market in a January 2008 post, click on 'Dow Theory' to the right in the Labels Section.

Good Luck!

Dow Theory

In technical analysis there is a lot of confusion as to when a proper Dow Theory trend change is confirmed. I have attached a chart and email I sent on Jan 14, 2008 to a few friends and family showing the true Dow Theory Bear Market confirmation. Enjoy.

Dow Theory states that a trend change occurs when both the Dow Industrials and Dow Transports either BOTH make higher highs or BOTH make lower lows. Both indicies made lower lows the first week in 2008 for a confirmed bear market trend change. There was an important negative divergence that occcured in the transports at the October highs, which was a warning sign, but the confirmation of the Bear using Dow Theory did not occur until January 2008

Email sent Jan 14, 2008

Subject:Tuesday morning relevance

"Dow Theory says end to bull market! Confirmation by the Industrials occured last week for the first time since the bear market of 2002."

200 Day Moving Averages are very interesting right now

The 200 Day Moving Average has been playing a game with the markets this last week.

On the Nasdaq, it is long blown thru on the upside, so no games there, but on the Dow and S&P500 is a different story.

Attached are the Dow and S&P500 5 min charts with the 200 day Moving Average in pink.

Notice on the Dow, it has yet to break thru the 200 day as it rejects price as resistance, but on the $SPX the 200 day is already acting as support having bounced along it yesterday.

Once the Dow breaks thru then we can get more comfort that this rally has legs.