Dow Theory is one of the oldest market techniques in existence and right now it suggests the Dow is in a very precarious situation.
On one hand the Dow Transports have again roared to new all time highs, but on the other hand the Industrials have not joined in making new price highs above September’s 17,350.
This has also all occurred after both indices recently confirmed new lows, resulting in a Dow Theory bearish signal in mid-October (a signal that now looks inevitably to be a false one).
As if its not complicated enough, if the Dow (NYSEARCA:DDM) joins the Transports (NYSEARCA:IYT) in new highs, it will reverse that bearish Dow Theory signal to bullish. I know, it all sounds very confusing, but really it’s pretty straightforward, both the Dow Jones Industrial Average and the Dow Jones Transportation Average should be moving together in price, and right now that is still up in the air as the Industrials lag the Transports.
A popular saying, sums up the reasoning, “what the Industrials make, the Transports should take”, and when one sector is behaving differently than another it can be a warning that the overall market trend is not as strong as it should be. In other words, the Transports need the Industrials to make new highs, otherwise the current trend of higher prices is at risk.
Dow Theory Helps Identify Trends – Primary Trend Turned Down in October
The chart below attempts to show these signals and why the recent new lows resulted in a bearish signal along with the bullish non-confirmation now occurring between these two popular indices.
In Dow Theory, both the Industrials (NYSEARCA:XLI) and the Transports need to make new price highs or new price lows to confirm any trend change signal.
Back in January of this year is a good example shown on the chart of a non-confirmation as the Transports (NYSEARCA:XTN) did not confirm the Industrial’s new price lows below December price levels, thus the bullish trend signal remained in place and there was no Dow Theory signal.
But more recently, when both these indices fell below August’s price lows, a Dow Theory bearish trend signal was confirmed. Both the Transports and Industrials made new price lows below August’s, turning the Dow’s primary trend to down.
So, for now anyways, Dow Theory remains in a sell signal due to October’s confirmed breakdown, but it is also sporting a non-confirmation as the Transports have made new highs without support (yet) from the Industrials (NYSEARCA:DXD).
The bearish signal will remain intact until the Industrials can join the Transports in new highs. With the Dow (NYSEARCA:DIA) now less than 200 points from another new all time high, it seems inevitable that this confirmation back to a bullish trend will occur soon. However, if the Dow Industrials (NYSEARCA:SDOW) don’t join their Transport counterparts in new highs, it will be a big red flag known as a Dow Theory Non-Confirmation, something that often occurs at key market turning points.
The ETF Profit Strategy Newsletter utilizes technical, sentiment, and fundamental analysis to stay abreast of the market’s direction. Although Dow Theory is not necessarily a trading strategy, its signals have historically kept investors on the right side of the market’s trends.