The Current Market according to the Dow Theory

by: Paul Castro March 29, 2008 | about stocks: DIA / QQQQ / SPY    
Paul Castro

Paul Castro

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Dow Theory was, as you might guess, developed from analysis (technical in nature) done by Charles Dow. Two of the basic tenets of Dow Theory are trends (up and down) and signals (buy and sell).

Mr. Dow looked to the industrials and the rails to confirm each other in order to provide buy/sell signals and to confirm up/down trends. For purposes of analyzing Dow Theory, we now look to the Dow Jones Industrial Average and the Dow Jones Transportation Average.


Buy signals are given the first time both averages make a concurrent higher high. Conversely, sell signals are given the first time both averages make a concurrent lower low. Up trends trace their origin to the last time both averages made a concurrent lower low previous to a buy signal being given while down trends trace their origin to the last time both averages made a concurrent higher high previous to a sell signal being given.

Let's apply the theory to the recent action in the averages. The last time both averages made a concurrent higher high was in July 2007 when the Industrial Average scored a higher high by closing at 13,971 on July 17th, and the Transportation average scored a higher high by closing at 5,446 on July 19th. Then Dow Theory flashed a sell signal in November 2007 when both averages made a lower low with both the Industrials and the Transports undercutting their respective August low. Thus, a downtrend was confirmed and the origin of said downtrend could be traced back to July 2007, which was the time previous to the sell signal that both averages made a concurrent higher high.


Most recently, the Transporation Average scored its first higher high since July when it closed at 4,861 on March 24th which bested its February 1st closing high of 4,807. All that remains for a Dow Theory buy signal is for the Industrial Average to best its February 1st closing high of 12,743. If the Industrials can overcome 12,743 on a closing basis, then a new uptrend would be in place that could trace its origin back to the January lows when both the Industrials and the Transports last made a concurrent lower low.


For more on Dow Theory, see Wikipedia which contains a pretty comprehensive overview.

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This article has 18 comments:

  •  
    Mar 30 08:42 AM
    Another good article explaining a theory--and providing another place to do research, this time Wikipedia.
    Reply | Link to Comment
  •  
    Mar 30 08:45 AM
    I may be wrong, but I thought the theory also included the utilities average.

    At present only the Dow transports are above the 200 day moving average. The industrials and utilities are still well below their moving average.

    Did you know that only Mexico of the major stock exchange indexes around the globe is above it's 200 day moving average? That includes China, India, Brazil, England, Germany, Korea etc.

    The Dow theory was developed at a time when USA was de-coupled, but for many years now our markets are directly tied to the success of all the world markets.

    So, in my humble opinion, the rest of the world must be added to the basic theory to confirm an uptrend. Thus most of the world markets should be in an uptrend, not a down trend. There is nothing that I can see that supports the notion that we are even close to have reached a bottom.

    Get real, the bull herd has not even been willing to even admit that we are in a "recession" yet. If we had a rally from here, it can only be considered a bear market rally since we or only at the beginning stage of the recession.

    Lets face it we are in big trouble since Citigroup has lost $150 billion of market capitalization since the beginning of 2007, and is no longer the largest bank by assets in the country, and now it is Bank of America. Then consider how stupid it is that are now biggest bank has acquired the largest residential mortgage originator which really promoted the huge subprime mess. Then consider that the guys who made those terrible decisions are still running Countrywide and BAC has paid them huge salaries to continue their bad management.

    So now we are told that both BAC and C are in trouble and will be cutting dividends, again.

    Then add to the mix that even Goldman and Lehman are both on the edge of downgrades by S-P.

    So hang on to your hat, we are still in a downturn that will not reach bottom until possibly 2010, if we are lucky!
    Reply | Link to Comment
  •  
    Mar 30 08:48 AM
    I'll bet my team beats your team and am willing to put up $10,000 to back my belief. This is called gambling, and so is playing the stock market. Sure there are educated guesses, but which school of thought do you use? I prefer the school of hard knocks! The genius, Ivy League scholars, with all of their theories, ought to be rich by now if they are correct in their assumptions. Ditto for all the so-called financial advisers.
    Reply | Link to Comment
  •  
    Mar 30 09:16 AM
    Mixter is confused... is he going to bet his $10,000 at Las Vegas or Wall Street? Is he bullish?
    Reply | Link to Comment
  •  
    Mar 30 11:12 AM
    technical analysis indicates overhead resistance for the DJIA at 12800, I have placed my bets on the scenario that the Dow will test and fade a 1000 points
    but what would a TN hick know
    Reply | Link to Comment
  •  
    Mar 30 12:00 PM
    The whole game is the cat chasing the mouse, and the dog chasing the cat, so are BEARS & BULLS. The reality is the banks are there to make money for the bigwigs, and fleece the innocent investors and depositors, and caught in the middle is the Government, with former Wall Street employees running the treasury departments, to safe guard the banks commercial & investment and brokers and traders, who falsely advise investor to buy or sell.In this biased atmosphere nobody can make correct decisions to buy or sell, but only lose their capital. My best advise to investors is to keep of the markets for a while, till everything cools.
    Reply | Link to Comment
  •  
    Mar 30 12:20 PM
    The American consumer is the engine that has carried the economy and it's credit to manage debt load is the fuel.That gas tank is looking pretty empty just now.Add a continuing loss from home mortgages as ARM's reset and their derivatives tumble, and the road begins to look pretty bumpy.
    Reply | Link to Comment
  •  
    Mar 30 12:50 PM
    This was a great summary.
    Precise and direct to the point we want to learn - how to apply the Theory to the market Today.
    Reply | Link to Comment
  •  
    Mar 30 01:00 PM
    The Dow Theory is very valid. I have been trying to justify the bounce in the Transports, think about it. The rails were pumped by the media on Buffet's buys, even though there are thousands of rail cars now parked in Montana and other states (see yesterday's yahoo story)for lack of goods shipped. Airlines were pumped by the media on merger rumors, despite the highest jet fuel costs in history. Truckers media-pumped in recent weeks, even though they are abandoning rigs and striking. Fedex and other shippers warning. The Transports chart shows extreme intervention after the recent low, with massive buying, my guess is it was the Plunge Protection Team's efforts. Now, the transoprts hit the 200-day brick wall, and will fall back to the 50dma (still under, bearish), we will see in the next 4 weeks if fundamentals win over all the hype and manipulation in the index. chart>
    stockcharts.com/h-sc/u...=$TRAN&p=D&yr=...
    Reply | Link to Comment
  •  
    Mar 30 01:03 PM
    sorry... here's the chart tinyurl.com/2bdpdv
    Reply | Link to Comment
  •  
    Mar 30 01:11 PM
    Gordon good post!! My son-in-law is a trucker and is being killed by fule costs. He said last nite the repo's of trucks is at an all time high, higher then the last downtrun by 130%,
    Reply | Link to Comment
  •  
    Mar 30 02:14 PM
    Tim Wood is a foremost expert on the Dow Theory, here's a link to a good audio conference call from last Friday, see the link near the top, audio icon with 2 other writers for financialsense.com, he says the Transports are only 20 stocks and subject to easy manipulation.
    www.cyclesman.com/Arti...

    here's the story on rail car mothballing biz.yahoo.com/ap/08032...

    here's the Dow Industrials chart, tinyurl.com/2xoxbq
    showing a small recent head & shoulders(discussed in the audio link above) with support here at 12,200, they all agree, if the Transports are now giving a sell non-confirmation, the Dow needs to get back above 12,767 or 12,800 , to give a buy signal on the Dow Theory (Industrials-Transport...
    Reply | Link to Comment
  •  
    Mar 30 05:16 PM
    Is there a time frame when the $INDU & $TRAN need to confirm to be a valid buy or sell signal or is it open ended ?
    Reply | Link to Comment
  •  
    Mar 30 05:21 PM
    How far apart, in time, can the two averages be and still confirm a valid buy or sell signal ?
    Reply | Link to Comment
  •  
    Mar 30 06:24 PM
    So let's give this much-vaunted theory a little test drive. The last buy signal was on July 19, when the Diamonds closed at 139.89. The Dow promptly went down, struggled back to a slight gain in October then plunged again. You don't give the date of the sell signal, but it looks to me like the close of 127.79 for the Diamonds on Nov. 21. That's a loss of 8.6%. Let's hope your next buy signal works out better.
    Reply | Link to Comment
  •  
    Mar 31 12:48 AM
    so should we buy or sell? I thought this article was mostly useless!
    Reply | Link to Comment
  •  
    Mar 31 02:22 PM
    The Dow Theory is a 4-yr cycle, it tells you when the market makes a trend change, meaning to protect your capital now, it's a bear market until the Dow gets above 12,780, lets say. The $tran looks like it's failing here and heading back to the 50-day. The Dow Theory tells you any rally you see now is a shortcovering rally within a bear market, and it's aided by what Paulson is now stealthily calling the "PWG", he just changed it from WHWG (White House Working Group) to PRESIDENT'S WORKING GROUP,(PWG) otherwise known as the PLUNGE PROTECTION TEAM, PPT now he wants complete control of markets, so any move in the Dow (30 stocks) or Transports (20 stocks) can be manipulated by Paulson's buddies at the trading desks, this is a new factor in the Dow Theory's reliability.
    Reply | Link to Comment
  •  
    Apr 03 12:33 PM
    Hillcrest,

    The buy signal was given in early 2004 which was the first time coming out of the bear market when the Industrials and the Transports first made a concurrent higher high. The higher high in both the transports and the industrials in July 2007 served at the time to confirm the uptrend phase was still intact, at least until a sell signal was given in November 2007. There is a distincition between signal and phase (ie, trend).
    Reply | Link to Comment
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