After seeing our core portfolios taking the most cautious stance they can last Friday I’m guessing you’re surprised that I’m writing a post telling you that according to Dow Theory the long term bullish trend is still intact. I’m also guessing that somewhere in the next few days you’ll read or hear people saying a Dow Theory sell signal has just been triggered. Those misinformed people will cite the fact that today both the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA) have closed below their previous lows.
There are two problems with people calling a Dow Theory sell signal today. The first is that there is no such thing as a Dow Theory sell signal. The second problem (which is moot because the first problem negates it…but I’ll keep writing for those of you who still aren’t convinced) is that although both averages closed below their previous lows today, they didn’t close below their previous secondary low points. One of the major requirements for a secondary low is that it should retrace 33% to 66% of the rally from the previous secondary low (which the recent low did not do).
On the chart above you’ll see the current drop has only retraced about 20% to 25% of the rally out of the 2012 lows. As a result, to confirm a change in the primary trend from bullish to bearish on this decline both averages would have to fall below their 2012 lows. That would be about 12542 for DJIA and 4847 for DJTA. That’s a long way to fall for confirmation…and also a very unlikely scenario.
A more likely scenario for the bears would be for the current dip to continue and make lows that are somewhere below 15715 on DJIA and 7415 on DJTA. That would create a secondary low. If a subsequent rally (in both time and price) doesn’t carry above the previous highs then rolls over to fall below the new secondary lows a confirmation of a new bear trend will be in place. Until then a Dow Theory practitioner would be looking at the current dip as a probable correction in a bull market…and an opportunity to buy stocks expecting the primary trend to continue.
If you’re interested in Dow Theory here’s the beginning of several posts that explain it.