One of the primary tenets of Dow Theory is that secondary movements tend to be more steep than the move they are retracing. For example, the Dow Jones Industrial Average (DJIA) made a secondary low point in June of 2012. The subsequent rally lasted four months. Then the next decline retraced 50% of the rally in only six weeks. This is typical behavior during long term bullish trends. What happened next isn’t typical. The market had a continuous rally lasting more than two years without a secondary reaction. This is because no price declines over that period retraced at least 33% of the move in a period lasting more than three weeks. We’ve now reached a point where both averages have declined for over a month. The fact that this decline has lasted over a month but is only down roughly 5 to 6% shows a market that is changing character. Instead of quick declines and retracements (V bottoms) we’re now seeing some sideways to slowly down consolidation. If the
Out of the lows in 2009 there has only been one of the indicators that I follow that hasn’t had whipsaws or bad signals somewhere along the way. That “indicator” is Dow Theory. It has continued to confirm a long term bull market for the entire period from its bullish trend change in July 2009. This is due to time being an important factor in Dow Theory. The system outlined by Charles Dow and William Peter Hamilton waited for roughly three weeks of trend before declaring a secondary reaction point. The lack of secondary lows that subsequently failed has kept Dow Theory bullish. On the chart below I’ve annotated the secondary low and high points from the last several years. In addition there is a Dow Theory line during the first several months in 2012. We’re now approaching a month long decline in the Transportation average (DJTA). The industrial average (DJIA) will need to break below the December lows to pass the three week mark. At this point we’ll need
The Trade Followers momentum indicators for many of the major indexes (DJIA, SPX, and Nasdaq 100) are warning of a short term correction in the market. This increases the odds that we’ve finally got the short term top I’ve been expecting for the last month. I still think that the most important index at the moment is the Russell 2000 so I’d like to see it confirm before getting too bearish. If we’re getting the expected dip then it will be important to watch how internal indicators react.
A few weeks ago I mentioned that Dow Theory was still confirming the long term bull market even though many others were calling a bearish long term trend change. On Friday, both the Dow Jones Industrial Average (DJIA) and Dow Jones Transportation Average (DJTA) closed above their last secondary high points. This confirms again that we’re still in a long term bull market. Those that called for a sell signal made the most common mistake in interpreting Dow Theory. These technicians misidentified the last secondary low point as a result of not paying attention to the size of the price decline. Secondary reactions should retrace between 33% and 66% of the rally from the previous secondary low. As a result, the last secondary reaction was in 2012. This means that price will have to fall below those points (about 12542 for DJIA and 4847 for DJTA) without any rallies to change the trend from bullish to bearish. As I’ve mentioned before, that’s not a likely scenario. You can read this post
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
For the last few months the major indexes have been diverging from each other. While the Dow Jones Industrial Average (DJIA) and the S&P 500 Index (SPX) have traveled sideways in a range, the Nasdaq Composite and Russell 2000 Index (RUT) fell to their 200 day moving averages and bounced back to their 50 dma. As you must know by now this is a result of rotation out of the high fliers from 2013 into large cap and value stocks. The rotation caused damage in Nasdaq and RUT while at the same time kept SPX and DJIA in the range (DJIA made a marginal new high this week, but not a clean break of the range). With Nasdaq and RUT stuck in the middle of moving averages and SPX and DJIA stuck in a range it’s decision time. Over the next few weeks the market will most likely turn over and start a down trend or break higher out of the current range. I wish I could tell you which
Both the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA) closed above their last peaks today. This reconfirms the primary bull trend of the market according to Dow Theory. Going forward traders who use Dow Theory will continue to buy dips. If you’ve read my posts on the subject you know that both averages going to new highs does not constitute a “buy signal”. Instead, it is nothing more than renewed confirmation of the trend. As a result, you shouldn’t take this as a signal to get fully invested right here. In fact, you should have been building positions on the dips during this rally. Robert Rhea in his book “The Dow Theory” actually warns that breakouts like those that occurred today can be a dangerous place to invest and “every trader should remember that from such new peaks or valleys secondary reactions can occur with amazing rapidity“. Here’s a post with more information about new highs and how to trade with Dow Theory. For an
Over the weekend we mentioned that Dow Theory was showing a small non-confirmation of the current uptrend. Today that condition was cleared as the Dow Jones Transportation Average (DJTA) joined the Dow Jones Industrial Average (DJIA) closing above the previous peak. This reconfirms the primary bullish trend and suggests that the most likely long term direction is up. Traders that utilize Dow Theory will continue to be buyers of dips…especially dips that create a secondary low point.
We haven’t done an update on Dow Theory for a while. This is because the market has been moving almost straight up from the last secondary reaction and reconfirmation of the long term up trend (which occurred in mid January). We thought that the recent consolidation might give us a secondary low point from which we could initiate new trades or use as a buying opportunity to add to our long term positions. It didn’t happen. If you take a look at our criteria for secondary reactions you’ll see that although many of them were met, a few critical items were not. Take a look at the chart below and you’ll see that the consolidation in the Dow Jones Industrial Average (DJIA) wasn’t deep enough to meet the “33% to 66%” draw down requirement. One thing we like to see as well (but isn’t necessary by rule) is a secondary low point that is below the last minor low in the averages. This would make a close roughly below 5900