Dow Theory is the oldest of the technical approaches to market analysis – in the western world, anyway. And we like it, even though its purpose is limited to determining whether the market is in a secular bull or bear trend.
To that end, it’s helpful for traders as a first-stop compass of sorts, a means of gathering one’s bearings, determining whether the prevailing winds are blowing north or south.
And if we mean to be successful at our trade, we sailors on the equity tides must always keep an eye on the Dow Industrials and Transports, as it’s upon these two indexes that the entire system is based.
We’re not going to delve too deeply into the details of the theory here, and it should be known that not everyone even agrees on them. The method was never codified or systematized from the get-go; rather, it was developed over decades by a number of market watchers who added to the original observations of Charles Dow that appeared on the editorial pages of the Wall Street Journal over 110 years ago.
The basis of the theory is that bull markets are in force so long as the two Dow averages are confirming each other’s latest highs, and bear markets as long as they confirm the newest lows.
That’s a gross oversimplification, but it’s all we really need for now. Beyond that, the only other condition you should be aware of is what’s called a ‘non-confirmation’. That’s the status of the indexes when one has hit a new high (or low), and we’re still waiting for the other confirm.
Now let’s look at a chart of both the Industrials and Transports charted against each other to get an idea of how the thing is applied.
First, some background.
As you can see, both the industrials and trannies were climbing through 2014. The trannies maxed out first in November of that year, and the industrials confirmed immediately thereafter.
Beyond that, the picture gets a little confusing, because the paths of the two diverged strongly. The Industrials kept breaking new ground for another six months, while the trannies plain sunk.
Time Marches On…
Half a year later, in August of 2015, both indexes dropped below their former retracement lows, marking a bearish Dow Theory signal that still (sort of) obtains today.
We say ‘sort of’ because this summer the industrials surged to set new all-time highs. The transports have struggled, however, and as we write still have a significant march ahead of them if they intend to confirm the industrials’ break to new highs (shown in blue).
In other words, we now have a Dow Theory ‘non-confirmation’, meaning that despite the industrial’s performance, the last, bearish call is still in force, unless and until we see the transports scale above their former highs at 9300.
Today, the transport index sits at 8054. That translates to a roughly 15% move required to change the picture from a Dow Theory perspective.
That’s precisely the question on our mind, Thearissus.
And while nothing is inevitable in this game, we offer the following charts of the Dow Transports as evidence of the likelihood of a strong move higher transpiring forthwith.
Have a gander –
In the last two weeks, the transports’ price has edged above all her major moving averages (blue circle), and three of those four moving averages are themselves trending higher.
It’s all happened on the back of consistently bullish movement from both RSI and MACD indicators (in green), leading us to believe that there’s still more to come from the move.
We’ll turn now to the weekly chart of the transports to get an idea of just how much more.
Take a look –
There’s a lot to discuss here, so let’s take it piece by piece.
- In the first place, RSI and MACD indicators are now trending positively, both above their respective midway waterlines for over two months now (in green). We’ve pointed to this recently as being the first genuinely good news for the transports in the last eighteen months.
- Next, we have price once again bumping up against overhead resistance at 8150, for the fifth time in the last eight months (red line)! The likelihood of a break higher is growing, particularly because the baseline lows are moving higher with each attempt, a sign that the bears are running out of ammunition.
- Resistance at the aforementioned 8150 level also coincides with the last of the weekly moving averages that need to be overtaken – the 137 week (in deep red). Once that’s conquered, it’s clear sailing to at least the former highs at 9300.
- We note, additionally, that all the weekly moving averages are trending higher, and while they’re not completely unfurled, that development could be less than a month away. In the meanwhile, it’s important to focus on the fact that, outside of the short term weekly MA, the weeklies have never once in the last half decade lost their upward bias – this despite the 31% kit-shicking they took through 2015.
- A reverse head and shoulders pattern (in blue), one of the most reliable technical formations available, has now been completed after a full sixteen months in development. Just two weeks ago, price broke above the neckline (in black), meaning we’re ready to rumble. Significantly, price has separated from the neckline and is likely therefore preparing for a lift. Upside count for the pattern brings DJTA to a hard-to-believe 10,200!
- Finally, we have a three ray pattern now complete, for which we’ve produced another chart below. Take a look –
The chart shows three fan lines drawn through successive tops over the course of the last 18 months, with the final line broken unequivocally in mid-July. This is another fairly reliable indicator of a complete intermediate trend move. According to most technicians, the next six to eighteen months – or more – should be higher.
We’re using the iShares Transportation Average ETF (NYSE:IYT) to make our trade.- Content protected for Normandy Executive Lounge, Option Trader Elite, Executive Lounge members only]
Many happy returns,