Charles Dow's Original Editorials and Their Relevance Today

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Dow Theory Turns Positive

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I warned back in May that the shaky stock market and Dow Theory sell signal might not lead to a big decline because the NYSE advance-decline line wasn’t signaling broad market weakness before the Dow topped out.

As I’ve noted before, market tops that haven’t been preceded by erosion in the A-D line have led to a few declines in the range of 20%, most recently in 2011, but to get a major bear market of 25% or more, historically that’s required some erosion of internals before the market peaked. We didn’t get that before the market peaked in March 2012, and with new highs for the year in the Dow and Transports since then, it’s time to declare Dow Theory on the side of the bulls again.

For the record, the Dow Theory sell signal occurred at 12,442 on May 17, and I’ll call the buy signal at 13,350, when the Transports broke out of a six-month range two weeks ago.

Because Dow Theory buy and sell signals take a long time to form, it’s best to look for signs of broad market erosion before putting too much credence in a Dow Theory sell signal. In 2011, for example, the banking sector had been weak for months before the market top and subsequent 19% decline; we saw no such warning signs this time around.

There are no guarantees as to where the market goes from here or how far it goes, but it’s past time to abandon a Dow bear signal that never stood much of a chance.

Paul Shread is a Chartered Market Technician (CMT) and co-author of “Dow Theory Unplugged: Charles Dow’s Original Editorials and Their Relevance Today.”

Another Dow Theory Sell Signal

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The Dow Industrials and Transports recently suffered a couple of significant breakdowns, creating a sell signal under Dow Theory. The Dow broke down out of a two-month trading range, while the Transports broke down out of a three-month range, both satisfying my requirement for a significant pattern of a month or more.

While any Dow Theory signal should be respected, we would note that this one once again came without a negative divergence in the NYSE advance-decline line, as the broad list did not begin to decline before the major indexes. So while the market may indeed go lower, historically a sell signal accompanied by broad market strength hasn’t gone very far. There have been a few 20-25% declines under such circumstances, including last summer’s 19% decline, but we’re unlikely to see a major bear market as long as there is enough liquidity to support the broader market.

As Dow Theory signals take a while to form, it’s possible the next buy signal could come at a higher price, as happened last year when Dow Theory issued a sell signal at around 11,900 in August and a buy signal some 400 points higher a few months later.

Past performance is no guarantee of future results, of course, and any Dow signal should be respected. This may still be a good time to lighten up on high-beta, economically-sensitive stocks, for example.

Paul Shread is a Chartered Market Technician (CMT) and co-author of “Dow Theory Unplugged: Charles Dow’s Original Editorials and Their Relevance Today.”