Charles Dow's Original Editorials and Their Relevance Today

Archive for May, 2012

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.”