Dow Theory Turns Wobbly
Plenty of smart people are calling the recent action in the Industrials and Transports a Dow Theory sell signal, but we’ll hold off for two reasons: last month’s new bull market highs in both the Transports and the NYSE advance-decline line (see charts below).
I look for persistent new trends in both the Industrials and Transports before calling a major trend change, and last month’s new bull market high in the Transports means the index still needs a four-week rally followed by a new closing low to confirm the Dow’s bear signal. I look for 18 trading days for an intermediate-term move, so an 18-day rally followed by a new closing low would do it. Some who see this as a Dow Theory sell signal are calling the top in the Transports a “line,” or trading range, which the index broke down out of. That view has some historical legitimacy, although it’s a pattern the market hasn’t seen in recent decades.
Still, it’s hard to see this becoming a major bear market when most NYSE stocks continued to gain right into the top; that suggests that there may be enough liquidity to limit the decline. As Paul Desmond of Lowry Research noted in a 2006 paper, market internals tend to erode before the top if a major bear market is going to occur.
That said, the market is quite ugly here, but all the pieces aren’t quite in place yet to declare it a bear market.
Paul Shread is a Chartered Market Technician (CMT) and co-author of the book “Dow Theory Unplugged: Charles Dow’s Original Editorials and Their Relevance Today” from W&A Publishing.
Posted in: Dow Theory