Dow Theory 101

Well, the Dow seems to be moving above the 11,750 area that I referenced a couple of weeks ago. It’s been a struggle, but the Dow has slowly inched higher. However, I do think there are some major red flags starting to pop up.

First, it is very concerning that while the Dow has been moving higher, the secondary indices have been struggling. For example, after reading this article, take a minute and review the charts of the Russell 2000 and the Nasdaq. Even though the Dow held it’s ground, and actually grinded higher last week, those two indices have moved lower. In a healthy market, we’d like to see everyone moving higher together. With the “risk-on” stocks like those contained in the Russell and Nasdaq selling off, it wouldn’t appear that the markets are NOT healthy. Rather, they seem to be falling apart a bit.

More importantly, let’s stick with the Dow. More specifically, Dow Theory. Investopedia probably sums it up best: “A theory which says the market is in an upward trend if one of its averages (industrial or transportation) advances above a previous important high, it is accompanied or followed by a similar advance in the other. The theory also says that when both averages dip below previous important lows, it’s regarded as an indicator of a downward trend.” Those that follow Dow Theory will look to the Dow Jones Industrials (DJI) and Dow Jones Transports (DJT) to gauge the “health” of the trend in force, based on the criteria set out above.

So, take a look at the following charts of the DJI and DJT (closing prices):

As you can see in the first chart, the DJI has in fact continued higher. Unfortunately, the transports have turned lower. This appears to be one of the first steps in the unfolding of a move lower, to one extent or another. Of course, if the DJT reverses and confirms the DJI’s high, then all will be well again, for now.

The Tale of the Tape: Although the DJI has continued higher, and may be on it’s way to 12K, the DJT has failed to take part. In addition, other secondary indices such as the Russell 2000 and Nasdaq have also “peeled away”. While the DJI seems dead set on marching higher, the overall market does not seem to agree. Keep an eye on the DJT and the other secondary indices.  The DJI cannot go it alone. Be prepared to adjust your trading and/or investing strategy if the markets finally turn lower. OR, look to see if the DJT, Russell and Nasdaq eventually confirm the recent DJI’s move.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT