Since its conception in the late 19th century by Charles H. Dow, the founder of The Wall Street Journal, Dow Theory has been a reliable instrument for stock speculators in understanding the movements of the stock markets. Although pundits nowadays renounced the theory as antiquated and incapable of studying modern markets, I am a strong believer that Dow Theory still reads current markets as correctly as it read markets of its time, based on a sample fact that traders today have the same greed and lust as those in the 19th century.
One of the prevailing key points for reading the markets with Dow Theory is confirmation between the two widely tracked indices: the Industrials (DJIA) and the Transports (TRAN). When both indices move side-by-side and break above previous high or below previous low within close time proximity, a sign of confirmation, the market is thought to be on the right track of the major trend. Conversely, a non-confirmation is when one indices reaches a new high while the other is still far below its previous high; at some point, the markets, as a whole, will submit to the imbalance (non-confirmation), and be pulled the opposite way.
This is precisely what is happening to the stock market now.
Back in May, the low of both indices were non-conforming -- DJIA dropped past its previous low of 10007 to 9852 on May 12, but TRAN dropped only to 2785 on May 17; it didn’t overrun its previous low of 2743. Because of this non-conformation, the market changed its downward trend, and started to move up.
Fast forward to today. DJIA and TRAN have been trending up lately. TRAN raced above its previous high of 3020 to 3072, yet this time DJIA is lagging behind, closing today 105 points away from its previous high of 10537. This is labeled as an upside Dow Theory non-confirmation. If DJIA doesn’t confirm the strength of TRAN by breaking above 10537 in the next few trading sessions, we will see the overall market commencing a downward trend. Remember my post that DOW is topping out, where it's making lower highs and lower lows; therefore, my money is on the DJIA turning downward before hitting 10537. The chance of seeing the markets hitting new lows is much higher than continue its upside.
There aint many Dow Theorists around these days. The most celebrated one is Richard Russell, the creator of Dow Theory Letters. He writes pretty much daily, commenting the market actions and everything under the sun. He was the first to point out the non-confirmation, and believes the market will tread sideway until both confirms.
posted by jason @ 4:35 PM
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