|Dow Theory is built on the assumption that the Dow Industrials and Dow Transports confirm one another to produce signals. A Dow Theory buy signal occurs when both the Dow Industrials and Dow Transports hold above their prior reaction lows AND move above their prior reaction highs. This is the basic definition of an uptrend: higher lows and higher highs.|
|Conversely, a Dow Theory sell signal occurs when both the Dow Industrials and Dow Transports hold below their prior reaction highs AND move below their prior reaction lows. This is the basic definition of a downtrend: lower highs and lower lows. Closing prices should be used and a non-confirmation occurs when only one average produces a valid trend change.|
|Figure 1: Dow Jones Industrial Average.|
|Graphic provided by: MetaStock.|
Figure 2: Dow Jones Transportation Index.
In order to weed out the minor moves, the zigzag indicator (thin red line) was applied to both averages, and price movements of at least 5% were used to identify reaction highs and lows. A 5% minimum is good for medium-term trends. For long-term trends, a 10% minimum move may be more suitable. Based on the results, there have been three non-confirmations since July and the averages may be close to creating a fourth.
|(1) The Dow Industrials formed a higher low in August, but the Dow Transports failed to confirm and formed a lower low. |
(1A) The subsequent advances went on to record higher highs in August, but the prior non-confirmation invalidated the signal.
(2) In January, the Dow Transports went on to form a higher high, but the Dow Industrials failed to confirm and formed a lower high.
(3) The January-March decline carried the Dow Transports below its October low, but the Dow Industrials held above its March low for a non-confirmation.
(4) Most recently, both the Dow Transports and Dow Industrials formed higher lows in April, but only the Dow Transports has managed to exceed its March high. The Dow remains below its March high and needs to close above 8522 to better the 21-March closing high. Also of note, volume in the Dow Transports expanded considerably on the latest advance.
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