A Top in Transports?

07/07/03 07:57:27 AM

by David Penn

How the Dow Transports handle a nearby resistance level might tell investors all they need to know about the resilience of this bear market rally.

Security: $TRAN
Position: N/A

While many Dow theorists are flitting their eyes back and forth between charts of the Dow Industrials and Dow Transports for signs of divergences, there is much to learn in studying the averages on their own first, and then comparing the analysis. Rather than trying to determine whether or not there is a divergence, analysts can determine whether the averages are bearish or bullish and then use that assessment to figure out what the bearishness or bullishness in one average says about the other.

Looking at the Dow Transports, there are a number of things that stand out. First is the trendline break in late May/early June. So far, while the Transports have broken the uptrend line that more or less tracks the entirety of the bull market since the March lows, they have yet to break down through support at approximately 2345. This support remains key for any upward movement in the Transports. On the other side of things, the 2492 level-- and beyond that the early June highs around 2555, are crucial resistance. Any successful move above these levels suggests that while the bull market that began in March might be leveling out somewhat, the uptrend would still be intact. The new relevant trough low would move from the May low to the June low for purposes of drawing the new trendline in this scenario.

A rally from a June break in the uptrend line could set the stage for a head and shoulders top in the Dow Jones Transportation Average ... and send bearish signals to the Industrials.

Graphic provided by: TradeStation.

Another aspect of the Transportation Average since May is the negative divergence with the moving average convergence/divergence indicator (MACD). A negative divergence between price action and an indicator occurs when price action continues to advance higher, while the indicator is providing increasingly bearish signals. In the case of the MACD, increasingly bearish signals come as the indicator moves lower, particularly as it crosses the "zero line" and continues to drop.

The bearish case for the Transports would be further served if the volume oscillator began moving up-- particularly if the MACD continued to move down. Recently, I've noted how-- in a mature trend-- the combination of a rising volume oscillator combined with a falling MACD often anticipates a turn to the downside. While this has not yet occurred with the Transports, we can see the opposite (i.e., a falling volume oscillator combined with a rising MACD) in effect back in the spring. As prices began moving down in mid-March, the volume oscillator-- which had been rising-- began to peak and, by the end of the month, began to reverse to the downside. When the volume oscillator peaked on March 26th, the Dow Transports were at 2204. One month later, with the volume oscillator continuing to move downward, the Transports were up more than two hundred points. Note further that the trough low in the volume oscillator between March and July occurs about eight trading days before the price peak in the Dow Transports in early June.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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DOW THEORY

A Top in Transports?

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