|Of the Dow Industrial and Transportation Averages, famed market technicians Robert D. Edwards and John Magee wrote:|
"The Two Averages Must Confirm -- This is the most often questioned and the most difficult to rationalize of all the Dow principles. Yet is has stood the test of time; the fact that it has 'worked' is no disputed by any who have carefully examined the records. Those who have disregarded it in practice have, more often than not, had occasion to regret their apostasy."
Well! That said, what exactly do Edward and Magee mean?
"What it means is that no valid signal of a change in trend can be produced by the action of one average alone."
|One take-away from this tenet of Dow theory is that while most of the world is watching and worrying over the fate of the Dow Industrials ("the Dow"), there is good reason to look at the Dow Transports with every bit as much dedication. By this I mean that most market participants have, at any given time, a pretty good sense of whether or not the Industrials are moving up, down or making a "line" (in fact, most AM radio stations still announce the prices of the Dow Industrials almost as often as they mention traffic or the weather). If a trader or investor can add to this knowledge a sense of whether or not the Transports are "confirming" the moves of the Dow, then he or she will gain a valuable insight into the bullishness or bearishness of a given market.|
|This head and shoulders top anticipates a correction to 2800 if prices break down below the neckline.|
|Graphic provided by: eSignal.|
|The recent behavior of the Dow Industrials and Transports is perhaps a sound example. The Dow Industrials sold off sharply into the close on Friday, November 14th. Conventional market wisdom suggests that a down close on Friday tends to lead to a down open on Monday. But the deeper question is whether or not a market that has moved sluggishly through the first weeks of November is likely to correct and, if so, how far down might a correction take the market?|
|At present, the lows of late October appear to be the support area that will prevent both the Transports and Industrials from losing too many of their autumn gains. The Transports, for their part, have developed a head and shoulders top in the hourly chart that, while mildly sloped upward, have a formation size of approximately 150 points and a downside to approximately 2800. This, incidentally, is about the area where the 50-day moving average lies for the Transports and, thus, could provide significant support at the end of a brief sell-off.|
|A similar move in the Dow Industrials would mean a drop from the Friday close near 9768 to the area near the late October lows near 9500.|
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