Back To The August Lows?

09/24/04 12:17:03 PM

by David Penn

Failing new year-to-date highs in the Industrials, the next Dow theory event could well be a test of the August lows.

Security: $INDU, $TRAN
Position: N/A

When both the Dow Industrials and Transports broke out above their August highs on September 2nd, those Dow theorists who had been comforted by the resilience of the Dow theory sell signal earlier in the year were struck with a problem. The sort of simultaneous confirmation that occurred on September 2nd was exactly like the kind of simultaneous confirmations that led the markets higher late in 2003. Same day confirmations do not inherently matter "more" than confirmations that are separated by a day -- or even a week. But there is a certainty that can be difficult to ignore when both markets move significantly in the same direction, at the same time, in roughly the same context.

The confirmed moves above the August highs meant -- at a minimum -- that one or both of the Averages was likely to continue moving higher. While I will not go so far as to suggest that the September 2nd move constituted a Dow theory "buy" signal (and not just any buy signal, but a buy signal that necessarily would have had to cancel out the Dow theory "sell" signal from March 2004), it was clear to me that bearish bets were going to be a harder way to make money going forward than bullish bets might be.

Simultaneous moves above their August highs on September 2nd warned bears to be prepared for more upside in the immediate-term.

Graphic provided by: eSignal.

Nevertheless, there was likely some gratification when the September breakouts led to what might have been seen at the time as an inevitable upside non-confirmation. After all, the Dow transports had set a new high for the year in late June, while the Dow industrials were consistently making lower highs and lower lows. So while it was conceivable for the Transports later in 2004 to take out their June highs, it was pretty difficult for most objective observers to imagine the Industrials doing the same.

What do we know about nonconfirmations? As I've repeated ad nauseum, nonconfirmations are Dow theory non-events, but they may be technical events. So while the failure of the Industrials to make a new year-to-date high during its September advance was -- just like the Industrials' failure to make new year-to-date highs during its June advance -- a non-event in Dow theory terms, an astute and broad-minded technician would nevertheless suspect that there might be trouble ahead for the bullish cause.

By mid-September, that caution would have been well-rewarded -- as the upside nonconfirmation between the Transports and Industrials became clear. At present, the Transports are retreating toward support at the 50-day EMA (not shown, but is approximately at the same level as the early September "breakout"), while the Industrials have fallen below such support. Now, the question is: if it seemed improbable that the Industrials would catch up with the Transports on the upside, is it equally improbable that the Transports will catch up with the Industrials on the downside?

That question will be answered over the next month. First stop will be a successful and confirmed penetration of the September lows -- which the Industrials have completed. Should the Transports fall to these levels (about 3085), then a further confirmed penetration of the August lows (2966 in the Transports; 9815 in the Industrials) might be all it will take for Dow theory to smile on the bears once again.

David Penn

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

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DOW THEORY

Back To The August Lows?

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