Dow Theory Dreams

08/02/05 10:54:05 AM

by David Penn

Longing for bullish signs in the Dow industrials and transports? Look no further than the March 2005 highs.

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

Back in late July, I pointed out the same-day bullish Dow theory confirmation in the industrials and transports ("Intimate Confirmations," July 21, 2005; Traders.com Advantage). Actually, the goal of that piece was two-fold. Not only did I want to underscore that the same-day confirmation meant that the path of least resistance for stocks remained upward, but also I wanted to guide overeager bears away from the brink of believing that a recent "non-confirmation" was loaded with especially potent bearish portents (read about that June non-confirmation in my "Nonconfirmation Comes To The Averages," June 24, 2005; Traders.com Advantage).

Because it is occasionally a contentious point among Dow theorists, let me say it again: While nonconfirmations provide information to Dow theorists in specific and market technicians in general, that information simply is not on par with the information provided by confirmations. Confirmations in Dow theory are real signals indicating market direction. Nonconfirmations, by contrast, warn simply that "all might not be as it seems."

Figure 1: The transports' inability to take out their April highs in June (compared to the industrials) might have seemed like weakness. But the transports are neck and neck with the industrials as far as the race to the March highs are concerned.

Graphic provided by: Prophet Financial, Inc.

Again, that is often actionable information. But the speculator who went short in the second half of June based on the nonconfirmation between the Averages would have found him or herself covering and joining the bulls not so shortly thereafter.

Figure 2: The industrials will have to break free from its late July consolidation if they are to stage a run on their March--and year-to-date--highs.

Graphic provided by: Prophet Financial, Inc.

Which brings us to the current status of the Dow industrials and transports. Since "Intimate Confirmations" in late July, the averages remain more or less where they were. Given the recent confirmation, my suspicion is that the largely sideways trading over the past few weeks--particularly in the industrials--has been related to accumulation. Since the consolidation began on July 14th, there were five days when the trading volume in the industrials was above 1.5 billion shares. Four out of those five days were "up" days. Additionally, three out of the four lowest volume days during that period were "down" days.

So if the sideways trading in late July going into August is accumulation, what is likely to be the next bullish Dow theory signal? For better and worse, it appears that the next likely confirmation would have to be a breach of the March highs--highs that represent year-to-date extremes to the upside in both the industrials and the transports. Presently, the industrials are some 280-odd points away from year-to-date highs, while the transports are less than 100 points away. As percentage, both the industrials and transports are looking at gains of about 3% if they are to set new highs for 2005--and provide yet another bullish confirmation for Dow theorists to sink their teeth--and align their trading.

David Penn

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

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DOW THEORY

Dow Theory Dreams

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