Transports Find Support At Old Breakout

09/08/05 08:10:52 AM

by David Penn

Looking for the true measure of the move as an old breakout level supports a bounce in the Dow transports.

Security: $TRAN
Position: N/A

Back in earliest August, I suggested that the next significant challenge for the Dow Jones industrials and Dow Jones transports would be a test of the March 2005 highs, which represent year-to-date highs ("Dow Theory Dreams," August 2, 2005). This, of course, was the bullish case, as both the industrials and transports had been in rally mode since putting in bottoms in April.

The bullish case for the markets in general was buoyed tremendously by the same-day bullish confirmation in the industrials and transports from July 21 (also referred to in "Dow Theory Dreams"). It was on July 21 that both industrials and transports closed above their respective June highs, sending a powerful signal that the market was in a bullish mode.

As I've written before, confirmations aren't necessarily trading signals--at least not in the sense that buying on the day of a confirmation will reap instant rewards. "People, get ready" is the motto of the Dow theory confirmation, as far as I'm concerned. Indeed, those who loaded up on equities on the day of the July 21st bullish confirmation would have suffered about a month's worth of buyer's remorse. On the other hand, the bullish confirmation would have (or should have, as the case may be) warned those bears eager to short the August correction that any gains they won on paper were best swiftly converted into cash.

The August correction, interestingly, has set up a new test for the bullishness of the market (Figure 1). Given the correction, which failed to take out any significant reaction lows in the industrials or transports, the new measure of bullishness will be the ability to vault above the highs of late July and early August. Just how poised are the markets to do that? If the transports are an indication, the odds look better than many might think.

FIGURE 1: The August correction finds the Dow transports returning to the breakout/Dow theory bullish confirmation level from mid-July.

Graphic provided by: Prophet Financial, Inc.

The July 21st bullish confirmation day was also an old-fashioned breakout day for the transports. The transports broke out just above 3650 in mid- to late July and rallied to just over 3800 by month's end. Along with the rest of the market, the transports sagged into and through August. And while the transports did move below the July breakout level near the end of August, the transports managed to close above that breakout level during the late-month consolidation. Holding support at a former breakout level is often a sign of true underlying strength (see my "Building A Better Breakout," Working-Money.com, July 1, 2003).

If this assessment of support at the 3650 level is accurate, then the chances for the transports to make a serious run on the August high are great. In fact, both the industrials and the transports are about 3.75% away from those highs. Should they both reach and surpass the August highs, then those "Dow Theory Dreams" of the March highs will again begin dancing in the heads of market bulls. Conversely, should either or both of the averages fail to take out the August highs, then it may be the bears who, teased by the moodiness of the August correction, finally get the satisfaction they've been longing for.

David Penn

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

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Transports Find Support At Old Breakout

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