The Confirmation Next Time

09/19/05 02:04:28 PM

by David Penn

Will the Dow industrials follow the Dow transports to a break below the August lows?

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

A little over 10 days ago, I wrote about the prospects for the Dow transports just as a move lower looked to find significant support on the back of old highs ("Transports Find Support At Old Breakout," Traders.com Advantage; September 8, 2005). What was key about this potential support was that it opened the door for a bounce that might take the average back to a test of recent highs. Those recent highs were the August highs just north of 3800.

There was significance beyond even this. The last Dow theory confirmation involving the industrials and transports was a same-day bullish confirmation in late July. This confirmation came as the averages took out their June highs simultaneously. While not any more bullish than a confirmation that was a few days apart, same-day confirmations never fail to be eye-catching events. In this case, they warned that any downside in the immediate term would be better bought than sold.

FIGURE 1: DJIA. The bounce from the August correction runs out of buyers at the level of the July/August highs.

Graphic provided by: Prophet Financial, Inc.

That advice itself would have been a hard sell as August unfolded. Both averages took a shot to the gut in that last month of summer (Figures 1 and 2). But while the industrials found support late in August and bounded higher surprisingly in the first half of September, the transports slipped below the previously mentioned support at 3650. And the performance of the industrials notwithstanding, the transports have failed to rally strongly in September at all.

FIGURE 2: DJTA. Having fallen below support at 3650, the transports may now struggle to rise back above that level--which might now serve as tough resistance to any upside move.

Graphic provided by: Prophet Financial, Inc.

Given those developments, I began wondering about the possibility of a nonconfirmation. This theoretical nonconfirmation would occur as the Dow industrials--which were showing true strength going into September--took out their August highs, while the Dow transports--which were showing weakness going into September--failed to do so. Such a nonconfirmation would not necessarily be bearish, but it certainly wouldn't be bullish. For bears who watched the industrials (or, more so, the Standard & Poor's 500) soar toward four-year highs, that nonconfirmation scenario was the only Dow theory argument they could pin their hopes on.

And while this remains a possibility, there is an even more ominous one for market bulls. If the pronounced market weakness on Monday, September 19--the first trading day after a quadruple witching Friday--produces follow-through to the downside in subsequent days, then there is a good chance that rather than a nonconfirmation in which the industrials take out the August highs while the transports do not, the averages might both break below the August lows, producing a bearish Dow theory confirmation.

The transports have already played their part, breaking down below the August lows on September 9. That was a day during which the industrials rallied for more than 100 points. But if the September 19th selloff begets more selling (the industrials were trading down 101 points on Monday, as of this writing), then it will be worth watching to see how the industrials manage any test of support at the level of the August lows near 10350.

David Penn

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

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DOW THEORY

The Confirmation Next Time

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