A Dow Theory Confirmation

07/19/07 07:21:46 AM

by Arthur Hill

Recent highs in both the Dow transports and the Dow industrials confirm the primary uptrends and a bull signal according to Dow theory.

Security: INDU
Position: Accumulate

Dow theory was derived from the writings of Charles Henry Dow at the turn of the century. In a nutshell, the theory asserts that an uptrend consist of higher highs and higher lows. A downtrend consists of lower lows and lower highs. A bullish signal is given when both the Dow industrials and Dow transports record new reaction highs. A bearish signal is given when both the Dow industrials and Dow transports record new reaction lows. Failure by one of the averages to follow suit results in a nonconfirmation.

First, let's take a look at the Dow industrials and the primary trend. The Dow bottomed in March and surged until May. The average then consolidated in June and broke its June highs in July. The breakout forged a new reaction high and signaled a continuation of the primary uptrend.

FIGURE 1: DOW INDUSTRIALS. Here, the Dow Jones Industrial Average bottomed in March and surged until May.

Graphic provided by: Telechart 2007.

The Dow transports also bottomed in March and surged from mid March to late April (Figure 1). A consolidation formed and the average broke consolidation resistance to forge another higher high in early June. There was a pretty steep pullback in June, but the Dow transports found support near its early May low and surged to another new reaction high in early July. See Figure 2.

Both the Dow industrials and Dow transports forged higher highs in April and again in July. The combination is a Dow theory confirmation and bullish signal. The Dow transports is more volatile and erratic than the Dow industrials, and this explains the deep decline in mid-June. Nevertheless, the Dow transports recovered to confirm a new reaction high in the Dow this month. The June lows now form key support, and a break below these lows would forge new reaction lows. Support breaks from both the Dow industrials and Dow transports would forge a bearish signal according to Dow theory. However, it ain't happened yet and the current bull signal remains in force until proven otherwise.

Arthur Hill

Arthur Hill is currently editor of TDTrader.com, a website specializing in trading strategies, sector/industry specific breadth stats and overall technical analysis. He passed the Society of Technical Analysts (STA London) diploma exam with distinction is a Certified Financial Technician (CFTe). Prior to TD Trader, he was the Chief Technical Analyst for Stockcharts.com and the main contributor to the ChartSchool.

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DOW THEORY

A Dow Theory Confirmation

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