Friday, March 28, 2008

Dow Theory Buy Signal?

I'd like to briefly talk about Dow theory and using the transportation index to confirm moves in the stock market. I know many people feel that Dow theory is not relevant anymore like it was years ago, but in my opinion I still find it to be very useful and profitable.

Above is a chart of the transportation index and below that is a chart of the Dow Jone's Industrials. Back in October 2007 the Dow made a new swing high but the Transportation index did not. According to Dow theory, this is a sell signal and as we all know that was the top in the stock market. Two weeks ago the Dow made a new swing low but the transportation index did not. According to Dow theory, this is bullish for the Dow.

If you look at the chart of the transportation index, you will see an inverse head and shoulders formation which is a bullish pattern.

Based on the above chart, I would have to be looking for reasons to get long stocks. If I see the Dow beginning to make higher lows and higher highs, I will look to be a buyer. I'd probably look to get long if the Dow can get above 12600. Until then I'll remain on the sidelines.


Anonymous said...

is transport leading indicator here? or you can always argue that transport will go down to confirm dow theoryc

marketmakerX said...

I understand what you are saying regarding Dow Theory, and I like your analysis. But, the Dow did not make a new swing low in March. It made a higher low, higher then the January low. It only made a lower closing price but did not break down the lows of January. Is the Dow theory based on closing price? If you can clarify that for me I'd appreciate it.

Rudy said...

Hi Kevin,

If you extend the transports chart, you'll see a multi-year head & shoulders pattern beginning at the start of 2006. Neckline at 4100, top at 5400 & left shoulder at 5000. To become bullish, the left shoulder (5000) should be taken out, which is possible with the inverse h&s pattern you mention. It would be fascinating if this played out while there is a housing slump and general recession talk.

Kevin said...

Hi Marketmakerx,

Excellent point. You are correct about the dow not making a new swing low. I actually wrestled with the idea if a new closing low is valid or not. I think a new closing low is valid and if you look at the SPX chart, you'll see that the S&P made a new swing low in march. So in my opinion, stocks did make a new low in march while the transports are showing strength. That's bullish!


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