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February 24, 2008

Dow Theory Update
by Tim Wood

Since the rally out of the January lows began, I have heard it said on numerous occasions that the strength of the Transports somehow has bullish undertones and implies that the decline is over. The overall spirit of the comments I have been hearing has to do with the fact that the Transports have recovered more than the Industrials. I have also heard that some are saying we now have a Dow theory non-confirmation in place. None of these comments or interpretations are correct in regard to traditional Dow theory.

In addressing this issue I can quote from the original writings of Robert Rhea himself. If you are not familiar with the Dow theory lineage, then you should read the brief article posted at www.cyclesman.com/Articles.htm titled The History Of Dow Theory giving you this background.

According to Hamilton and Rhea, "Under Dow's theory the primary trend, once authoritatively established as bullish, is considered to be continuing in force until negated." The opposite would of course be true once the trend is authoritatively established as bearish. According to Dow's theory, on November 21, 2007 the Primary Trend was confirmed as being bearish. I can assure you that nothing has occurred to negate this bearish trend. In the chart below I have plotted the Industrials in the upper window and the Transports in the lower window.

Following the August Secondary Low Point, the Industrials moved into their October all time high while the Transports lagged. This in turn created a non-confirmation in association with the October all time high and is noted with the blue trend line on the chart above. This non-confirmation then evolved into a confirmed primary bearish trend change on November 21, 2007 when both averages closed below their August Secondary Low points. This break is noted in green on the chart above. At that time I warned that a short-term low was near and that as a result many would question the November 21st Primary Trend change and that is exactly what happened as the markets rallied into the December highs. Anyway, once that rally failed the Primary bearish trend resumed and was reconfirmed by the decline below the November 21st Secondary Low Point, which is noted in red on the chart above. The fact that the Transports have rallied back above their previous Secondary Low Point or as far as they have is of no consequence at this time because nothing has occurred to negate the Primary bearish trend that was established on November 21st. Therefore, this trend has to be considered still in force.

Furthermore, the suggestion or interpretation that there is currently a non-confirmation in place because the Transports bottomed 2 trading days before the Industrials is a misinterpretation of non-confirmations. So, in regard to the Transports making their most recent closing low on January 17th verses January 22nd for the Industrials, here it is from Robert Rhea himself.

"It is by no means necessary, as experience shows, that the low or high point of a Primary movement should be made in both averages on the same day."

Rhea goes on to say "The two averages may vary in strength, but will not vary materially in direction especially in a major movement."

Here's another quote on this matter from Mr. Rhea, "It is not necessary for the rails and the industrials to confirm each other in extent of movement, nor is it required that they confirm in duration; nevertheless, while we may disregard the extent of a rally (or decline), and while we may ignore, to a degree, the time required for a movement, it is necessary for these formations to confirm each other, both in direction and in the penetration of preceding critical high or low points."

I could go on and on with more quotes from the Dow theory founding fathers, but there is no need. The bottom line here is that the Primary bearish trend was confirmed on November 21, 2007 and was last reconfirmed at the January lows. Furthermore, the price movement since the January lows has not negated the previously established Primary bearish trend. Thus, that trend is still considered to be "in force." Should the up turn out of the January lows further evolve to the point that the Primary Trend has changed or should a legitimate non-confirmation form, warning of a possible trend change occur, then at that time the existing Primary bearish trend may be trying to change. But, until such time there is simply no evidence, in accordance to classical Dow theory, to support any claim that the Dow theory has turned or is turning bullish at this time.

Now the question at hand is whether or not the rally out of the January lows has run its course. The short answer is, we can't tell just yet. This is where extreme disciple and patience are required. I think it was Robert Rhea that once said "playing the markets required the patience of a dozen men." This is certainly one of those times. My intermediate-term Cycle Turn Indicator is key. This indicator is designed to identify important intermediate-term trend changes. This indicator identified the 1929 top and the crash that followed as well as the top of the 1930 rebound and beginning of the decline into the 1932 low. It also called the 1987 top beautifully. Point being, if it called these major declines, then odds are it will signal any major decline in the present. If/when the intermediate-term Cycle Turn Indicator turns back down it will set the stage for the Primary bearish trend that began in November to resume. Until such time, this counter-trend rally remains intact.

I have begun doing free Friday market commentary that is available at www.cyclesman.com/Articles.htm so please begin joining me there. Should you be interested in more in depth analysis that provides intermediate-term turn points utilizing the Cycle Turn Indicator, which has done a fabulous job, on stock market, the dollar, bonds, gold, silver, oil, gasoline, the XAU and more, those details are available in the newsletter and short-term updates. A subscription includes access to the monthly issues of Cycles News & Views covering the Dow theory, and very detailed statistical based analysis plus updates 3 times a week.

Tim W. Wood
Cyclesman.com

Copyright © 2004-2009 by Tim W. Wood. All rights reserved.

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