Dow Theory Update

By: Tim Wood | Sat, Jul 10, 2010
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The Dow theory has certainly been a hot topic of late. Seems that everyone has become a Dow theory expert and the price action into the July 2nd low had everyone tripping over each other to make the call that a Dow theory "sell signal" had occurred. I could not disagree more and I told my subscribers over the weekend that a so-called Dow theory "sell signal" had not occurred and that rather than a melt down, a bottom was expected.

In accordance with Dow theory the primary trend is considered to be in force until it is reversed by a joint move of the averages above or below the previous secondary high or low point. My read on Dow theory is that the bullish primary trend change, which followed the March 2009 low, still remains intact, because we have not yet seen a joint close below a previous secondary low point. The decline into the June closing low carried the Industrials below their February secondary low point, but it is because the Transports have held above their February secondary low point that a primary trend change has not occurred. The current Dow theory chart can be found below.

Dow Jones Industrials and Transports

I have read and studied all of the original material by Charles H. Dow, William Peter Hamilton and Robert Rhea. Based on these writings, I first want to address the topic of so-called Dow theory "buy and sell signals." I want to explain that our Dow theory Founding Fathers would anticipate trend changes. If they felt that a market was peaking, they would sell into very short-term rallies, if those rallies proved to be failures. They termed these areas of weakness "sell spots." On the other side of the coin, when they were anticipating a bullish reversal they would buy into very short-term weakness as those declines failed to move to new lows and they termed these areas of strength as "buy spots." Then once the averages jointly moved above or below the previous secondary high or low point, which ever the case may have been, this was considered a "primary trend change" that served as confirmation of their anticipated buy or sell spot. In other words, the Dow theory Founding Fathers did not wait for a confirmed move above or below a previous secondary high or low point to establish their position. Their core position was already established and the movement surrounding the previous secondary high or low point was actually confirmation that the primary trend had indeed changed. Today, people perceive what is really a confirmed trend change to be a "buy or sell signal." This is in error with orthodox Dow theory and few understand this because few have actually read and studied the material.

In addition, the levels that most people rationalize as being representative of bona fide secondary high and low points, is typically wrong as well. It seems that anyone who had not already proclaimed a Dow theory "sell signal" prior to June 30th did so with the price break seen on June 30th. Based on my study of the writings of the Dow theory Founding, as well as my own independent work, this is wrong because the June 7th low did not mark a bona fide secondary low point. Thus, decline into the July 2nd low did not serve as a Dow theory primary trend change. Here's why.

True, there are no concrete rules for the identification of secondary high and low points in any of the original material from our Dow theory Founding Fathers. For the most part, the identification of these levels comes with experience. Our Dow theory Founding Fathers said that a secondary reaction generally lasts from three weeks to as many months. But, by actually reading, studying and understanding their writings one can also develop a deeper understanding of how to identify these points.

Let's first apply this very simple guideline. The advance out of the May 7th closing low ran a mere 3 trading days before it peaked and the advance out of the June 7th closing low ran a mere 9 trading days. As I have said all along, I have not been of the opinion that either of these lows marked secondary low points. They were far too short in duration. Also, in accordance with the rough guideline of three weeks to as many months, these rallies have fallen short not only with this rough guideline, but when compared to other periods. During the hard decline between the 2007 top and the 2009 low, the shortest advance into a secondary high point was 19 trading days, which is one day short of 4 full weeks. During the 2000 to 2002 decline the shortest advance into a secondary high point was 25 trading days, which was 5 weeks. During the 1966 to 1974 bear market the shortest advance into a secondary high point was 19 trading days. During the 1930 to 1932 decline the shortest advance into a secondary high point was 27 trading days. Therefore, even by this measure, in those extremely negative time periods, the advances seen in May and June come up far too short to be materially significant enough to have marked a secondary high point. Without question I do not believe that either the May 7th closing low nor the June 7th closing low marked secondary low points, therefore, violation of those levels was meaningless. The move down out of the April high into the current lows is all part of the same primary movement and I believe that the secondary low points for the Industrials and the Transports are now being made.

There is also an additional reason for this opinion. First, let me again say that cycles have nothing to do with Dow theory. But, the cycles work does give us an edge on our Dow theory work because we know that secondary high and low points occur in conjunction with intermediate-term and seasonal cycle tops and bottoms. No one else has this advantage or understands this, because they have not done this research. We knew all along that the May 7th closing low did not mark an intermediate-term or seasonal cycle low. With the decline below the June 7th low we now know that the June 7th closing low did not mark an intermediate-term cycle low either. Therefore, we know from our cycles work as well that neither the May 7th nor the June 7th lows marked secondary low points.

The current call on Dow theory serves to show who has done their homework and who has not. In other cases this also shows that many are merely mimicking the faulty lead of others. What may seem obvious is not always so obvious and the current situation with Dow Theory is a perfect example of this. Everyone is jumping on the so-called Dow Theory "sell signal" bandwagon because it appears obvious. But, when we take the time to examine history and to apply our knowledge of cycles, the obvious is not so obvious in this case. There is no doubt in my mind that it is our historical perspective and knowledge of cycles that allows us to stand on our own two feet in regard to this call.

With this all being said, don't misunderstand the message here. I continue to believe that the advance out of the 2009 low is a bear market rally that will ultimately prove to separate Phase I from Phase II of the ongoing secular bear market. I continue to believe that this bear market rally will peak in accordance with the DNA Markers that I have found have occurred at every other major top since 1896. I continue to believe that the Phase II decline will be the most devastating portion of the bear market. I continue to believe that the deflationary forces of K-wave winter will impact most all asset classes. I continue to believe that the powers that be will not be able to save the markets. I also believe that a proper Dow theory trend change will eventually occur, but this has not yet been the case.

I have begun doing free market commentary that is available at www.cyclesman.info/Articles.htm The specifics on Dow theory, my statistics, model expectations, and timing are available through a subscription to Cycles News & Views and the short-term updates. I have gone back to the inception of the Dow Jones Industrial Average in 1896 and identified the common traits associated with all major market tops. Thus, I know with a high degree of probability what this bear market rally top will look like and how to identify it. These details are covered in the monthly research letters as it unfolds. I also provide important turn point analysis using the unique Cycle Turn Indicator on the stock market, the dollar, bonds, gold, silver, oil, gasoline, the XAU and more. 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 Wood

Author: Tim Wood

Tim W. Wood
Cyclesman.info

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