The Dow Report: A Brief Update on Dow Theory

By Tim W Wood CPA, June 24, 2005

On April 14th, 2005 both the Industrial's and the Transports violated their previous secondary reaction low points that occurred in mid-January. This break is shown by the red trend line and served to re-align the Secondary trend with the Primary trend. From that break the averages both declined into their April lows. Note that at the April lows the averages formed a small scale non-confirmation as noted by the small blue trend lines. This non-confirmation marked the beginning of the most recent rally. Under Dow's theory, this advance currently has to be labeled as a "Secondary Reaction."

As the market has advanced in this Secondary Reaction another interesting development has occurred. That being the formation of a "Line." Here is what the great Dow theorist William Peter Hamilton said about lines: "A 'line' is a price movement extending two to three weeks or longer, during which period the price variation of both averages moves within a range of approximately five percent. Such a movement indicates either accumulation or distribution. Simultaneous advances above the limits of the "line" indicate accumulation and predict higher prices; conversely, simultaneous declines below the "line" imply distribution and lower prices are sure to follow. Conclusions drawn from the movement of one average, not confirmed by the other, generally prove to be incorrect."

The following is a comment from Robert Rhea, the Dow theorist following Hamilton, on this subject. "Hamilton showed us that either important accumulation or distribution might be occurring when a 'line' formation is in the making, but few people have been able to guess, over a period of time, whether emergence would be topside or downward. Until joint penetration has occurred, it is unwise to attempt to guess whether the selling is of better quality than the buying. If the former is true, the 'line' is broken downside and distribution is said to have taken place. Should the penetration be topside, then the judgment of the bulls was better than that of the bears, and accumulation has occurred."

"It seems that Hamilton did not give much authority to a 'line' formation until it had run about three weeks, and he frequently stressed the fact that the longer a 'line,' and the narrower its range, the greater the forecasting authority when its limits are finally broken."

As you can see, each of the averages has broken out of their line formations. The Transports broke first and to the downside. The Industrials broke last and to the upside. So, once again the words of these great Dow theorists from nearly a century ago have once again proven to have been very wise in that the downside break by the Transports were not a sure indication that a downside break of the Industrials would follow. The fact that one average broke up and one down now leaves the averages again with a non-confirmation on a secondary level.

Now in order to know what these great Dow theorists of the past would say about this non-confirmation, let me once again return to their writings and I'll let them tell you.

William Peter Hamilton - "The movement of both the railroad and industrial stock averages should always be considered together. The movement of one price average must be confirmed by the other before reliable inferences may be drawn. Conclusions based upon the movement of one average, unconfirmed by the other, are almost certain to prove misleading."

William Peter Hamilton - "Dow's theory stipulates for a confirmation of one average by the other. This constantly occurs at the inception of a primary movement, but is anything but consistently present when the market turns for a secondary swing."

William Peter Hamilton - "When one breaks through an old low level without the other, or when one establishes a new high for the short swing, unsupported, the inference is almost invariably deceptive."

William Peter Hamilton - "Indeed it may be said that a new high or a new low by one of the averages unconfirmed by the other has been invariably deceptive. New high or low points for both have preceded every major movement since the averages were established."

William Peter Hamilton - "The two averages may vary in strength, but they will not vary materially in direction especially in a major movement. Throughout all the years in which both averages have been kept, this rule has proved entirely dependable. It is not only true in the major swings of the market, but it is approximately true of the secondary actions and rallies. It would not be true of the daily fluctuations, and it might be utterly misleading so far as individual stocks are concerned."

Robert Rhea - "The most useful part of the Dow theory, and the part that must never be forgotten for even a day, is the fact that no price movement is worthy of consideration unless the movement is confirmed by both averages.�

Robert Rhea - "The Dow theory deals exclusively with the movement of the railroad and industrial stock averages, and any other method would not be Dow's theory as expounded by Hamilton."

Robert Rhea - "A wise man lets the market alone when the averages disagree."

Robert Rhea - "When the averages disagree they are shouting 'be careful.'"

This non-confirmation has lead to a breakdown below the lower boundaries of both "Line" formations, just as Rhea and Hamilton suggested above. Guy's, I have hundreds of pages of writings by both Hamilton and Rhea. I have no doubt about the interpretation or application of Dow's theory on either the Primary or Secondary level. Yes, the market has somehow managed to hold on much longer than most anyone imagined and I'm sure that this is because of the greatest re-inflation efforts ever know to man, compliments of Greenie and the Boys. But, the writings of these great Dow theorists also tells us that the market cannot be successfully manipulated on a long-term basis. Greenie and Company will not win this battle. We have two forces at play here: the natural force of the market and the manipulative re-inflation efforts by the FED. History tells me that nature always wins. You have been warned again and if you don't believe me, then perhaps you will believe the words of Robert Rhea and William Peter Hamilton!

If you would like more specific technical research on the stock market, gold, the dollar or bonds, then you should consider Cycles News & Views. My work is grounded in market history such as the Dow theory. I also use cycles analysis as a method of developing quantified expectations for future price movement. When combining these quantified expectations with the Dow theory and my Trend and Cycle Turn Indicators, we are provided with a unique perspective of the market with long, intermediate and short term expectations.

Over the last couple of weeks I have mentioned that I have greatly expanded my newsletter service to include not only the monthly newsletter, but also web based comments during the week. I also provide charts on the stock market, the dollar, bonds, gold, silver, oil, the HUI and others that include my proprietary Cycle Turn Indicator and Trend Indicators. If you are interested in a service that is a detailed technical based newsletter with a focus on the Dow theory, cycles analysis and the works of master technician George Lindsay, along with web based comments and these indicators, please visit www.cyclesman.com for details and Contact Information.

I incorporate the use of the Dow theory, Cycle theory, the work of George Lindsay and other master technicians of the past in my market analysis, which is published in my newsletter, Cycles News & Views. These theories are applied to the current markets on an ongoing basis covering the stock market, gold, bonds and the dollar. For more information, visit my website at www.cyclesman.com or call 251-955-2327.

Tim W. Wood

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