The Dow Report: Non-Confirmations July 1
By Tim W Wood CPA, July 1, 2005
It seems that there has been some confusion on the subject of non-confirmations. Being that a picture is worth a thousand words, let's turn to the charts and look at a few examples. In doing so I thought that it would be fun to go back in time and use some historical charts from near the inception of the averages in order to demonstrate this concept. The chart below begins in mid-April 1897.
The advance out of these lows ended with one of the very first Dow theory non-confirmations on record. The Industrials, plotted in the upper window, topped on September 10, 1897 at 55.82. The Transports, plotted in the lower window, continued higher into September 17, 1897. It is the fact that one average topped prior to the other average that created this divergence known as a non-confirmation. I have marked this non-confirmation in red on the chart below.
Understand that had the Industrials and the Transports bettered their previous high points in say late September, then this small scale non-confirmation would have been corrected. But, when both averages bounced out of their September 21st low and both failed to better the previous levels, a decline below the September 21st lows followed. The move below those lows cemented the non-confirmation and the breakdown was then underway. In other words, the move below the September 21st lows confirmed the non-confirmation.
Now, before we go any further I want to point out that these divergences, known as non-confirmations, occur at various levels or degrees. In other words, small-scale non-confirmations that form over a few days can occur or the market can form larger scale Primary non-confirmation, which take much longer to form. Either way, non-confirmations are important and even the small scale ones can be followed by important trend changes.
From the September 1897 non-confirmation the Industrials declined some 18% into the November lows. At that low notice that no non-confirmation was formed. So, another point about non-confirmations is that they are not a requirement before a trend change can occur. But, when you do have non-confirmations you had better be on your toes, because a trend change is definitely probable.
Now look what happened. The Industrials advanced into January 1898 while the Transports advanced into February 1898. This in turn created another non-confirmation at what turned out to be another top. In this case the non-confirmation was confirmed when the averages jointly violated their January lows. This non-confirmation lead to another 16% decline by the Industrials.
This decline carried the averages down into their March/April lows. It may be hard for you to tell on this chart but the Industrials bottomed in March while the Transports made their low in April. This in turn set the averages up with a downside non-confirmation and warned of an upward reversal. When both averages cleared their late March highs, this non-confirmation and the ensuing rally was confirmed.
Now I want to draw your attention to the chart below. This chart picks up at the March/April 1898 non-confirmation and continues through most of 1900. You can see that the March/April 1898 bottom lead to a one year rally that carried the market up some 83% into the April 1899 minor non-confirmation, marked in red.
From that minor non-confirmation the market again declined into late May. Notice that at the May lows the averages did not form a non-confirmation. Again, this is not a requirement for a trend change. Then, from these May lows the averages advanced into September where another non-confirmation was formed. Both averages topped out on September 5, 1899. But, in doing so the Industrials were able to marginally better their April high while the Transports did not.
Rather than get off into the details of this larger scale non-confirmation and confusing everyone, let me simply say that after the averages made the next rally attempt into October and then failed, the decline that followed took the averages below the October lows. This non-confirmation then became a non-confirmation of Primary degree. As a result a 29% decline followed, which took the market down into September 1900.
I hope that these examples of non-confirmations have been helpful. The point is that whenever one average makes a higher high or a lower low that does not jointly occur with the other average, then a non-confirmation exists. Then, when the previous low point or high point, which ever is applicable at the time, is violated, then that non-confirmation becomes validated or confirmed, so to speak. It is important to understand that not all turn points occur with these non-confirmations, but I have found, as an example, that 81% of the 4-year cycle tops in the stock market have historically occurred with some degree of non-confirmation. Some say that the Dow theory is no longer valid for this reason or that. Well, the same thing has been said before and the Dow theory has proven valid for well over 100 years. Ignoring non-confirmations is just not wise.
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Tim W. Wood
© 2005 Tim Wood