The Dow Theory Update November 30
By Tim W Wood CPA, November 30, 2007
In the November 16th Observation I explained that in accordance to Dow's theory we had an important non-confirmation at play, which served as a warning that something was wrong. I also explained that we were then in what is known as a Sell Spot in anticipation of a Primary Trend change. On November 21, 2007 this Primary Trend change occurred. As a result, the "Stock Market Barometer," as it was described by William Peter Hamilton back in the 1920's, is telling us that conditions are now stormy. This Primary Bear market will remain in force until negated by another confirmed bullish indication in accordance with Dow theory.
In the November 16th Observation, I showed you the following quote from Robert Rhea:
"Under Dow's theory the primary trend, once authoritatively established as bullish, is considered to be continuing in force until negated by a confirmed bearish indication such as would be the case when, after a reaction of full secondary proportions in a bull market, a rally fails to lift both averages to new high ground, and a later decline carries both averages below the preceding secondary low."
Now that the Primary Trend change has occurred, I want to walk you through this quote, and in doing so, please refer to the chart below.
The last joint high confirming the Primary uptrend occurred on July 19th. The decline into the August lows were a "reaction of full secondary proportions in a bull market," and I told all of my subscribers that this was the case at the time the decline began. Anyway, from the August Secondary Low Points, the rally that followed failed "to lift both averages to new high ground." Thus, a non-confirmation was born. But given that the Primary Trend had been authoritatively established, and since the averages were still above the previous Secondary Low Points, this non-confirmation only served as a warning. Once the Transports broke down below their August low, the warning became even louder. But still, the existing Primary Bull market remained intact. It was then when the "later decline carried both averages below the preceding secondary low" that the Primary Trend change occurred.
I said in an interview on my website last week to look for this Dow theory signal to be questioned, and sure enough, that is already occurring. In one such example I received an e-mail stating that there is an error with Dow theorists saying that a primary sell signal was triggered when the Industrials moved below the August 16th closing low because the intraday low was not violated. I have also seen additional e-mails stating that because the August intra-day low on the Industrials has not been violated, that we also have a Dow theory downside non-confirmation in place. In yet another e-mail it was suggested that because the August 16th low was not violated by more that 1% that no signal was given, while another e-mail suggested that new lows had to be made on the exact same day.
In fairness, I can see why such misunderstandings can occur. But none of these notions are correct from a pure Dow theory perspective. Now, you don't have to believe myself or Richard Russell in regard to this matter. Rather, we can turn to the original writings, which do reveal the facts. Charles H. Dow never actually wrote a book, but in his writings in the Wall Street Journal he clearly spoke in terms of closing price. If I turn to the works of Robert Rhea, who was the leading Dow theorist during the 1920's and 30's, we find that he in fact states, "In studies of the application of Dow's theory to the price fluctuations of the Dow Jones Industrial and Railroad averages, only the closing prices are considered." So, in accordance with pure Dow theory, it is the close that counts, and as a result the requirements have been made to fulfill a Dow theory Primary Trend change, and since it’s the close that counts, there would not be a downside non-confirmation now forming.
In regard to the Dow theory requiring a 1% close below a previous level to trigger a Primary Trend change, that too is not a part of traditional Dow theory. Rhea explains that William Peter Hamilton would "quote various prices, correct to two decimals, then refer to the fact that one average had penetrated its earlier price by perhaps two or three cents." Rhea also wrote on this topic stating, "Some students of the averages believe that under Dow's theory the piercing of a previous high or low point is inconclusive until both averages penetrate those prices by 1.01 points." Rhea goes on to state that both Dow and Hamilton considered "any penetration confirmed by both constitutes a valid penetration." Thus, it is clear from these writings that there is no threshold for price penetration of a given price level in order to be valid.
In regard to price penetration, on the same day Rhea wrote, "It is by no means necessary, as experience shows, that the low or high point of primary movement should be made in both averages on the same day."
The next question in regard to Dow theory is how long and how far down will this Bearish Primary Trend take the market. In accordance with Dow theory, the extent nor the duration of the Primary Trend once established is known. All I can tell you from a Dow theory perspective about this is that we are now operating within the context of a Primary Bear market, which will remain intact until it is reversed.
Tim W. Wood
© 2007 Tim Wood