Given the volatility of late, one might turn to the Dow Theory to ask if markets are showing signs of a top. There are many components to the Dow Theory. The main tenants involve identifying the market’s phase, trend identification, volume confirmation, and finally market average confirmation. We’ll be looking at market average confirmation today to see if there are signs of a problem in the US markets at this point.
When viewing market average confirmation, we examine the Dow Jones Industrial Average (INDU) and compare it to the Dow Jones Transportation Average (TRAN). In its simplest format, the INDU must move in the same direction as the TRAN index. On a more analytical basis, we look for recent highs and lows within the indices to see if there are confirmations of trend, or if there are divergences.
A confirmation of trend will consist of a peak on one index being confirmed by a peak on the other. If a peak is not confirmed, this may be a sign of divergence – but confirmation of such a divergence would be both a peak and a trough on one index diverging from the other. For example– If a new high on the INDU was not confirmed by a new high on the TRAN – and a higher low on the INDU was not confirmed by a higher low on the TRAN – that would be a sign of a divergence between the indices.
Above we see a chart of the INDU (bottom pane) and the TRAN (top pane). A new lower low was put in by the TRAN index (top pane) recently, while the INDU put in a slightly higher low. That should worry us as a sign of divergence. The INDU recently took out its February high via a lower high in March. However, the TRAN index put in an almost flat high in March to its February high (it was infinitesimally lower, but not so much that I will be a- retentive over that deviation…) .
At this time, I do not see a true deviation between these two Dow indices. Markets are showing signs of consolidation, but remain in a longer termed uptrend according to traditional technical analysis. A significant breakdown of both the February high and low points by the TRAN index in particular would be a divergence between the two indices. At this point, this has not occurred – suggesting the current trend has at least a favorable near termed outlook.
Community talk on technical analysis with Keith Richards: Richmond Hill Central Library 1 Atkinson St, Richmond Hill, Ontario on Thursday April 16th 7:00PM
Keith will be speaking on how to “Win by not losing”: Using the power of technical analysis to profit in uncertain markets.
Keith on BNN Market Call Monday April 20, 2015 at 6:00 PM
Tune in to BNN next Monday April 20th to catch me live on BNN’s 6:00 pm call-in show.
You can email questions now to [email protected] – or you can call in with questions during the show’s live taping between 6:00 and 7:00pm. The toll free number for questions is 1 855 326 6266
Keith, the current INDU components mix is different from the original INDU mix. How will this affect the comparison between the INDU and TRAN.
See my reply to Dave Houson’s similar comment below
Guess that oil trade didn’t work out after all.
Seeing the opening for oil right now, we are flat from our purchase-wow–easy come, easy go!!! We can tolerate WTI back down to $45/barrel-then we would sell if that broke. This is why we took only a third of the position we ultimately wanted.
Having said that–you have to expect volatility in something like oil–there are many traders with differing views. It could quickly reverse, yet again- given a piece of news flashed across somebody’s screen.
We just follow our rules–if we profit, great, if not, we know where to sell and cut losses.
Technical Analyst Bill Carrigan says “The “new” Dow has rendered one Dow Tenet – according to Charles Dow -The Averages Must Confirm Each Other totally useless” According to him ” today’s Dow should have a name change – to the Dow Consumer Average because unlike the 1980’s when there were 18 industrial components – now there are only 6 industrial components. The number of consumer related components has jumped from 6 in 1982 to 12 in 2014″
That’s a very good observation–like any theory, over time they can become flawed– Dow originated the theory based on industrials (being the main engine of the economy in his day) being confirmed by transports, but todays industrial average doesn’t represent a basket of “industrials” in Dows traditional sense. However, MSFT, for example, could be called a new type of manufacturer. They manufacture products and services–but more in the present sense of the word, than in the sense of the late 1800’s
I guess the question is this. When and how do you tell when the divergences are significant?
both a high and a low diverging on the transports vs. the INDU
You must have both to confirm a divergence