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Dow Theory Update

This past week I received an e-mail blasting Dow theory. The allegation was that Dow theory no longer works and that it is completely irrelevant. The reason sited for Dow theory allegedly being wrong was that following the so-called Dow theory "sell signal"in late June, the market has rallied and continues to do so. Therefore, the question was, "How can Dow theory be valid?"

As it turns out, the problem is not at all with Dow theory, but rather with those who misinterpreted it. On June 30th both the Industrials and the Transports closed below their previous lows, which had occurred on June 7th. For the next couple of days it seemed that everyone, even CNBS, was talking about the alleged Dow theory "sell signal." Fact is, the Dow theory did NOT give a so-called "sell signal"on June 30th as was erroneously interpreted by so many at that time. Rather, as I explained to my subscribers at that time, the averages were making a secondary low point, meaning that a low of intermediate degree was forming and that a rally of intermediate degree was to follow. Some may argue that it is always easy to say you said something months ago that perhaps you did not really say. For that reason I am including a major portion of the Dow theory section from my July research letter that was released to my subscribers on July 3rd.

"The Dow theory has certainly been a hot topic of late. Seems that everyone has become a Dow theory expert and is now saying that we have a Dow theory "sell signal." I could not disagree more and I feel that this is a sign of the pending intermediate-term low.

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. Based on the current structure, it would require a move by the Transports below their February lows in order to give us a confirmed bearish primary trend change. Yes, I understand that others are saying that the recent violation of the June 7th lows has triggered a so-called Dow theory "sell signal." I have read and studied all of the original material by Charles H. Dow, William Peter Hamilton and Robert Rhea. Based on these writings, it is my opinion that we do not yet have a Dow theory primary trend change. Here's why.

There are no concrete rules to identifying 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 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 mark 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. Also, since we know that an intermediate-term low should now be in the making, we also know that it should coincide with secondary low points in accordance with Dow theory. Once the rally out of the pending secondary low point/intermediate-term cycle low begins, we should look for a multi-week rally. Then,........

The current call on Dow theory serves to shows who has done their homework and who has not. 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. Additionally, I feel that this is a premature sign of bearishness that is occurring right as the secondary low is being made......."

So, my point here is to clarify for those who want to point their finger at the Dow theory and say that it is wrong or that it no longer applies, the Dow theory is not wrong. In fact, it is never wrong and it has never been wrong. Rather, it is the interpretation of Dow theory that can be wrong and that is the fault of the one interpreting it and not a fault of Dow theory itself. The Dow theory has done a beautiful job at calling every primary move since the inception of the averages in 1896. Of late, the Dow theory successfully called the 2000 top, the 2002/2003 bottom, the 2007 top, and yes, even, the recent early July low. Just like with any other tool, be it a saw, a hammer, a wrench, a gun, a fishing pole, or even Dow theory, when in the wrong hands, that tool can be worthless if one does not know how to use it. Problem is, many that misuse the tool then blame the tool for their own error. The other problem is that people listen to the ones who have misused the tool and they too, begin to believe that it is the tool that is faulty when in reality it is the person behind the tool. I can assure you, the Dow theory is still very much relevant and that it is never wrong. I can also assure you that no one, including myself, is 100% immune from a misinterpretation.

At present, my view of Dow theory has not changed. I continue to believe that the rally out of the March 2009 low is a bear market rally that is likely to prove to separate Phase I from Phase II of a much longer-term and ongoing secular bear market. Thus far, according to orthodox Dow theory, the bullish primary trend change that occurred in conjunction with the advance out of the March 2009 low still remains intact. I continue to monitor my cycles work and the issues surrounding the DNA Marker that has been seen at all major tops since 1896 as this and how it all sets up in accordance with Dow theory is extremely important. I have also been asked whether or not the rally out of the March low could have been the end of the bear market. I've discussed this before, but I will cover this topic again here in my next post. The current Dow theory chart can be found below:

Dow Jones Industrial Average

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.


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