MONEY MATTERS
DOW THEORY REVISITED
BY DOUG WAKEFIELD & BEN HILL

Dow Theory sent a sell signal on Jan. 21. The last time it did so was February of 2000. Dow Theory also called for a sell on Oct. 25, 1929, just four days prior to Black Tuesday and the beginning of the Great Depression. Dow Theory called the tops in 1937, 1966 and 1987. Dow Theory was also used to call significant market bottoms in 1932, 1942, 1949 (after a top in 1946), 1952 and 1974. Had you (and your ancestors) traded according to Dow Theory over the last 103 years, you would have made 10 times as much money as a buy-and-hold strategy over the same time period.

Dow Theory is the oldest technical trading system. It was discovered by its namesake, Charles Dow, who also created the averages that bear his name and was once the editor of the Wall Street Journal. He gave top priority to valuations and emphasized economic conditions and the various stages of bull and bear markets. As well, he noted the importance of the confirmation or non-confirmation of the Dow Jones Industrial Average (DJIA) and Dow Jones Transportation Average (DJTA). 

Here’s how this works: In a healthy economy (and therefore healthy stock market), both the DJIA and DJTA should rise in sync (called a confirmation). In an unhealthy economy, both would fall in sync (still a confirmation). When the DJIA and DJTA move in opposite directions (called a non-confirmation), this signals a change in the primary direction of the markets. The DJIA topped in January of 2000 at 11,722. Since then, though the DJTA has continued to set newer highs; the DJIA has not. This is a non-confirmation and signals a change in direction. In this case it is a bearish (sell) signal.

The DJTA closed below its December 2004 low of 3,669 on Jan. 5 at a level of 3,653. On Jan. 21, the DJIA joined the Transports and closed below its December 2004 low of 10,440 at 10,368. This is a confirmation to the down side and constitutes a Dow Theory sell signal. Again, this is bearish. 

Since then the DJIA recovered to 10,984, while the DJTA recovered to 3,889. Another interpretation of the Dow Theory suggests waiting for a re-confirmation of the initial sell signal. Once again, on April 14, the DJIA dropped below its January low, falling to 10,248 while the DJTA fell below its January low of 3,435 to 3,421. This constitutes a strong sell signal based on a technical trading tool that has been in use for more than 100 years.

Will the deluge come tomorrow? Maybe. Will it come next month? Draw your own conclusions. While no one can forecast with a 100-percent probability, this latest signal is sending a strong warning. Ignoring this warning could prove very costly.

As George Santayana said in 1905, “Those who cannot remember the past are condemned to repeat it.”


Editor’s note: Nothing in this story should be construed as advice to buy, sell, hold or sell short. The safest action is to constantly increase one’s knowledge of the money game. To accept conventional wisdom about the world of money, without a thorough examination of how that “wisdom” has stood over time, is to take unnecessary risk. Best Minds, Inc. seeks advice from a wide variety of individuals, and at any time may or may not agree with those individuals’ advice. Challenging one’s thinking is the only way to come to firm conclusions.