Dow Theory Fails to Confirm
As a trader one of the 1st things to learn is that the market is always right. Many times one can get caught up in the arguments that the market is wrong or that the market isn’t taking into account certain facts. Normally, this type of talk leads to trading disasters. For technical traders, the question of whether a trend is sustainable becomes a big one. Right now the market continues to see very little selling making the question…buy here and go higher or sell here to go lower? One of the tools I often use to help me with this question is Dow theory.
Dow theory is one of the oldest market theories and has many interpretations and nuances. I like to use the theory for trend confirmation. If there is no Dow theory confirmation on a move in the market I stay skeptical and trade lightly. When Dow theory confirms a market move, I have a bit more leeway to get aggressive.
Confirmation comes from the movement in industrial ($INDU) and transport stocks ($TRAN). When both sectors hit new highs, a bullish rally is confirmed. When industrials and transport sectors hit new lows, a bearish decline is on. While Charles Dow did not mean for his theory to be used in short term trading, its principles can help to understand the strength of a rally or decline.
In June, both transports and industrials hit new short term highs after bottoming. Both continued to rally but notice how the industrials continue to make higher highs while the transports do not. The lower highs on the transports are an early warning sign to traders that the rally may not be as sustainable as many might perceive. While the lack of confirmation is in no way a sign of going lower, it signals to a trader like me that it is time to tread lightly. I suspect a confirmation or breakdown will happen as the month draws to a close and more volume begins to enter the market.