About That Dow Theory Non-Confirmation

Dow Theory is the grandaddy of all technical analysis. Back in the late 1800s, Charlie Dow did not think of his “theory” as a forecasting tool for the stock market, or even as a guide for investors, but rather as a barometer of general business trends. The basic principles of the theory, which were later named after him when he died, were all laid out by him in the Wall Street Journal.

There are a 10-12 basic tenets of Dow Theory, depending on who you ask. Some of these include the fact that the market averages discount everything, stocks move in trends (Primary, secondary and minor), closing prices are the most important, etc etc. Today we’ll turn our attention to the Principle of Confirmation. Charlie Dow, referring to the Industrial and Rail Average (“Transportation” Average today), meant that no important bull or bear market signal could take place unless both averages gave the same signal (“Confirming” each other). He felt that both averages must exceed their previous peaks in order to confirm the continuation of a bull market.

The Dow Jones Transportation Average made a new high this month but the Dow Jones Industrial Average did not. This leaves a Dow Theory non-confirmation still in place:

3-24-14 dow theory

The sell signal comes if/when both averages put in fresh closing lows. Based on the recent action, the bears want to see the Industrials and Transports both close below their February 3rd lows. This would tell us that the trend has changed. Until then, it’s more of a red flag (a big red flag).