The Dow Theory Today

[HenryTo]

Dear all,

I am appalled at the recent lack of reporting/coverage of the most flagrant divergence in the Dow Industrials and the Dow Transports in history since the historic non-confirmation of the Dow Industrials by the Dow Rails in the 1933 to 1937 rally.

I really am. This flagrant divergence in the Industrials and the Transports is trying to tell us something, and yet we ignore it or even worse, we say things like: "The Dow Theory is antiquated or that the 30 companies are not relevant anymore." I have read such claims before - these claims are not new but the most amazing thing is that these claims have been around since William Hamilton started writing his editorials for the WSJ nearly 100 years ago!

The Dow Theory has worked for practitioners that have been patient and that have learned the history of the Dow Theory. It is not a wise thing to abandon the study of the Dow Theory now - especially since I believe the Dow Theory is trying to tell us something right at this very minute!

[texfly101]

Henry,
Thanks, that definitely helped in forming my opinion of what is happening currently. I am assuming that your reference of H&S as to the retail investor is vis a vis the institutional investor. I would agree with that. Currently I'm almost through reading "Technical Analysis" by Kirkpatrick & Dahlquist and can see how complicated using technical indicators is and why institutional investors use it and why retail investors will use reading signal patterns like H&S. I also can see why the Dow Theory writers caution against a straight reading of the indicators and say that the context of the market needs to be considered. So to me, I am seeing the H&S not as much a pure signal as just a part of the total picture. Its just another piece of the context, right? Now if I see it not reach the neck, then it says that the bear has been held off and that the market still is searching for a direction. I think that it is a period of consolidation, right? Taking some time to let all the current problems and potentials work their way thru the system. That is one reason why I joined here, it seems that the participants, to me at least, have a contextural view of the events and are not here for argumentative reasons. Information that helps me to decide what I think is going on. And I think that the analogy to 1906 is very appropriate. Its interesting to me that as I have read thru your suggested readings that things make more sense. I'm glad I have taken the time to do the reading, it sure helps to add technical and historical meaning to the context. My feelings have changed totally during this time. Previously, I had a definite unease of not knowing why things were happening. Now that unease has eased off. I'm not as uncertain and inclined to do the, as Bill so aptly terms it "Help mommmy!!!!" type of knee jerk reaction and have reasons for staying with my positions as a consequence. But more importantly, I have a plan now for whichever direction the market will take and will execute it with a lot less "am I doing the right thing?" questions. I'm really seeing where the psychology of the market is as important as the research. As Bill speaks in his excellent commentary, I have asked myself those questions and now look at my psychological makeup vs the market sentiments and directions. For example, I do note your at times dispassionate reading of events mixed with particular sentiments about directions. Again, I read context into that and that helps. Its like your writing back and commenting on the 1906/107 period's relevancy gives added meaning to listening to all the talk by analysts, CEO's, governmental spokesman, and general market actions. Like what you write, I am not convinced that we are anywhere near the total impact as a result and will be very wary of any major move that I can't exit quickly. New Zealand bonds are very attractive as I calculate the risk/reward ratio of trading. I also am looking very favorably towards high dividend paying, undervalued stocks and am not looking at anything that takes over a year to get the desired returns I want. Taking your signal as something I agree with, I have looked into puts, am glad I went short on Boeing, and am definitely not looking at speculative investments depending on a bullish market for their returns. It takes a fundamentally sound business case to get me interested. Keep writing and I'll keep reading....thanks for the reply and for the commentaries...dj
_________________
dj

[HenryTo]

Hi DJ,

I generally don't believe the H&S indicator has much predictive value when it comes to a particular stock market index, given that most of its components could be exhibiting totally different chart patterns. However, to the extent that the retail investor pays attention to it, and as long as we're looking at at least a multi-week timeframe (such as now), then I think we do at least need to think over it.

Note that a H&S indicator is only "confirmed" when it breaks below its "neckline" on higher-than-average volume. We're still not there yet, but getting close.

The stock market is generally a leading indicator of credit conditions - until it isn't. The "delayed reaction" of stocks such as Union Pacific to the damage caused by the 1906 San Francisco Earthquake is one example. By 1906, most of the public was rampantly bullish and had adopted a "buy on the dips" attitude, such as what we're having now. Even during the Summer of 1907, most of Wall Street and the public chose to ignore the tightening credit conditions, until everything "hit the fan" in the Fall. Notably, the 1907 "cleanout" was accompanied by the exposure of many fraudsters and those who were very overextended, such as what we're experiencing now. You always get these kind of episodes after a protracted boom period or a protracted period of risk-taking.

A subscriber who runs a mortgage company told me that he doesn't believe Countrywide can make it, and I agree with him.

Best regards,

Henry

[texfly101]

Henry,
Looking at the DJIA, it seems to me that it is appearing to look like a head and shoulders condition with the mid July, mid October and now a mid December high. If it turns down, imo, that is a classic head and shoulders form. If a December high is less than the October, and the July high, doesn't this confirm the beginnings of a downtrend? Or does it have to retrace the total rise before making the call? I guess what I am trying to ascertain is the psychological effect that a down trending head and shoulders would have on non professionals. Its got to be a distinctly negative meaning. To me, I am affecting a very cautious attitude, even though my trades have been doing well enough, keeping them on a tight leash and not exposing myself to any major risk. I haven't taken a short position yet, even though trading at the reduced level could be taken as such, but am preparing myself for just such a change from my previous long stance before closing positions in August and December and taking my profits. It is interesting. The current rise given the credit crunch sure does seem worrisome. I have heard and read why this isn't like the S&L problems but to me that doesn't make sense, a lot of talk about why billions of lost dollars doesn't matter, the Santa Claus Rally, election year rise, etc. But billions do matter. Tight credit has to draw down business expansion. Jesse Livermore kind of describes this when he writes of the San Francisco earthquake and how it took some time for the true effect to catch up to the market. Do you pay any attention to psychology of head and shoulders market patterns or is it strictly a technical analysis with sentiment indicators taking into account psychological effects on the market? Maybe I'm being way too cautious and missing the boat but 50% short call with the possibility of 100% short says to me that my caution is a good stance. Thanks for the commentaries, it helps to have reference info for why I am so uncertain about the market right now.
_________________
dj

[texfly101]

Rhea in The Dow Theory Chapter X, Secondary Reactions, writes "Secondary reactions are always confusing...are hard to guess and sometimes deceptive. Frequently they bear many of the earmarks of a reversal of a primary trend...". And in Chapter XIII, Determining the Trend, "...because a proper understanding of the rise and fall of prices as compared to previous similar movements is of such vital importance when using the averages as a forecasting device..."
The current stretch of the market trading seems to be in this vein. A lot of discussion and questioning about the direction, recession, arguments about yes and no to each question. It looks a lot like the previous secondary movement last summer so maybe a bounce comes and all this is a secondary movement that continues the trend. I guess that we will probably have to wait and see if the DJIA goes below the summer's lows as the Transport have penetrated the 52 week low. If this happens, is this confirmation? This is fascinating to see this play out just as a book written in 1932 about his views and regarding writings from men in the first quarter of the 1900's.
_________________
dj

[texfly101]

Good to hear your thoughts and that this site is helpful to you. I was in about the same position awhile back that you are with wanting information and feeling the the Dow Theory had something to it. As I said before, that quest led me to these sites which have proven to be very informative. That, imo, is based on two circumstances. The first is that all of this fits my view of what works for me. The Dow Theory and Value Investing work together well. One, a time proven theory documented in numerous books, and the second a style of investing. Both have the ability to analyze a set of parameters that are easily available and can be watched for validation of the analysis. The second is the ability to connect to, write to, and listen to more informed people in this area of market analysis that the internet provides. Years ago, you only had an expensive broker who usually had a seperate agenda than yours, or the tips and opinions of water cooler experts to depend on. The present day circumstance of web based sites helps provide the explanations and validations of the first circumstance, just look at the postings on this site as example. The ability to watch how knowledgeable people view events and form opinions and to be able to tap into their knowledge and experience is invaluable. I don't think you can buy this from a broker. As my previous posting might indicate, I prefer people who give information rather than people who want to tell me to buy their product. As such, I tend to stay in contact with the first types and stay away from the second. You can tell from reading past commentaries and following the threads that a bunch of these people know each other and are familiar with each others talents and writings. The number of postings on this site is evident of that. People like Bill Rempel and Henry To have proven to be very helpful in learning about the markets, and more importantly, willing to answer question that beginners like us have. Take a look at Bill's site, http://billrempel.com , it is very different and offers analytical insight but isn't pitching a product, just providing information. Also, notice his presence on this site and Henry's familiarity with his views. It was through Henry's commentaries and answers to posts that lead me to writing to Bill and joining these sites. I tend to gravitate to that sort of dialogue that occurs on Market Thoughts et al, as it has a built in validation vs just buying and following a system from someone who has himself as the main topic and stump thumper. I won't say that this is the place for everyone, but if the shoe fits, then wear it. It fits me so the time I have dedicated to this sort of topic is spent on sites I trust. So I read, listen, write, listen and learn and that's about all I ever expected and feel I am getting my money's worth in return. I hope it turns out likewise for you.
_________________
dj

[emergingwave]

Thankyou Mr. To and DJ,

I appreciate your thoughtful replies. The link was interesting. I suppose this could be chaulked up to "marketing madness." As part of my research I signed up for his free portfolio grader pro. Unfortunately, in return, you get his marketing e-mails quite regularly.

I look forward to learning more about the market, especially your comment DJ, that examines its underlying "nature." All very intriguing. It seems at first glance there is something "deep" about Dow Theory. I read that Mr. Dow had a fascination with watching the ocean and observed that the markets unfolded quite similiarly.

This is fun so far (easy for me to say, I am not in the markets).

I am also enjoying the Dow Theory Letters. I am enjoying Mr. Russell. Thoughful and conscientous. Thank you all. I am sure I will have more questions. I am up in Canada but I'm sure the markets share similiar characteristics and the Dow Theory can be applied.

[texfly101]

I really despise websites like MarketWatch that take over your browser and change the default settings. I wish I hadn't clicked on the link. Oh well, welcome to cyberspace, right? Now to close out the page and reopen another instance. Anyway, I would answer that writers like Navellier are the types that I have a healthy amount of skepticism as he shows a considerable hidden agenda in his writings. That agenda as I see it, is both to promote his products and to sway opinion that he is right and to be followed rather than to inform and let one make their own decision. I choose to make my own opinions and chart my own course and give his writings a discounted viewing. But that's just me.
So what does this have to do with the question as posed before asking for intelligent replies? Well, its my opinion after doing the suggested readings that the DJIA, the Dow Theory and the set of stocks that they are based on are not about maximizing profit. They are about understanding the movements and inter-related nature of financial transactions in the market arena. To say that it is not relevant or should not be used because some other index has a greater measure over a small period of time is to miss the point. And as Henry points out, other indexes have specific focus that can be of limited value. Read the writings, books, editorials, and commentaries, and as I see it, its more about ascertaining the economic state of the world's business to form a informed stance to make stock buying decisions. How does this work? Look at the Dow 30 and its very evident that they are about a select collection of big cap companies doing international business and represent a cross section of major, relevant sectors. Follow their movements and as stated over numerous editorials and you see how the world is happening, reacting and taking into account the world's activities. All of the world's actions are taken into account according to the Dow Theory. Add in that is has both a history and determined ability to be analyzed and you get a reasonable theory to understand the market's actions.
Now let me state that I too am a relative newcomer to this. While having traded in stocks for years, I never had a true understanding of what I was doing or wanted to do. Seeing that others exhibited an understanding that I didn't have gave me a desire to learn. That then led me to the Dow Theory and commentaries such this site and Bill Remple's sites. Everyone has an opinion, its just that their writings and views make sense to me as does the Dow Theory as it fits my personal belief structure. So I have been doing a lot of reading, writing and learning. And consequently, a lot of the underlying nature of the market has become clearer. While the Dow and the Dow Theory is not a "one size fits all", it does work for me. Others have different views, different methods, different focus. And of course that is what makes the market work. Those differences make for trading possibilities, profits, losses and all the various goings on that we read, talk and write about. Its just that my view is that the Dow 30 have what it takes to make the theory work. But that's just one person's view and one piece of the overall view that the decisions are based on.
_________________
dj

[HenryTo]

emergingwave,

The Russell 2000 makes up a mere 8% of the total market cap of the US. It also severely underperformed the S&P 500 during the late 1990s, and especially the Russell 1000 growth index. So it is not a surprise to see small caps overperforming the large caps since the end of the large cap bull market in early 2000.

I am not sure where this comment came from

[emergingwave]

Hi folks, I am brand new to this. I am a pure virgin and have not bought my first stock yet. I have been doing alot of reading and researching of all investment styles. I am completely sitting in cash with the exception of a private real estate investment.

I would like to present a quote from Louis Nevallier, legendary growth investor. It comes from a marketing e-mail for his "Emerging Growth" newsletter.

I was hoping to hear some intelligent replies to his claims:

"The Dow Jones Industrial Average made news this week when it briefly fell below 13,000. But I’ll tell you a little secret Wall Street doesn’t want you to know. The Dow has badly underperformed the real stock market.

Most people don’t realize how bad it’s been. The Dow just follows thirty mega-cap stocks and that’s not where the best action has been. I’ll give you a perfect example. If the Dow had merely kept pace with the S&P 600 Small-Cap Index, then the Dow would be around 23,500 today. Instead, it’s more than 10,000 points lower.

Still, the Dow’s closing number is reported by every newspaper and media outlet in the country. In fact, it’s now reported all over the world. The problem is that investors don’t know how poorly it’s done. I get frustrated by the media’s lack of interest in anything that’s not a $100 per share stock."

Any comments?

[texfly101]

Henry,
Thanks very much for the reply. This subject has proven to very interesting. And yes, Rhea is the one who talks about it. Its really neat to see things play out like the editorials talk about. I have to admit that I look at the charts with a different eye now. I'll look forward to reading what you come up with, have a great vacation....dj
_________________
dj

[HenryTo]

Hi DJ,

My personal thoughts on this is that "double tops" are only obvious in hindsight. There have been many cases where an index or a stock has experienced a double top in the classic sense (where the volume is higher on the second top but there is no new high) and where the index/stock would consolidate and then go on to make new highs.

I do agree that as a bull market matures, the probability of a double top being played out gets higher and higher. Valuations should also need to be considered.

I also think that "double tops" have only been mentioned by Robert Rhea, and not the other Dow Theorists.

As for your other questions, I intend to take some of my time from my winter vacation and revisit the Dow Theory - starting with the books, and the various comments by the Dow Theorists going back to the late 1890s (I have all the editorials from Dow, Hamilton, Rhea, and Russell spanning more than 80 years).

Best,

Henry

[texfly101]

Henry,
Recent charts are maybe the double tops that Rhea warns against? I know that you feel that the market has a bit more to shed before recovering as the bull isn't over yet. I'm just trying to look at these recent values in terms of what I've read. I can see why it is so hard to say one way or the other, but basically, you just have to wait and see...am I correct in viewing it that way?
_________________
dj

[texfly101]

Watching CNBC this morning and one of the reports was about one of the senior analysts (didn't catch the name) saying that all the end of the bull, start of the bear, Dow Theory indicators were obsolete and irrelevant in todays' technical driven market. That this was business as normal, the trend was still up, and that the market will return to its past pattern, that this is a normal correction. I say that this is the classic pattern that is described in the Dow Theory, that we have to wait and see if this is a secondary movement like this summer or if we will see a confirmation signal for a downturn. The way I see it, the DJIA has to penetrate its August lows before the signal can confirm. Am I right in this?
_________________
dj

[texfly101]

Both the Industrials and Transportations SMA 100 lines have moved away from a positive inflection trend line. Those two derivatives are moving into negative territory. For the past 3 weeks both resistance lines are at negative slopes. Secondary movement? Industrials and Transportations confirming? Since according to theory, a secondary movement can last from a few days to weeks, we have to wait and see, right? The way I read it, the Industrials have penetrated previous lows, just barely once, as the Transportations have penetrated several times over the same period. This is what we are supposed to watch for according to the theory, right?
_________________
dj

[texfly101]

Henry,
Having done a lot of reading of the suggested books, i.e. Rhea's "The Dow Theory", and now having a lay person's understanding of the basics of the Dow Theory, it has set me to thinking. If it wasn't evident before, and if one agrees with the tenets of the Dow Theory, one has to agree that it is very indicative measure of the interconnected nature of economics and probably even societal circumstance as the market discounts all of this into the values that are seen. Hence Rhea's chapter "The Averages Discount Everything".
What I am wondering about is that with the growing importance of the world's economies and the emergence of the different individual markets and exchanges like China, India etc and the fact that their relative size to the US had grown significantly, how closely does the Dow reflect them? I know that when the European markets dive, that will be reflcted in the Dow as it follows, but is that in the Daily Movement significance only? Does the statement that the Dow takes into account everything economic reflect the influence of those markets in the results of the application of the theory too? It would seem so to me, given that the Dow 30 are international corporations and operate in the world's, the US and all those countries economies at the same time. But I have to ask the question as a way of validating that view so to speak.
Also, not having the experience to have followed those markets for any appreciable length of time and not really knowing the data sources, do they also follow the tenets of the Dow Theory? Industrials and transportation indexes, both needing to confirm the other, secondary movement chardacteristics, etc are still valid, right? Or are there idiosyncracies that are not obvious but are significant? To my beginner's viewpoint, it should hold true in theoretical sense, people being people no matter where they reside, but things like governmental economic control in China, and different societal norms like in India, begs the question of what differences are there and how signifcant are they? I give the example of in WWI when the Army ran the railroads, Rhea writes that the transportation index was not to be used as it was not valid. And I don't see any corresponding analysis of the British exchange. So how valid is the Dow Theory for analysis of foreign markets?
_________________
dj