Is Dow Theory Still Valid?

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Of late, I have been seeing another round of articles circulating the internet claiming that Dow theory is no longer valid. These articles all generally theorize the same common theme in that they claim the Dow theory is an antiquated relic of the past and that for this reason it does not apply in today’s new high tech age.

Another commonality with these articles is that it is clear to me that the writers of such articles do not understand Dow theory. Reason being, they have never studied the original writings by Charles H. Dow, William Peter Hamilton or the detailed studies by Robert Rhea. As a result, 99% of the articles on Dow theory are incorrect in that they are full of erroneous statements, misapplications and false conclusions.

As an example, Dow theory worked beautifully at the 2000 top. In fact, a bearish primary trend change was triggered in September 1999. From there, the Industrials moved to a higher high in January 2000, which created a Dow theory non-confirmation in addition to the bearish primary trend change. But, as a result of the higher move by the Industrials, people did not seem to understand the non-confirmation and the warning that orthodox Dow theory was clearly sending. I remember the criticisms of Dow theory and the claims that it was wrong. This non-confirmation and the original bearish primary trend change was followed in March 2000 by another bearish primary trend change. Surely we can all remember the roughly 40% decline that followed. Obviously, Dow theory was not too antiquated at the 2000 top, after all.

Then there was the 2007 top. The fact is, the averages made joint highs in July 2007. That high was then followed by a breakdown of the Transports while the Industrials moved above their previous secondary high point into the October 2007 high. This in turn created a Dow theory non-confirmation that was soon followed by a bearish primary trend change in November 2007. In June 2008 the Transports actually moved to another all time high. As a result, we again heard stories of why Dow theory was wrong. Truth was, this additional advance again created a non-confirmation following the bearish primary trend change. According to orthodox Dow theory, a trend change is considered to be in force until it is authoritatively reversed and that requires a joint close above or below the previous secondary high or low point, whichever the case may be. Given that the averages were not into gear to the upside following the November bearish primary trend change, that bearish primary trend change was never reversed and the advance by one average unconfirmed by the other has no forecasting authority according to Dow theory. Surely, we can all remember the roughly 50% decline into the 2009 low and the worst financial crisis since the 1930’s. Again, Dow theory worked just fine. It was the misunderstanding and bad calls by those that did not know how to properly read Dow theory that was wrong.

Then, there was the so-called “Dow theory sell signal” in July 2010. Oh yeah. I remember it well. Everyone that had ever heard of Dow theory came out with this one. However, I explained that this was merely a decline into a secondary low point. The same thing happened again in August 2011. Again, everyone and their dog was proclaiming a “Dow theory sell signal.” Yet, once again, they were wrong. Big time wrong, but then again, they blamed Dow theory. I came out with articles publicly stating that there was no such thing as a “Dow theory buy or sell signal.” I further explained that while we had seen a bearish primary trend change, “not all Dow theory bearish trend changes were created equally” and that the market was expected to move higher in spite of the August 2011 bearish primary trend change. My reasons for this at the time was simply because of my missing DNA Markers and my quantitative approach to Dow theory. I actually received e-mails telling me that I was “stupid.” Regardless, the fact is, at the depths of the October 2011 lows I specifically called for a move above the May 2011 high, which did occur in early 2012 and the so-called “Dow theory sell signal” was in fact proven wrong.

Now, that said, the Dow theory bearish trend change that occurred in August 2011 remained in force all throughout the remainder of 2011 and 2012. All the while, as the market moved higher and eventually bettered the May 2011 high in early 2012, we once again saw the articles proclaiming Dow theory to be wrong. As is always the case, it was the application/interpretation of Dow theory that was wrong, not Dow theory. Now with the Transports having moved to all time highs and Industrials moving above their 2012 highs, we are again hearing the controversy about Dow theory. Some are again claiming that the Dow theory is irrelevant and antiquated for the same various reasons that we always hear. Others are saying that because the Industrials have not also moved to all time new highs we still have a Dow theory non-confirmation in place.

I assure you the Dow theory is every bit as relevant as it was in 2000 or 2007 or 1929 for that matter. Fact is, there have been other bullish primary trend changes within other longer-term secular bear markets. This is not the first nor is it uncommon. As an example, bullish trend changes were seen during the counter-trend bear market rallies, during both 1967 and into 1968, in association with the rally separating Phase I from Phase II of the longer-term secular bear market. The same thing also occurred during the 1971 to early 1973 rally in association with the rally separating Phase II from Phase III. It was the understanding of the Dow theory phasing that was key. This was also seen in reverse during the great secular bull market of the 1950s and 60s in which traditional Dow theory bearish primary trend changes occurred. But, during that time E George Schaefer, who was the leading Dow theorist of that day, understood that these bearish primary trend changes were occurring within a longer-term secular bull market period and he was able to do so based on Dow theory Phasing. I believe that we are seeing something similar to the 1967 to 68 and the 1971 to 73 rallies and here too, the phasing is key. Once a Dow theory non-confirmation is seen, a bearish primary trend change is again triggered AND the DNA Markers that I have found, which have occurred at every major top since 1896, are seen, we will again see just how valid the Dow theory really is. Until such time, just as I’ve maintained ever since the 2009 low, higher prices will remain possible.

Now, as for the fact that the Industrials have not bettered their all time high along with the Transports is of no consequence in accordance with orthodox Dow theory. According to the original writings by our Dow theory founding fathers, it is the joint close above and below previous secondary high and low points that count. All time high or lows are not a requirement of Dow theory.

In closing, my long-term view on the market remains the same. It is a house of cards. An out right disaster waiting to happen and it will happen. The rally out of the 2009 low is a rally within the context of a much longer-term secular bear market. The underling issues with the market have not changed nor have they gone away. Again, I have identified a very specific set of common denominators, which I refer to as DNA Markers, that have been seen at every major top since 1896. By understanding Dow theory and the identification of these DNA Markers we will know when the tide turns. Once these pieces fall into place, the die will be cast. Until then, just as I have said all along, higher prices will remain possible. In fact, I wrote in my December research letter to my subscribers: “Based on the weight of the overall data, we simply cannot rule out the possibility of the advance out of the November intermediate-term cycle low carrying price above the October high. In fact, I’ll even go so far to say that the balance of the evidence at this time is actually more suggestive that it will than that it won’t. But, even if this proves to be the case, the overall weight of the evidence also suggests .......” If you want to know more on the developments and details surrounding Dow theory, my quantitative methods and the DNA Markers, that research is available in the monthly research letters and short-term updates at Cycles News & Views.

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About Tim W Wood CPA