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REQUIEM
FOR THE DOW THEORY “Either
he’s dead, or my watch has stopped”- Groucho Marx in “A Day at the
Races” It is with great sorrow that we come here today to give thanks for a great theory that has now passed over to the other side. We all have fond memories of the theory and its faithful disciples, but as we mourn our great loss(es), it is time to consider what lead to the death of this veteran idea whose time has passed. We could go back over the years and recount every last gasp of the theory and the valiant attempts by stalwarts such as Richard Russell to revive the remains, but that would be churlish. Instead we’ll look at incontrovertible evidence that Dow Theory is dead. The most obvious is the action of the Dow Transports. This has been a thorn in the side of Dow theorists as it has taken off well before the Industrials. We have taken the view that it is a form of inter-market analysis. All forms of inter-market analysis find relationships that are pertinent to the major market drivers of the time, but can’t be relied upon in perpetuity as these will change. The second piece of evidence is the real clincher. This shows that the Dow components are no longer representative of the general market action. In other words, the theory has suffered a mutiny, and this has brought on its final demise. Think about what this means:
It will take some explaining, but please stick with me. We have developed a new tool that analyses the volume moves in the market and assess whether there is accumulation or distribution. It is named “Quantal Volume” after the theory it was developed from. You can read more about it at http://www.trader007.com/Infognome/quantal_volume.htm Quantal Volume showed that the Dow components were being distributed before the present market turnaround, whereas the stocks of the NYSE, The NASDAQ and S&P 500 were being accumulated. In other words, the Dow components were giving the wrong signal. Let’s examine the evidence a piece at a time: A. The NYSE Composite index We have been using this as our lead signal generator for trend analysis that should always be done before interpreting volume moves. There was subtle distribution leading up to the old 2004 high (1) and then a positive divergence of Quantal Volume at the 2004 Low (2) with both volume and price showing a new bull market in Sept. (3)
B. The S&P 500 Although narrower than the NYSE Composite, and heavily weighted by Dow components, accurate signals are still provided based on our volume analysis.
B. The NASDAQ This is the quintessential trickster, although it makes no pretences that it is anything otherwise (unlike the Dow).
C. The Dow Transports Even the Dow Transports add some additional volume based deception.
D. The Dow Jones Industrials Only once you have digested what “normal” representative markets look like, will you appreciate the intrinsic disorders in the Dow as a leading index. You have seen that in a “normal” situation, Trend and Volume should move in sync. except at major market turns as volume turns the trend. Here we see a reverse of this situation:
Thanks for taking the trouble to reads this so far. Some of you will be confused, others angry. I am not a human bulletin board, so please don’t write and say:
We’ll be holding a wake and you’re all invited. Thanks to Sol (www.tacticalinvestor.com) without whose support I would be one more wealthy retired fishing fanatic….but then there’s Elliot Wave Theory, another corpse that needs dealing with if we’re not banned from all sites after this! “Drink
and dance and laugh and lie Dorothy Parker “The Flaw in Paganism” 1937 ©
2004 John Tyler CEO DOW
THEORY It is against stupidity in every shape and form that we have to wage our eternal battle. But how can we wonder at the want of sense on the part of those who have had no advantages, when we see such plentiful absence of that commodity on the part of those who have had all the advantages? William Booth 1829-1912, British Religious Leader, Salvation Army Founder The Dow Theory has undergone no change, while the Dow industrials it self has undergone several in the last few decades. First of all the Dow 30 was never the Dow 30 to begin with; it was more like the Dow 12. American Cotton Oil, American Sugar, American Tobacco, Chicago Gas, Distilling and Cattle Feeding, Laclede Gas, National Lead, Tennessee Coal & Iron, North American, U.S. Leather, U.S. Rubber and General Electric. Now we will look at the Original Dow 30 Allied-Signal (Allied Chemical), Primerica (American Can), American Smelting, Atlantic Refining, American Brands (American Tobacco B), American Sugar, Bethlehem Steel, General Motors, Goodrich, Chrysler, General Electric, General Railway Signal, Navistar International (International Harvester), Inco Limited (International Nickel, Paramount Publix), North American, Mack Trucks, Nash Kelvinator (Nash Motors), General Foods (Postum Inc.), Radio Corp, Sears, Exxon (Standard Oil New Jersey), Texaco (Texas Corp.), Texas Gulf Sulpher, Union Carbide, USX (U.S. Steel), Victor Talking Machine, CBS (Westinghouse Electric), Woolworth, Wright Aeronautical. (Source http://www.dogsofthedow.com/dow1928.htm) Finally let's look at the current 30 stocks that make up the Dow industrial average as of February 2004. Alcoa, Altria Group ,American Express, AT&T ,Boeing, Caterpillar, Citigroup, Coca-Cola, Disney ,DuPont, Eastman Kodak, Exxon Mobil, General Electric, General Motors, Hewlett-Packard, Home Depot, Honeywell, Intel, IBM, International Paper, Johnson & Johnson, J.P. Morgan Chase, McDonald's, Merck, Microsoft,3M,Procter & Gamble, SBC Communications, United Technologies, Wal-Mart The Dow has undergone such a transformation that it looks almost nothing like the original Dow. In fact if you are look at the original Dow 12, only one company is still around and that is GE. Less than half of the original Dow 30 stocks make up the Dow 30 presently. There is a huge change in composition to; we now have several huge companies from the technology and financial sector which have added an incredible amount of volatility to the index. Just by looking at how transformed the new Dow is from the Old Dow, one can draw one simple conclusion. A theory that was drawn up years ago and based on a model that has completely changed, cannot survive unless it to is adapted to reflect the new changes. Since the Dow Theory has not been modified at all, it’s a miracle that it has made it so long. Increasingly it has been misfiring and we agree with John Tyler that unless something drastic is done to incorporate present changes it will have to be retired. Like John Tyler we to have our proprietary indicators and throughout this year as the markets were correcting we kept stating that this was nothing but a correction in an otherwise bullish trend. Instead of using our indicators which are not available to the average Joe we are going to illustrate how the Dow theory was wrong in stating that we were going to plunge by using simple TA indicators. One Anomaly that started to point out that something was wrong was the huge positive divergence between Oil and the transports, (you can see the charts by clicking on our previous essay The Markets). Another anomaly was indicated by the positive price divergence between the Dow Jones utilities and oil. As oil prices rose the utilities went up in price instead of dropping just as the transports did.
If you look at the chart of the Dow above (DIA which is a proxy for the Dow) you will notice the following: The new low in the Dow was not confirmed by the Macds or the RSI and the Stochastics actually flashed a huge positive divergence. This evidence was strong enough in that at the very least one should have been sitting on the sidelines and waiting to see what unfolded. It clearly illustrates that all the pundits out there that were screaming the market was going to end were completely wrong.
This is the same chart except we have removed the other indicators put in the money flow index and the volume. If you look at the charts closely you will notice just when it looked like the world was dropping and the Dow was in the process of setting new lows, the volume started to drop; very bullish this was. The money flow index also did not confirm the new lows set in by the Dow another huge positive divergence signal. Conclusion
So we agree with John Tyler’s view that very soon the Dow Theory if not properly used/interpreted or adapted will have to find a good resting place. In the end a theory is nothing but intelligent speculation and while it can hold its ground for sometime, it can never hold it forever. Nothing lasts forever. Finally we stated our bullish views before the Dow had even passed the 10k level and you can read it right here. “I believe with the above data one can draw the following conclusions: A pull back to the 8,800 to 9,000 area would be very healthy for this market. However, it is not necessary. If we pull back to even 9,400 to 9,500, it would serve the minimum criteria to provide the necessary ingredients to start the next phase of this rally. So far there is nothing extremely spectacular about this rally when one looks at it in terms of a stronger currency. If we can hold in the 8,800 to 9,000 range, then the outcome looks rather interesting. Esoteric cycle analysis (our proprietary indicator at the Tactical Investor) is basically suggesting the following targets if we can hold the above ranges” 1st target
will be a break of the Dow over the 10,000 range Published 11/19/2003 http://www.financialsense.com/fsu/editorials/2003/contrarian.html We would like to state the following, that most Dow theorists have simply taken another’s works and tried to interpret it, most of them have failed to add anything new to this theory and many of them act as if they are the founders of this theory. A notable exception in our books is Tim Wood; he is also known as the Cycle Man, he uses the Dow Theory, but also applies principle of Market Cycles and thus is not bound by the limitations poised by the Dow Theory. One can conclude by saying that the Dow Theory has worked pretty well over time, unlike the Elliot wavers who have been nothing but wrong and bankrupted almost all their original followers with one of their most notorious calls of shorting the market in the 1990’s, in the midst of one of the biggest bull markets ever. At one point they had the audacity to suggest that their followers go 200% short, a recipe for suicide. For those of you tempted to write in and scream that we have lost our minds, please don’t bother, the local psychiatric ward is more than happy to check you in and listen to your ramblings. If you come up with a good argument and present your facts in a logical manner then please do write in and if we are proven wrong we will be more than happy and willing to admit to our mistake. One only learns something new after making a mistake and then trying to find the answer. It
takes 50,000 nuts to put a car together, but only one to scatter them all
over the road.
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INFORMATION The opinions of FSU contributors do not necessarily reflect those of Financial Sense. |
