Dow Breaks June Low, Transports Key

The best weapon the amateur investor possesses to protect himself from stupid or ill-conceived action is technical analysis. For instance, if you own a stock, and you watch your stock "walking" up and above a rising moving average, then as long as that action continues, the amateur knows he's on the right track. But the higher the stock climbs, the more enthusiastic the amateur becomes.

Then one day his stock plunges below its moving average. That's the signal for the amateur to halt his enthusiasm. The stock is finally doing something different. Despite the amateur's enthusiasm for the stock, technical analysis has told him to check his enthusiasm. With regrets, the amateur goes against his emotions (he really loves the stock) and sells the stock. He sells the stock, not because he no longer loves the stock, but because technical analysis says, "Something has changed, the up-trend is over -- sell it).

Thus technical analysis has performed a valuable service. It has over-ruled the amateur operator's emotions. In breaking its trendline, technical analysis has not told the amateur "WHY" he should sell. All it has said is that the trend has reversed, and that it's dangerous to stay with a stock that has suddenly reversed its trend to the downside.

Dow Theory deals with the trend of the entire market and the economy. The basic tool of Dow Theory is the secondary reaction. When both Averages, Industrials and Transports turn down and lapse into secondary reactions, Dow Theorists take notice. After the secondary reaction bottoms, the market recovers and heads up again. This is a sign that the primary bull trend continues bullish. But after a two or four week rally, if the two Averages then turn down and both Averages violate their previous secondary lows, such action constitutes a reversal of the primary trend from bull to bear market.

In other words (and most people don't understand this), it's what the two Averages do following a secondary reaction that defines the all-important primary trend.

By the way, a secondary reaction usually retraces one-third to two-thirds of the preceding move -- this over a period of two to three weeks or longer. Definitions in this business can be confusing or too restricted. Thus some secondary reactions may retrace only one-third of the preceding progress, and this may take place is a week-and-half. Interpretations under Dow Theory are seldom exact or "by the book." Much of the validity of Dow Theory depends on the skill and the knowledge of the interpreter himself.

To make matters more confusing, every bull and every bear market starts and ends differently, which puts great pressure on the knowledge and judgment of the individual Dow Theorist.

Very near-term – Yesterday morning the Dow broke below its June low (chart).

But did anybody notice this? The Transports (study the chart below) held far above their own June lows. This is currently the most constructive (bullish) situation in the D-J Averages.

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