A Dow Theory Bear Signal
by Randall Ashbourne
For the first time since September,
1999, a Bear sell signal has been thrown up by new lower Lows being
recorded in both the Dow Industrials and the Dow Transports.
Back in October, I introduced the basic concepts
of classic Dow Theory which is that the two indices must confirm
each other for a rally to be sustainable.
The logic behind the confirmation is quite simple.
If the factories (Industrials) and the railroad and trucking companies
(Transports) are both moving upwards, the overall economy is in
good shape and is growing.
If both indices agree with each other – that
is, both of them record new, higher Highs – it is a strong
sign that the economy is moving ahead very nicely and the stock
market as a whole is in a sustainable, long-term uptrend.
A state of negative divergence exists when one index
does not confirm the signals from the other.
For example, if the Industrials put in a new High,
but this is not confirmed by a new High in the Transports in roughly
the same timeframe, it is a signal that something, somewhere is
going wrong with the underlying economy.
And again the logic is simple … the trains
and trucks aren’t moving as much stuff as the factories are
apparently still producing.
If this condition exists, one of the indices is
Either investors are being too optimistic about
the future of industrial production, or they are being unduly pessimistic
about the state of the transport industry.
Dow Theory is, first and foremost, about confirmation
between the two indices.
Which is why we now have real cause for caution
… because both the Industrials and the Transports have each
recorded lower Lows, in the same general timeframe, for the first
time since September, 1999.
The first chart we’ll look at is the multi-year
weekly view of the DJI. We can see that in October, the Industrials
put in a new, all-time High.
If we skip down to the similar period chart of the
Transports, we see that this new, higher High was not confirmed
by the second index, which put in a much lower High in October than
it did during July.
The first point is … this was a classic “non-confirmation”
signal. It told us that the October rally in the DJI was not sustainable!
It had gone too far. It was too optimistic.
And we know what happened.
*QHT technical chart:
Now, the next point about these two charts is that,
in both cases, the November Lows are lower than the August Lows.
The difference here is that we have a confirmation
signal … the Industrials and the Transports agree with each
From early to late 2004, the Industrials made a
series of lower Highs and lower Lows. Now, lower Highs and Lows
are a Bear signal … they’re a downtrend.
But! They were not confirmed by the signals from
the Transports. During that time frame, the Transports made a series
of ascending Lows.
The Industrials were crying “Bear” …
but the Transports were saying “Bull”.
In other words, one of the indices was wrong! As
it turned out, it was the Industrials … investors were unduly
pessimistic about the state of the factories.
Which brings me back to the point
… we now have, for the first time since September, 1999, a
Bear signal from both indices simultaneously.
*QHT technical chart:
That makes the months ahead a whole different ballgame
from 2004, when only one of them was Bearish.
And it’s also a whole lot different from the
position where one of them doesn’t confirm a new rally High
in the other, leading to a short-term correction.
We have both major indices pointing towards the
potential for a very significant downturn.
And we should remember that it is a potential …
a warning sign … not something engraved in stone and handed
down from a high place.
After the 1999 signal, the Dow Industrials continued
rallying for several months before the Bear came out and started
mauling everyone in 2000. In fact, the DJI added another 14% or
so before going into long-term crash mode.
If we go back to the Transport chart above, we can
see from the MACD peaks that negative divergence had been building
between the indicator and the actual price levels since midway through
But this was not the case with the Industrials.
Negative divergence did not appear between the MACD and the DJI
price until October’s MACD peak came in at a much lower level
than it did during July.
And that was a second piece of evidence that the
DJI’s strong rally out of the August Lows was not sustainable
… too far, too fast.
These two charts also contain other information
we will find useful in the weeks ahead as we gather evidence of
where the next big move will show itself.
We can see from the Transport chart that price has
fallen very decisively through the bottom of its trend line since
this long-running Bull started its charge.
That is not the case with the Industrials. Some
commentators have been remarking that the DJI has fallen through
its long-term trend line.
The trouble is, they’re talking about a trend
line drawn from the 2006 Lows! That is not long-term … it’s
a second-tier, intermediate-term trend line!
The real, long-term trend lines are easily seen
on the chart of the Industrials and, at this stage, the index isn’t
even particularly close to breaking its middle-level support trend
line, let alone the bottom one.
At this time, the long-term uptrend in the Industrials
is completely intact.
Both the breakdown from long-term support
in the Transports and the fact that both indices have confirmed
each other in a classic Dow Theory Bear signal does, however, indicate
the need to exercise extreme caution over the next few months.
a printable version of this article.
*QHT Technical Charts created using Quick
Harmonic Trader Software, by P.A.S. Astro-Soft, Inc. makers
of Galactic Investor Astrology software.
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