Loading ...Dow Theory Primary Trend Change Still in Effect- Delivering Clarity to a Deceptive Market
The great analysts of old developed a market system that is as valid today as it was 100 years ago. Dow Theory was developed by Charles Dow, William Hamilton and Robert Rhea from 1900 to 1939. This system lends clarity to a deceptive market. Rather than listen to FED governors pontificate and CNBC commentators bloviate, lets look at what Mr. Market is saying by examining the language he speaks… price action.
Follow along the sequence of events that have played out over the past year: First the transports topped in November of 2014. While the Dow proceeded to put in higher highs the transports failed to follow. This was the first red flag indicating a non-confirmation of the averages. Next the Dow topped in May 2015 and its next rally was unable to exceed this level. This indicated the averages were in trouble and sounded a top alert. In August of 2015 we then had a Dow Theory Primary Trend Change Signal. This occurred due to both averages breaking below their previous reaction lows of fall 2014, as indicated. Since this time we have been in a confirmed primary down trend. In accordance to Dow Theory this is considered a bear market. That’s right, DOW Theory has no problem claiming this as the beginning of a bear market. The down 20% “rule” is bogus, where did this come from? No one has ever attributed a source for this, it just showed up on CNBC about 20 years ago.
Since this Primary trend change the averages have reconfirmed this trend again in January of 2016 by breaking to lower lows and then for good measure, recently put in an upside non-confirmation of the of the averages in this recent rally in stocks. Note how the transports failed to exceed its previous rally while the DOW broke above its previous rally. This shows the averages not confirming each other indicating misalignment, consistent with the still valid primary downward trend.
OK Plunger big deal, so what does all of this mean? Sounds pretty technical, so what’s the big picture?
The big picture is we are likely in the early stages of a massive bear market when savvy insiders trade in their stock for cash because they sense danger. Its called distribution, and they distribute to the future bag holders of the next bear market. That’s where we are today and you can see the tracks of the bear in the below chart. Mr. Market likes to be deceptive and the only way he can pass along damaged goods to tomorrows bag holders is to polish them up before he dumps them. This is how he operates and he is a pro at it, so he engineers a nice spike rally and is able to plant a bullish narrative into the minds of market participants. In a bear market a healthy organically driven rally is hard to pull off, but a spike rally, oh that’s not a problem at all, just jam the shorts and pretty soon it feeds on itself. You can see on the chart the large supply overhang at the current price. Price is not likely to be able to absorb that supply and then have the power to punch through that big distribution dome.
Ok Plunger, you’ve finally got my attention so remove all the noise you mention and give me the real scoop, you know the big picture, where is all this leading?
It could very well be leading to a bear market that has been held off for years. That is the bear that has not been allowed to develop or “clear” the market to natural levels. Why? Because QE and FED/Govt interventions have prevented it until now. We always look at the market in nominal terms, what if we stripped out inflation in the averages and viewed the market and its cycles from a purchasing power perspective. We then see the distortion of inflation removed and the cycles display themselves clearly. We can now see the ebb and flow of bull and bear markets. We can see the 2000 bear market truncated by FED money printing and never allowed to run its course and properly clear the market of its excess. But here is the thing, when the imbalances of the previous bull are never allowed to clear and in fact added to the FED is not doing society as a whole any favors. They are just bailing out their cronies and polishing their egos. So let’s ask the question, with zero interest rates and the monetary gun now expended will the markets now be able to clear?
Although it may be just a matter of semantics, whenever I read “Dow Theory Sell Signal”, I cant help but think of Tim Wood’s reflections. I used to subscribe to his newsletter years ago but realized just understanding Dow Theory didn’t make him a very good trader. He said “There is no such thing as a “Dow theory sell signal.” Our Dow theory founding fathers would anticipate trend changes based on very short-term structural changes, sentiment, phasing, values, their feel for the market, etc. and they would establish their positions based on those developments in anticipation of a trend change. This is obvious when you read their writing. There was no ring of a bell that gave them a buy or sell “signal.” Secondly, what most people confuse with a so-called buy or sell signal is actually what is referred to as a Dow theory primary trend change. This occurs when both the Industrials and the Transports closed either above or below their previous secondary high or low point. The Dow theory founding fathers no doubt anticipated these primary trend changes, established positions ahead of these changes and used the actual occurrence of the primary trend change as confirmation that their previously established positions were correct. As a rule, if one waits on the primary trend change, a big piece of the move has already occurred.”
I do agree completely with Mr. Market setting up a spike higher to tee up the next major decline and that’s where I think we are now. I’m trying to profit from it now and suspect it could give us a new historic high before giving us an ideal short entry. With that said, I am watching this too which would be a swing target top in the S&P below a historic high. Let’s see how prices behave. I came up with this a week ago and meant to post it as an alternative: http://stockcharts.com/h-sc/ui?s=%24SPX&p=60&yr=0&mn=1&dy=11&id=p37164893820&a=390805984
Mark,
Thanks for the feedback. Indeed I corrected the use of the word “sell signal” as you are correct and get a notch for being a Dow Theory purist!. Yes, Russell noted that the founding fathers of Dow Theory would in fact reverse their positions and allow it before the actual confirmation event of a primary dow theory trend change.
There is always a chance we could go to new highs and reverse all of this technical work Mr. Market has diligently been putting in over the last 2 years. But for now its a confirmed Dow Theory primary downtrend and these normally lead to big bad bear markets. So any of you long positioned bulls out there, like Clint would say…”Do you feel lucky?”
Regarding Tim Wood. I feel his pain man. I listen to him and he sounds like he is undergoing the ultimate frustration with this top. He needs to loosen it up and go with the flow a bit.
Plunger, Great update as always. The last chart showing the series of 17-18 year cycles is very telling.
Love that Dow Transports vs Industrials Dow Theory chart!