I pointed out recently in my weekly Index Wrap commentaries that Dow Theory, through the action of the Dow 30 Industrial Average (INDU) relative to the Dow Transportation Average (TRAN) provided confirmation of a continuing primary bull market.

The Weekly close-only 'line' chart seen below and then in close up on the chart that follows this first graph, suggests that INDU has gone to successive new highs but TRAN has only just recently done the same. Both Averages at new highs is a 'confirming' type price action that suggests that the overall Market continues in a major bull market.

I'll provide some background to Dow Theory and how DIFFERENT of a view you can get if monthly charts of the two Averages are used, as Charles Dow did.

My next chart is just a closer up view of recent action with the two averages.

DOW 'THEORY' BASICS

Charles Dow lived from 1851 to 1902 and was a US journalist who co-founded Dow Jones & Company with Edward Jones and they in turn started the Wall Street Journal. Dow also invented the Dow Jones Industrial (INDU) and Transportation (TRAN) Averages as part of his research into market movements. He developed a series of principles for understanding and analyzing market behavior which later became known as Dow theory and was the groundwork for technical analysis.

What Charles Dow wrote about in his newspaper columns in the late 1800's was that if the Dow Industrials moved to a new closing high or low, without the Transportation average following suit, thereby 'confirming' the other Average or, vice versa; e.g., if TRAN went to a Closing peak or bottom, without the same action in the Industrials, no change in the primary trend was 'signaled'. We are talking about a situation where there is a potential reversal in the primary trend. To suggest such a change, the averages must be in synch.

The reasons for this are simple, but accounted for a very astute observation on Dow's part. For example, industrial or manufacturing activity could continue to be very strong for a period of time while orders for those goods were slowing. This would result in the build up of inventories. Where such a slowdown would show up however, is in transportation orders and activity. Slowing orders in the transportation sector, as fewer goods were shipped, would result in a fall off of company revenues. Astute followers of these stocks would notice this and selling would start to show up in these stocks, either keeping a 'lid' on stock prices or actually driving them lower.

Conversely, manufacturing could start picking up but might not be at first reflected in a pick up in those stocks. However, an increase in shipping might be noticed more readily and cause Transportation-related stocks to begin rising. The Dow Industrials might fall to a new low, but not be followed by the Dow Transports. This might suggest that the Market was bottoming. A new high or low in the Industrial average, not matched by a similar move in the Transportation average is suspect. In the case of a new high not confirmed by the Transportation stocks it may indicate that the same slowing of earnings and hence stock prices, will show up later on in the Dow Industrials.

I noted above that you can get a very DIFFERENT picture of the two Dow Averages if using a monthly close-only (or line) chart, versus the weekly INDU and TRAN weekly charts seen above. Seen next are MONTHLY charts showing the last 10 years price action in the Industrials versus the Transports. The month is not over of course, but my last chart is where things stood on a monthly chart basis assuming the most recent Friday Close becomes the end-of-January Close. However, we still have 8 trading days in January. Nevertheless, where the monthly chart below stands currently (a snapshot in time) provides an idea of how things are looking in using Dow's preferred time frame for his theory of bull or bear market 'confirmation'.

On a monthly chart basis, assuming we wind up January at least as high (or higher) than our most recent weekly (1/18/13) Close, the Transportation Average will have gone to a new 10-year monthly closing high, whereas the Dow Industrials has to get above 13900 at any month end ahead to 'signal' 'confirmation' of a major or primary bull market. I know that this is a Warren Buffet type time frame, but it is of interest. Stay tuned for the Dow (INDU) Closing above 13900 at the end of February, March, April, May, etc! At that point, according to Dow Theory, we can say that we have a confirmed bull market (this also assumes that TRAN on January 31st remains at or above 5500). Bets anyone on whether we get there?

I like to step back from time to time and look at the big picture as a break from trading options week to week. Since the Market is closed today (for Martin Luther King day), here's my now for something completely different Trader's Corner.


GOOD TRADING SUCCESS!