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NOISE CANCELING HEADPHONES

In black swan, DIA, dow theory, ETF, ETFs, GDX, Gold, OIL, transports, Uncategorized, XIU on June 25, 2009 at 4:03 pm

New Dow Theory Position

New Dow Theory Position

I recently went to an electronics retailer in search of “noise canceling headphones” for my iPod. You know, the kind you see people wearing on the airplane – they “cancel” out any ambient noise (my wife calls them “Sarah canceling headphones”). When you put them on you feel like someone shut the door on a noisy party next door. It makes you focus on the topic at hand. In my case I use the iPod mostly for audiobooks and it makes a big difference.

It made me think: “What if we had noise canceling headphones for the markets?”.  Often times, that’s what Dow Theory feels like to me. It cuts through the clutter of the day to day noise in the financial press and gives you an objective answer as to the primary trend of the market. Beyond a doubt the biggest question I get lately is “Is the Bear market over?”  I’m going to give you the answer in this post. But first a refresher:

1. Dow Theory provides us with a binary answer. That means it’s either 1 or 0. There is no room for interpretation. The “noise” as it were, is cancelled out. A “BEAR” signal is in force until such time as a “BULL” signal has been given. Think of the light switch in your kitchen. Once you turn the lights OFF, you can’t turn them OFF again until you turn them ON. There is a lot of bad information on the web about Dow Theory, including some high priced subscription letters that have made many mistakes in the last two weeks interpreting this exact situation.

2. Charles Dow, writing over 108 years ago, used only daily closing prices. An intra-day high is just more noise that is canceled out. The reason is that Dow felt that a closing price trumped all other intra-day prices because it represented a price that traders and investors were happy to carry home overnight. This showed more of a commitment.  This is important as you will see below.

Now I’m going to give you the answer. As you can guess from the image on this post, we are still in a BEAR market. That’s because the last unique Dow Theory signal was a SELL signal way back in November of 2007. That’s right. The light switch has been OFF since November 2007. We are waiting for a Dow Theory BUY signal if and only if the markets can better their most recent secondary reaction highs. What does that mean? That’s technical mumbo jumbo for “the market has to make higher highs and higher lows”. There’s no doubt that the Dow Industrial stocks have done this. They have bettered the May peak by a good margin. However, Dow required the two indicies to confirm each other. The Transport stocks have stubbornly NOT confirmed the high in the Dow Industrials.   The daily close that we need for a Dow Theory BUY signal is a higher close on the Transportation Average of 3404.11.  Above I stated closing prices were important.  That’s because two weeks ago the Dow Transports were on the verge of giving a signal intra-day, and then reversed and closed lower and therefore failed to “flip the switch” to ON.  Let’s look at a chart to see what I mean:

Dow Theory 24 June 09

Dow Theory 24 June 09

The point I am trying to impress upon you is that the Dow Transportation stocks may “know something” that the Dow Industrials don’t.  The failure of the Transports (lower high in June than in May in lower box above) signals a divergence in the indicies.  William Hamilton, Dow’s understudy, warned of such divergences in the indicies as potential danger spots.

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