Was That Really a Dow Theory Sell Signal?

In October 2007, I commented on the ominous divergence between the Dow Jones Industrial Average index and the Dow Jones Transport Index. The correlation between the two averages is the foundation of the venerable Dow Theory. Though subsequently the Dow Jones Industrials made a new all-time high, on October 11, 2007, the Dow Jones Transports continued to hover just above its August 2007 bottom.

The decisive downside break in the Dow Jones Transports two weeks ago, followed by the November 21 closing of the Dow Jones Industrials below its August 2007 low, generated a primary stock sell signal by the Dow Theory. As notable as the signal is, it must be noted that the Dow Theory has had its share of premature sell signals. In addition, downside and upside breaks that generate Dow Theory signals typically coincide with the market being overbought or oversold short-term. This results in short-term market moves in directions opposite to the primary trend signaled by the Dow Theory.

The divergence between the two Dow Jones averages is only one of the bearish divergences that were noted on these pages in my last article. On the one hand, indices still holding well above their August 2007 bottoms are the NYSE Composite, the NASDAQ Composite, the NASDAQ 100 and the TSX Composite. It is the Small Cap S&P 600, the indices and Exchange Traded Funds of financial, consumers’ discretionary, semiconductor, retail merchandising and homebuilders’ stocks that have broken below their August 2007 lows.

While this article may be a bit too technical for most PROFIT CONFIDENTIAL readers (and maybe that’s why Michael only lets me write it once a month!), my conclusion on the technical picture of the stock market is this: On the whole, the best that can be said about the consensus of technical indicators is that the stock market has oversold enough to stage a tradable rebound within days rather than weeks.