Dow Theory: "Hats Off" to TRAN's "Heads Up"

Trading the TRAN all on its own will produce better returns than most systems when you have the power of the dominant Hurst cycles on your side – and all indications are that ‘Sell in May’ may be late this year ! Let me explain how the Dow Theory works and illustrate the ebb and flow of its signals with 2 charts. Words: 919

So says ‘ReadTheTicker’ (www.readtheticker.com) in the above paraphrased comments from an article*  reformatted and edited below by Lorimer Wilson, editor of www.munKNEE.com, for the sake of clarity and brevity to ensure a fast and easy read. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement. ‘ReadTheTicker’ goes on to say:

The Dow Theory, developed by Charles H. Dow, has two components: the Dow Jones Industrials index (INDU) and the Dow Jones Transports index (TRAN) and is based on the following tenets:

• Stock market trends have three phases: accumulation, public participation, distribution.
• Stock market discounts all news.
• Stock market indexes must confirm each other.
• Trends of indexes must be confirmed by volume.
• Trends exist until definitive signals prove that they have ended.

The Dow Theory works because, as Richard Wyckoff has explained:

In Dow’s time, the U.S. was a growing industrial power. The U.S. had population centers but factories were scattered throughout the country. Factories had to ship their goods to market, usually by rail. To Dow, a bull market in industrials (INDU) could not occur unless the railway average rallied as well (TRAN), usually first. According to this logic, if manufacturers’ profits are rising, it follows that they are producing more. If they produce more, then they have to ship more goods to consumers. Hence, if an investor is looking for signs of health in manufacturers, he or she should look at the performance of the companies that ship the output of them to market, the railroads. The two averages should be moving in the same direction. When the performance of the averages diverges it is a warning that change is in the air.

A lot has changed since 1902, and so have the components of the respective indexes which now reflect globalisation and the all the modern modes transportation. The Dow Theory still demands respect, however, and the modern day results prove it with an 11.89% compound annual return

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The leading indicator for the Dow Theory is the Dow Jones Transports index in that it provides a heads up on the future market turns of the more senior Dow Jones Industrial index.

Dow Theory Signals from 2003 – 2011

Let’s review the Dow Theory signal since 2003 on a weekly Dow Jones Industrial chart (INDU).

 As stated above the Dow Jones Transports (TRAN) is a leading and confirming index of the Dow Jones Industrials. We completed our cycle scans using our proprietary RTT Cycle Finder Spectrum and we found a dominant weekly cycle of 66 weeks for the TRAN. For the 66 weekly cycle to maintain its dominance, price action must conform to the cycle peaks and troughs and we used our proprietary RTTHurstDPO to measure the conformity (whereby the price must move down at least half way to the cycle trough before the red shade (see chart below) has expired, and then move back up at least half way to the cycle peak before the green shade has expired. Any failure to do so may mean a price inversion to the cycle may be occurring).

“Hats Off” to TRAN’s “Heads Up”

The leading indicator for the Dow Theory is the Dow Jones Transports index in that it provides a heads up on the future market turns of the more senior Dow Jones Industrial index.

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The following chart shows a very accurate cycle relationship to price, with only two price inversions. (The math: 11 out 13 correct calls = 85% accuracy). Not all cycle swings resulted in Dow Theory sell or buy signals, but all Dow Theory signals were preceded by a cycle swing and it was a question of significance if a Dow Theory signal was generated or not. Currently we have a Hurst Cycle peak and I would expect the TRAN to roll over at a minimum to the 60 week simple moving average (red line) or about 12.5% correction. As I write this oil is the bearish catalyst. Prices are skyrocketing and this bodes ill winds for the US and world economies. Will a roll over in the TRAN be accompanied by the Dow Jones Industrials (INDU) significant enough to force a Dow Theory sell signal? Only time will tell You can thank, the 66 week cycle (with its 85% accuracy) on the TRAN for the heads up.

Conclusion

If you cannot be bothered with Dow Theory signals, trading the TRAN all on its own will produce better returns than most systems when you have the power of the dominant Hurst cycles on your side – and all indications are that ‘Sell in May’ may be late this year !

*http://www.readtheticker.com/Pages/Blog1.aspx?65tf=153_dow-theory-with-hurst-cycles-2011-03

Editor’s Note:

• The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
• Permission to reprint in whole or in part is gladly granted, provided full credit is given as per paragraph 2 above.
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