Long Standing Dow Theory says "hello" to new bull market

The long-awaited Dow Theory bull market signal finally arrived. This came about as a result of the Dow Jones Industrial Average and the Dow Jones Transportation Average both breaking through their previous rally peaks (registered on 12 and 11 June respectively).

The Dow theory, developed by Charles Dow, has been around for almost 100 years, yet even in today's volatile and technology-driven markets, the basic components of Dow theory still remain valid. However, it has been criticized for being too late a signal. The trend does not change from bearish to bullish until the previous reaction high has been surpassed.

The goal of Dow was to identify the primary trend and catch the big moves. They understood that the market was influenced by emotion and prone to over-reaction both up and down. With this in mind, it is concentrated on identification and following: identify the trend and then follow the trend. The trend is in place until proved otherwise. That is when the trend will end, when it is proved otherwise.

Although the breakouts provide confirmation of the nascent uptrends, one may question the relevance of the Averages as representative benchmarks in the modern economy. Also, most indices are quite overbought after very sharp moves over the last 12 days.

"In my opinion, it could be dangerous to blindly put one’s faith only in Dow Theory and investors should at all times rather base their decisions on a combination of fundamental and technical indicators."

While Dow Theorists delight in the bull signal, it is appropriate not to lose sight of the economic picture. It remains relatively bleak.

Reading the markets is an empirical science. As such there will be exceptions to the theorems put forth by Dow and others. They believed that success in the markets required serious study and analysis that would be fraught with successes and failures. Success is a great thing, but don't get too smug about it. Failures, while painful, should be looked upon as learning experiences. Technical analysis is an art form and the eye grows keener with practice. Study both successes and failures with an eye to the future.

We live in interesting times indeed!

July 24th, 2009 by Prieur du Plessis, Investment Postcards from Cape Town



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