Potential Dow Theory Confirmation On The Horizon?
Charles H. Dow, founder of the Wall Street Journal and creator of the Dow Stock Market Averages we hear mentioned on a daily basis, developed a series of principles in order to better analyze market price action. Little did he know, his 255 published WSJ editorials would later come to be known as 'Dow Theory', and ultimately laid the foundation for which modern-day technical analysis was built upon. One of his more important beliefs was that for a buy or sell signal to remain valid, the stock market averages (Industrials and Transports) must confirm one another. What was also significant was when there’s a divergence between the averages, as this typically signified a major top/bottom was looming.
Interestingly, from September onwards we were witnessing a potential Dow Theory Non-Confirmation, as the Dow Industrials broke above its prior Q1 2012 highs while the Dow Transports still remained below its corresponding 2012 highs. This was a rather ominous sign since many consider the Dow transports to be a leading indicator, premised on the belief that goods need to be distributed around the world in order to sell them to the consumer, hence since transports were lagging it suggested a decline in manufacturing output and/or consumer demand and this was not a good sign for the economy overall. However, price action over the past month implied a potential shift could be underway, as Dow Transports took out its previous September/October highs initially and more recently in 2013 it broke above its previous 2012 highs, and this was precisely the type of price action one would expect from Dow Theory – whereby transports are leading industrials.
Presently, the Dow Industrial average is above its previous Q1 2012 highs, yet it still remains below the prior highs from September/October around 13,660/65. While this does not guarantee that equities will continue to move higher over the coming days and weeks (since the Industrials can still falter and make a lower high), it does project a rather bullish signal. Although we do not feel it is prudent to look to place a trade based on a potential Dow Theory confirmation, we think it may be something to keep an eye on since equity markets can be a great proxy to gauge 'risk' – Therefore, its outcome could have a major influence on the USD and ‘high beta’ currencies (commodity and emerging currencies) overall.