Pending Dow Theory Buy Signal

According to Stockcharts.com Dow Theory is one of the oldest and most highly regarded technical theories. A Dow Theory buy signal is given when the Dow Industrial and Dow Transportation averages close above a prior rally peak. A sell signal is given when both averages close below a prior reaction low. According to Investopedia under Dow theory, a major reversal from a bull to a bear market (or vice versa) cannot be signalled unless both indexes (traditionally the Dow Industrial and Rail Averages) are in agreement.

For example, if one index is confirming a new primary uptrend but another index remains in a primary downward trend, it is difficult to assume that a new trend has begun.

Ok so let us chart the path of the industrials and the transports so far through 2012.

Note the December advance in both averages to their respective February peaks. They subsequently traded down to an April low which was higher then the prior December lows. Both then rally from their April lows but only to set up a bearish divergence with the industrials posting a new high at the April peak and the transports failing to exceed the February peak. This sets up a negative divergence condition.

Both averages then retreat down to test their respective April lows and hold. Note the higher low of the transports now setting up a bullish divergence condition. This divergence is first required in order to set up a possible Dow Theory buy signal. The buy signal is completed if and when both averages break up above their April peaks. That works out to about 13400 on the industrials and about 5500 on the transports. Now remember, Dow Theory signals are typically slow – about one third into a new bull so enjoy if we get the signal over the next week or two.