TimingCube - Dow Theory - Dow Theory, Dow Theory confirmations, Dow Theory signal

Current Signal Performance as of

Signal Type	Trade Date	Index	Return since issued
		Nasdaq 100
		Russell 2000
		S&P 500

Cumulative Returns since First TimingCube Live Signal () as of

Index	Long Only	Long Only with Margin	Long & Short	Long & Short with Margin	Buy & Hold
Nasdaq 100
Russell 2000
S&P 500

Market Update

Stocks rebounded nicely this week, led by the Dow Jones Industrial Average, which hit a new 4-1/2 year-high on Thursday. Both the S&P 500 and Russell 2000 are not far behind, but the Dow's outperformance may suggest a renewed appetite for more stable, less speculative companies. This is not completely surprising, as many leading stocks of the previous months, such as Apple or Google, have corrected about 20% or more since mid-January. It will be interesting to see if the shift towards blue chips continues in the coming weeks. Oil prices have now backed down to under $60 a barrel, easing inflation concerns, but a higher-than-expected Producer Price Index for January tempered investors' enthusiasm on Friday. During his first testimony to Congress as Fed chairman, Ben Bernanke left the door open for more interest rate hikes if deemed necessary. On the earnings front, most companies continued to beat analysts' estimates, a solid report from Hewlett-Packard helping lift the markets on Thursday.

For the week, the Russell 2000 and S&P 500 respectively gained 1.93% and 1.60%. Both indices rest well above their 50-day and 200-day exponential moving averages (EMAs). Still trailing, the Nasdaq 100 finished 0.69% higher. It has settled right at its 50-day EMA and remains above its 200-day EMA too. There is no change for us this week and our Buy signal remains in effect.

Trend Timing School

Dow Theory

This past week, markets have seemed pretty dull and uneventful, yet they gently edged further up, with some even marking major milestones in some circles. Surprisingly to some, the Dow Jones Industrial Average has finally (or again, or not yet depending on who's counting) joined its sibling the Dow Jones Transportation Average in setting new highs. Thursday's close at 11,120.68 represented a 4-1/2 year high for the Industrials, confirming the Transports' bullish action (it set 3 more records this week). For most adepts of a discipline (religion?) or one of its splinter branches (sects?) called Dow Theory, this week's action and confirmation gives a strong buy signal.

No, the Dow Theory is not yet another Dow Jones index. It is one of the earliest market timing systems in existence, and its first characteristic is that it is not really a single theory but rather a broad body of work developed over more than a century by many people. We certainly are no experts in the Dow Theory, and it plays no role in our Trend Timing system, but we thought it would be timely and interesting to introduce and compare this long evolving trend following system.

Initial developments by Charles Dow in the late 19^th century and extensive refinements by William Hamilton during the first quarter of the 20^th century were only known through their publication in numerous articles in the Wall Street Journal, of which Dow had been a co-owner. Robert Rhea is credited with documenting and assembling a lot of the earlier works. After years of quasi dormancy the theory was picked up again, modified and extended far beyond the initial Dow version by many more Dow Theorists such as George Schaefer and Richard Russell to name only two. In the last 10 to 20 years the number and variety of Dow Theory newsletters and advisors have mushroomed. Over the years it has become almost a cult-like phenomenon with tight circles of enthusiasts loudly proclaiming the superiority of their version and interpretation of the theory.

The vast majority of the initial work was purely what we now would call technical analysis of market indices, and was pitched directly as a substitute to emotional investing. It did in its principles have some commonality with our Trend Timing by identifying the predominant trend, participating in the big moves, and sidestepping downtrends. Dow theorists view individual stocks as way too risky, hard to predict and susceptible to manipulation so, much like us, they mostly rely on index investing.

One of the most important rules are Dow Theory confirmations, meaning that for a Dow Theory signal to be valid, when one index sets a new high or new low, the other must follow soon. This is exactly what has been happening recently and why there is excitement amongst the Dow Theorist ranks.

The basic tenets of the Dow Theory are that:

A bull market begins when a bull trend on one index (marked by a new high) is confirmed by the start of a bull trend on the other index
A bear market begins when a bear trend on one index (marked by a new low) is confirmed by the other index

The two indices in question used to be the Dow Jones Industrial and Dow Jones Rail averages, but the latter has long since been supplanted by the Dow Jones Transportation index.

Ironically, where the theory really began as a clear-cut mechanism to identify the primary trend with no room for interpretation, it has for years become fragmented with clearly divergent interpretations. Economic factors and market psychology have been added to the mix with ingredients such as valuation, economic environment, and investor sentiment, all requiring a subjective assessment. How the Dow Theory signals or breakout points are measured varies greatly from one advisor to the next. The strength of the confirmation is dependent on how close in time it is. The more time passing before confirmation, the weaker it is said to be. Even the definition of a new high is interpreted very differently, with some claiming that the Dow Jones Industrial actually needs to surpass its previous all-time high at 11,722 on January 14, 2000 for there to be a new high and real confirmation.

One of the primary criticisms of the Dow Theory is being consistently late and missing large parts of the big moves. Indeed, while some have been in a bullish stance since May of 2003 and are sitting on good gains, others have staunchly pointed to a downtrend and have yet to turn bullish. Maybe they never will. It is the eternal debate between bears and bulls and it results in widely ranging performance track records and positions on the current stock market.

As usual, we will stay clear of interpretations and predictions and rely on our simple 100% mechanical model to point to the primary market trend.

FAQ of the Week

Question: Should I get invested now or wait for the next signal?

This question comes up frequently, and not just from new subscribers arriving mid-signal, but whenever you get some new capital to invest, like your quarterly 401 (k) deposit or a bonus. With our average signal duration at a little over 3 months the current signal, which turns 4 months old this coming Monday, may appear somewhat old-in-the-tooth. The reluctance to invest between signals is obviously because of the risk that shortly after investing, the market will reverse and trigger a signal for losses. It is of course for each of us to decide, but because we have had signals that lasted over a year and that the long ones also tend to generate substantial gains, we generally recommend getting in with the signal. We don't know when the next signal will come, but you do not want to be sitting on the sidelines for possibly many months without participating in the market. In order to reduce the entry risk we recommend easing in with a series of investments over a few weeks per the dollar cost averaging technique we detailed in the March 05, 2004 Trend Timing School article.

Warm wishes and until next week.

The TimingCube Staff