Dow Theory - Confirmation
Dow split industrial stocks and railroad stocks into two separate averages. His theory requires that movements on one average be confirmed by the other:
- A bull market starts when a bull trend on one average is confirmed by
the other average commencing a bull trend.
- A bear market commences when a bear trend on one average is confirmed by the start of a bear trend on the other average.
The Railroad average has declined in significance over the years and the Dow Jones Transport Average is now used in its place.
Dow Jones Industrial Average is compared to the Transport Average.
- The Transport Average fails to confirm the lower High and Low on the Industrial Average. The bull market is intact.
- The end of the bull market is confirmed by the lower High and Low on the DJTA and a large correction on the DJIA.
Higher Highs and Lows on both averages confirms the
resumption of the bull market.
Railroads have declined in importance since the early 1900s when they dominated the stock market. The Transport Average has been expanded to include freight companies such as UPS and Fedex, airlines such as Southwest and Continental, and shipping companies such as OSG. Nevertheless, the index has declined in significance and many traders instead use the broader Standard & Poors 500 index to confirm Dow Industrial signals.
It is not an infallible system for beating the market ~ Robert Rhea.
The Dow Theory was created as a leading indicator of the business cycle. It should merely be used to indicate the direction of the primary trend — to be followed when trading individual stocks.