Laura Banks
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Dow Theory sell signal may actually be telling us to buy

On Aug. 24, the Dow Jones Industrial Average (DJIA) and Dow Jones Transportation Average (DJT) fell to new (one-year) lows. Most Dow Theory aficionados consider this a sell signal.

I got grilled for suggesting that this Dow Theory sell signal is actually bullish for stocks.

Why is Dow Theory unreliable?

What made this particular Dow Theory sell signal unique, is that the Dow Jones Utility Average (DJU) also fell to a new one-year low.

Although the DJU doesn't usually factor into the Dow Theory signals (as many commenters kindly pointed out; i.e., "What is this dude talking about utilities for? Get a clue on Dow Theory. Read Hamilton. Should I buy it for you, Simon?"), the implications of this particular triple-low constellation were statistically significant.

Why? Because this rare setup happened only four times in the past 25 years. The prior three times contradicted the Dow Theory sell signal, and actually turned out to be good buying opportunities.

Please know that I don't have a bias against Dow Theory (or any other indicator). My goal is simply to look at indicators objectively, and use historical data to assess their track record of accuracy.

The Aug. 24 sell signal just didn't pass the test, that's why the original column mentioned above proposed that: "the most important message is that some of the best buying opportunities occurred in September or October."

The chart below, which plots the DJI against the DJT, shows that both indexes bounced immediately after the Dow Theory sell signal was triggered (green line and red circles).

The DJI has been the stronger of the two, having retraced a bit more than Fibonacci 78.6% of the prior losses, and currently gnawing on trend line resistance.

The DJT has yet to recover even half of its losses, thus far unable to overcome resistance around 8,320 and 8,570.

Both indexes (or averages to be exact) need to overcome resistance to unlock higher targets. A more detailed stock market outlook is available here.

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