The Dow Theory is something that’s often mentioned in market commentary and on the major financial news channel. At least one component of it is, the confirmation of new highs and lows by the Dow Industrial and Dow Transports. This mythology of using these two indices to provide insight into the ‘health’ of a trend has been around since the early 1900’s when first created by Charles Dow.
To start the month the Dow Industrial Average ($INDU) made a new high however, the Transports ($TRAN) did not confirm the move. Much speculation was passed around for the cause or whether the lack of a new high in Transports was sending a signal that the for the end of the current bull market. You can make up your own mind on whether that’s true or not.
As far as the ’cause’ of the divergence we can look at momentum as a tool that helped show that may have been the outcome. Below is a weekly chart of the ratio between Transports and Industrials along with a 14-week Relative Strength Index (RSI), which measures momentum. Since November we’ve seen lower highs in the RSI indicator while the Transports led Industrials as shown by the green line rising. This bearish momentum divergence was sending a warning sign that the trend of out-performance for Transports may soon be coming to an end. And that appears to be what’ we are seeing now as Industrials have taken over leadership between these two major Averages.
For those that look for a reason in why markets act the way they do, this may help explain why the Dow was able to make a new high while the Transports have been unsuccessful in hitting one of their own.
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