November 2, 2009

Dow Transportations vs Dow Industrials

The overall market continues to rise - are there any signs the trend is waning?

The daily bar chart above plots the Dow Transportations (left) vs the Dow Industrials (right). Both high and low prices are denoted by black dashed horizontal and vertical lines for each index. A longer term trend line (in black, from Mar 09) as well as a shorter term trend line (in red, from Jul 09) is plotted. Blue dashed horizontal lines offer polarity price targets for each market. Lastly, 14 period Average True Range and Money Flow indicators accompanying each index.

Among the tenets of Dow Theory, price action in one market should be confirmed by that of another. Clearly, the Dow Transportations index has broken both longer and shorter term trend lines. Indeed, the fall has seen the transports form a double top. Meanwhile, despite its faltering sister index, the Dow Industrials remains in a strong uptrend holding above both longer and shorter term trend lines.

What confirmations does this chart hold? Similar to RSI, Money Flow can be used to identify overbought and oversold conditions. Reviewing above, the Money Flow indicator reached overbought levels in Jul 09 in both indices. Markets can remain overbought for long periods of time, however, so we plot the Average True Range. Similar to Volatility, Average True Range can be used to identify trend continuation (low volatility) or reversal (high volatility).

Both the Transportations and Industrials have been poised to reverse since summer 09. What's different this time? Money Flow is exhibiting divergence relative to new market highs, and continues to fall. Oct 09, however, has brought an additional market confirmation - a strong breakout in Average True Range. With more pieces of the puzzle falling into place, the market itself may finally be due for a long awaited correction.

Having broken both trend lines, the Transportations index now targets $3,434 to the downside. A break below this level will target critical support near $3,145. Consequently, should the Industrials break its corresponding trend lines and fall to $9,424, the market should target critical support near $8,798. Any break below this level will affirm a correction in progress. Technicians should watch for follow through in Average True Range and/or Volatility as well.

Jeffery E. Lay, CMT
President
Talon Eight, LLC

Disclaimer: This post is intended solely to disseminate information, and is not, and shall not be construed to constitute financial, investment or other similar advice. All posted material should be independently verified for accuracy and current applicability. Readers of this post are referred to the Risk Disclosure for further information.

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