Is The Old School 'Dow Theory' Flashing A Big 'Buy' Signal?

With the U.S. bull market in stocks rounding out its ninth year, investors have been keeping an eye on transport stocks for signs of a potential sell signal based on one of the oldest technical trading indicators.

Wall Street Journal founder Charles Dow wrote extensively about his theories on technical market analysis until his death in 1902. Robert Rhea used these writings as the basis of his book “The Dow Theory” in 1932.

Dow Theory Explained

Dow Theory is based on the idea of trading market momentum. At the center of Dow Theory is the idea that the transport sector of the market must confirm the trend of the overall market to trigger a true buy or sell signal.

According to Dow Theory, buy signals are generated when both the transport sector and the overall market are trending higher. Sell signals are generated when both are trending lower. When the two diverge, it could signal that a change in trend is imminent.

The idea behind Dow Theory is that a robust economic boom will drive up demand for shipment of both raw materials and final products. If both transport stocks and the overall market start heading downward, it’s a bad sign for the strength of the overall economy.

How To Play It

For traders who still subscribe to Dow Theory, 2018 is looking like another good year for stocks. Both the Dow Jones Industrial Average and the Dow Jones Transportation Average are trading at all-time highs heading into the end of the year. The Dow Jones Industrials are up 25.8 percent in 2017. While Dow Jones Transportation stocks have lagged the overall market, they're still up an impressive 12.8 percent year-to-date. (Price action as of Dec. 6.)

Traders that see both the Dow and its transportation stocks headed higher might consider looking at the SPDR Dow Jones Industrial Average ETF (NYSE: DIA) and the iShares Dow Jones Transport. Avg. (ETF) (NYSE: IYT).

Related Links:

What Is The 'Dow Theory Buy Signal' And Why Should Investors Care?

2017 Bulls Have Dow Theory On Their Side