Dow Theory

If you're an average investor you probably haven't heard of it but it's been around for over 100 years and is the basis of technical analysis in use today.

Charles H. Dow started publishing his theories on how the stock market behaved beginning in 1900 until his death in 1902. He never completed his work but others have stepped in to polish and finish what Dow started.

In a nutshell Dow believed that by analyzing the overall market an investor could accurately identify the direction of not only the market but of individual stocks. His theory was based not in individual securities but the movement of the broader markets.

Several problems have emerged over the years with the Dow Theory. One is that by its conservative analysis investors who follow may miss out on significant gains. The other is that the indices that Dow used to base his calculations have changed significantly.

That being said the Dow is again sending buy signals on August 11th based on Charles' Theory. One correlation is that as industrial firms profits increase so their output. And, because goods need to be transported to the marketplace the transport index must also rise. In other words for a bull market confirmation with the increase of one so should the other index rise.

The problem is that today not everyone is buying the Dow Theory. While some economists point to a definite buy others are not only skeptical but also worried the markets are due for a sell off. Skeptics argue that rather than using the Dow transport index as a confirmation analysts should be using the Baltic Dry index, which tracks international shipping rates of dry cargo. That index is falling like a stone.

So while the Dow industrial and the Dow transports have indicated the confirmation of a Bull market many economists believe much of the market's energy has been used up.

There is just enough bad and good news to confuse the best analyst and most cautious long-term investor. Making this not a market for the faint of heart.