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Dow Theory Confusion Offers Great Profit Potential (IYT/DIA)

Posted on October 19, 2020

Dow Theory doesn’t get a lot of attention these days.

At one time it was the only “technical” game in town.

But that was nearly a century ago.

In any event, Dow Theory still has its uses, and we monitor it – as we do nearly all approaches to the investment game – in order to glean every possible edge available.

That said, Dow Theory developments over the last few days are proving interesting.

Take a look here at the Transportation Average for the last three years –

 

As you can see, the index just posted new highs – its first since September of 2018.

According to the theory, the primary trend of the market will be UP if and when the Dow Industrials confirm the Transport’s highs with a high of their own.

Gastro-Industrial Indigestion

But that hasn’t happened.

Yet.

The Industrials enjoyed several bumps higher since their September 2018 crest, with all-time markers set again this February at 29,568.

But thereafter, the Batflu struck, and both indices sunk to new major lows.

Which means we’re now in a period of ‘Non-Confirmation’.

More on that in a moment.

But first, take a peek at the Industrials –

The Industrials have not been able to squeeze out new highs of late, and that means the next intermediate move will tell the tale.

  1. If the Industrials manage to trend higher, set new highs and confirm the Transport’s peak of last week, the primary trend is UP.
  2. But if we see both indices trend lower and post lower lows (below the March Batflu bottom), we’ll know that a major secular change in market direction is underway.  The long awaited – and in some quarters sought after – bear market will be upon us.

Either way, though, a resolution to the current impasse has to materialize.

And we’re playing it like this –

A Jew and His Money recommends you sell the IYT March 19th 215/220 CALL spread for $1.40 (11.50/10.10) and use the funds against the purchase of the DIA 290/295 CALL spread for $3.20 (13.55/10.35).  Total debit on the trade is $1.80.

Rationale: we believe the Dow’s non-confirmation situation will resolve directly after the election – or, at the very least, within a few months of it (depending upon the degree and duration of Washington shenanigans).

The chaos that we’re expecting will either provide sure cover for a steep rise in the indices, or will trouble the system to its core, resulting in a meltdown.

We see the overbought RSI read on the Transports as a sign that they’re unlikely to push higher in the near term.

We therefore expect better relative strength from the Industrials vis-à-vis the Trannies.

The pairing attempts to capitalize on that premise by going long an Industrials CALL spread and short a Tranny CALL spread.

Maximum gain on the trade is $5.00.

Maximum loss is $6.80, and would occur if the two indices diverged significantly

(Transports higher, Industrials lower).

With kind regards,

Hugh L. O’Haynew

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