On the Lookout for a Dow Theory Sell Signal

NEW YORK ( TheStreet) -- Investors and traders looking for clues about the stock market's direction should pay attention to Dow Theory, because it could flash a sell signal.

If you're unfamiliar with Dow Theory, it's an old-fashioned method of technical analysis that looks at the Dow Jones Industrial Average and Dow Jones Transportation Average.

Essentially, a Dow Theory buy signal occurs when either of those indices sets a new closing high for the period being analyzed, followed by a confirming closing high by the other index. If the second index fails to make that confirming high, it's called a Dow Theory nonconfirmation.

Similarly, a Dow Theory sell signal occurs when transports or industrials set a new closing low for the time being analyzed, followed by a confirming closing low by the other. If the other index does not follow, it is a Dow Theory nonconfirmation.

The daily chart for the Dow Jones Transportation Average (below) is negative with declining momentum (12x3x3 daily slow stochastic, and closes below the 50-day and 200-day simple moving averages at 5078 and 5075, respectively, which are close to a bearish crossover.

Last year, there were expectations for a Dow Theory buy signal, but it wasn't to be. The Dow transports set an all-time high of 5627.85, and an all-time closing high of 5618.25, on July 7, 2011.

The previous closing high for the transports was 5514.87 on April 29, 2011. The year-to-date high for the Dow industrials in 2011 was also set on April 29, 2011 at 12,810.54, so a Dow Theory buy signal in July required a close above 12,810.54 by the Dow industrials for confirmation.

Source: Thomson Reuters

The best the Dow industrials could do was a 12,724.41 close on July 21, 2011. On Aug. 2, 2011 both averages plunged below their 200-day simple moving averages.

The daily chart for the Dow Jones Industrial Average (below) is also negative, with declining momentum (12x3x3 daily slow stochastic). The Dow industrials is below its 50-day simple moving average at 12,609, but the 200-day simple-moving average at 12,523 held at Tuesday's low. The transports are thus leading the industrials lower.

Source: Thomson Reuters

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