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

The year-to-date closing lows for 2012 were set on June 4 at 12,101.46 for the Dow industrials and 4847.73 for the Dow transports. Closes below both of these levels would confirm a Dow Theory sell signal.

A year ago, the market was facing issues similar to the ones it confronts today. The U.S. had lost its triple-A rating, European debt concerns dominated headlines and there was discussion about the failure of QE2. Today, the European debt crisis is still front and center, and Wall Street is abuzz with predictions the Federal Reserve will offer QE3.

If we get a Dow Theory sell signal, the downside risk appears to be similar to 2011. The Dow transports fell nearly 30% from their all-time high on July 7 to a low of 3,950.66 on Oct. 4, 2011. The Dow industrials fell 19% from its May 2 high to a low of 10,404.49 on Oct. 4, 2011.

Before the market opened Tuesday, United Parcel Service ( UPS) reported weaker-than-expected earnings and revenue. The package shipper also lowered its full-year outlook, and its shares fell 3.61% on the day, closing below their 200-day simple moving average at $75.19.

Following are updated profiles for the transportation stocks I analyzed in June 2011.

CH Robinson Worldwide ( CHRW) is not in today's table because the stock was subsequently downgraded to hold from buy at www.ValuEngine.com. In addition I show no Value Levels.

CSX ( CSX) has a negative daily chart pattern with a monthly value level at $21.42, a semiannual pivot at $22.60 and quarterly risky level at $27.63.

FedEx ( FDX) has a negative daily chart pattern with a semiannual value level at $82.97, a weekly pivot at $89.92 and monthly risky level at $96.09.

JB Hunt Transport ( JBHT) has a negative daily chart pattern with semiannual value level at $49.82 and weekly risky level at $57.10.

Kansas City Southern ( KSU) has a neutral daily chart pattern with an annual value level at $61.62, a weekly pivot at $70.78 and monthly risky level at $76.40.

Norfolk Southern ( NSC) has a neutral daily chart pattern with a semiannual value level at $68.50, and a weekly risky level at $74.31.

United Parcel Service has a negative daily chart pattern with a semiannual value level at $70.89 and a weekly risky level at $80.52.

At the time of publication, Suttmeier had no positions in stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Richard Suttmeier has an engineering degree from Georgia Tech and a master of science from Brooklyn Poly. He began his career in the financial services industry in 1972 trading Treasury securities in the primary dealer community. In 1981 he formed the government bond department at LF Rothschild and helped establish that firm as a primary dealer in 1986. Richard began writing market research in 1984 and held positions as market strategist at firms such as Smith Barney, William R Hough, Joseph Stevens, and Rightside Advisors. He joined www.ValuEngine.com in 2008, producing newsletters covering the U.S. Capital Markets and a universe of more than 7,000 stocks. Richard employs a "buy and trade" investment strategy. You can reach Richard at RSuttmeier@Gmail.com.

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