After moving within 0.4% of a new low that would have put the Dow Theory in the bearish camp, the Dow Industrials have bounced with the help of some strong profit reports, explains Rich Moroney, editor of Dow Theory Forecasts.

For now, with the last confirmed Dow Theory signal the bull-market reconfirmation in November, our buy lists have about 94% in stocks.

Market action has been muddling since the Dow Industrials, Dow Transports, and S&P 500 Index reached all-time highs in November, with both unconfirmed new highs and unconfirmed new lows since then. Yet recent action has demonstrated the importance of three key Dow Theory principles:

  • Confirmation is crucial. As William Hamilton wrote in 1928, “Half an indication is not necessarily better than no indication at all. The two averages must confirm each other.”

The Industrials reached a significant high in January, while the Transports hit a significant low. But neither move was confirmed by the other average. (We use the S&P 500 as a check on the top-heavy Industrials, but only the Industrials and Transports figure in classic Dow Theory analysis.)

  • Close only counts in horseshoes and hand grenades. The Dow Theory attaches considerable importance to new closing highs and new closing lows. It doesn’t consider intraday lev- els or closing levels that nearly reach new highs or lows.

The Transports came close to confirming new highs in the Industrials in early January, and the Industrials nearly confirmed new lows in late January. But neither of those moves impacted the status of the Dow Theory, which requires that both averages move to significant closing highs or significant closing lows for a bull-market or bear-market signal.

  • The last confirmed signal remains intact until proved otherwise. As Hamilton wrote in 1929, “The barometer does not give indications every day and all the time; according to Charles H. Dow’s theory, an indication remains in force until it is canceled by another.”

While it may seem like the November highs are ancient history, experience over the last 30 years shows the wisdom of sticking with the last confirmed signal — Dow Industrials at 36,432.22 and Dow Transports at 17,039.38.

To do otherwise would risk being whipsawed by the secondary reactions that are part of all bull and bear markets. Moreover, if it is truly a bear market, the Industrials will eventually break below the December 1 level of 34,002.04. Such a breakdown would be bearish — and a reason to raise more cash.

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