- The Dow theory — a financial theory named after the father of technical analysis, Charles Dow — just flashed a bullish signal suggesting more upside ahead for the broader stock market.
- The theory is based on the relative price action of the Dow Jones industrial average and the Dow Jones transportation average, as traders look for a move in one to be confirmed by a move in the other.
- On Wednesday, the Dow Jones transportation average closed at a record high. The theory would suggest that the Dow Jones industrial average will soon follow.
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Following the death of Charles Dow in 1902, hundreds of his editorials published in The Wall Street Journal (which he founded) were compiled and expanded on, giving rise to “Dow theory.”
Coined by S. A. Nelson and refined by William Hamilton and Robert Rhea, Dow theory is the study of the intermarket relationship between the Dow Jones industrial average and the Dow Jones rail average, now called the transportation average.
The general idea is that both averages, over time, should move in tandem, given that the transportation average represents companies responsible for the movement of goods across the country. For that reason, it should serve as a leading indicator.
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Put differently, both depend on each other: If the economy is thriving, transportation companies should also be thriving, as they are tasked with literally moving the economy.
Technical analysts look to Dow theory to confirm broad movements in the stock market. Specifically, traders look for confirmations and divergences between the two indexes.
A confirmation is when the transportation