The Old Guys Say “Sell!”
What if I told you that the oldest technical indicator in the book – a system of signals established by the best-known name in the financial business – was telling you to sell blue-chip stocks immediately?
First, a little back-story. Okay, a good bit of back story, but bear with me and I promise to get to that sell signal (and what you can do about it) in the end.
Back in the days when beards, tails and top hats were de rigueur for gentleman in the financial biz, Charles Dow wrote a series of 255 editorials for his quaint new paper, The Wall Street Journal.
After his death, William P. Hamilton, Robert Rhea and E. George Schaefer took his various cogitations, stray comments and bits of sentiment, and hammered them into a cohesive “Theory of Everything.”
The Six Commandments
This eponymous trading system had six primary tenets:
1: The market has three movementsMajor trends last one or more years, secondary reactions retrace the major trend over some 10 to 90 days, and short swings oscillate within reactions over either hours or days, depending on whom you ask.
2: Market trends have three phasesAccumulation (when insiders are buying a into a good deal), public participation (when every Tom, Dick and Harry gets involved), and distribution (when the wise guys sell off their shares for profit).
3: The stock market discounts all news Also known as “the efficient market theory,” there are three flaws to this idea of a level playing field. The first presumes that all companies are completely transparent and all information is universally available. The second presumes that this information is universally understandable. The third is that investors will always act in their own best interest.
(Now things get interesting: While the first tenet is technical in nature, relating to the time it takes for the market to uptake ideas, and the oscillating reactions to that uptake, the second two are really philosophical, relating to our presumed intelligence and sanity. But with item 4, Dow et al. resume contemplating empirical data.)
4: Stock market averages must confirm each other Back in Chuck Dow’s time, our buying population had spread from coast to coast. Industrial centers were cropping up all over the darn place, and raw materials were even further astray.
It was all well and good to set up a saddler in St. Louis. If you want to make money, you have to be able to get cowhide at a decent price from Montana and then profitably ship your saddles to riders in Philadelphia.
So the gist of this rule is that an increase in manufacturing isn’t a trend until it is confirmed by an increase in shipping. The same holds true in inverse: It ain’t a genuine bite-you-where-it-hurts bear market until the steam ships stay in port and the railroads stop rolling.
5: Trends are confirmed by volumeThis one’s easy: Trends aren’t hiccoughs, twitches or momentary indigestion. They require the full force and faith of millions of investors putting their money where it matters.
6: Trends exist until definitive signals prove that they have ended Finally, Dow lived in an era where science was remaking the world. Because he trusted the tangible over the ephemeral, he tried to link the concept of physical momentum to the psychology of crowd behavior. To wit: “A market in motion tends to remain in motion.”
So What Happens Now?
Let’s set rules 2 and 3 aside for a moment.
They are, as I said, more philosophy than science, and depend on a certain level of rationality and honesty that is in short supply these days.
I think that we can all agree that the requirements of rules 1 and 5 for a genuine bear trend have been satisfied beyond a shadow of doubt.
The question at hand is: “What happens now?”
Will Washington suddenly uncover some unfound well of competence, and drag our collective behinds back from the brink? Or are we about to tip into another yearlong round of bloody sell offs?
Bad News and Worse
I could point out the worst GDP reading in a quarter century (except I think I already have several times over the past few weeks). I could read you chapter and verse on current unemployment (7.2% according to the government, already cresting 12% according to some more “inclusive” calculations).
I could quote no less a luminary than British Prime Minister Gordon Brown, who confessed in the House of Commons that we are truly mired in a great depression akin to the 1930s. (The apparatchiks at #10 Downing Street are desperately trying to retract the statement, but I’m afraid that this particular cat is out of the bag, through the door, and out of sight down the street already.)
Or I could simply go back to Charles Dow’s tenet 4: “The Transports must confirm the Industrials.”
The Facts of the Matter
If you look at the Dow Jones Industrial Average for the past few days, you can’t help but see the fact that last Monday’s low of 7867.37 beat the previous low of 7909.03 set on Jan. 23.
If you look to the Dow Transports’ chart you can see consecutive lower lows of 2926.66 on Jan. 27 and 2865.58 on Feb. 2.
The Only Sane Solution
The trend is already in place.
The counter-reaction is ending.
The next leg down has been signaled and confirmed.
The only protective tactic that makes any sense is to buy puts against both the Industrials and Transports