Mark Hulbert: Dow Theory Doesn't Signal Stock Selloff

Thursday, 07 Aug 2014 07:30 AM

By Dan Weil

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While some stock market participants predicted the end of the five-year bull market after the Dow Jones Industrial Average erased all of its 2014 gains last week, the Dow Theory hasn't turned bearish, says Mark Hulbert, editor of Hulbert Financial Digest.

The Dow Theory was formulated between 1900 and 1930 by then Wall Street Journal editor, William Peter Hamilton, Hulbert writes on MarketWatch.

Hamilton set three requirements for a sell signal, Hulbert says.

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1. The Dow Industrial Average and the Dow Jones Transportation Average must both endure a "significant" correction from new highs.

2. In subsequent "significant" rally attempts after the correction, one or both of the indexes must fail to rise above its pre-correction high.

3. Both averages must then drop beneath their correction lows

So far, not even condition No. 1 has been met, Hulbert states, noting that there is some disagreement. Many Dow theorists say a correction must last three weeks and retrace one-third of the prior gain to qualify as "significant," he explains. "That would rule out what we've seen since the July market highs."

Both indices have fallen for less than three weeks and by less than 6 percent from last month's peaks.

"This doesn't mean a sell signal is imminent, of course, since new highs in the major averages would abort this three-step process and indicate that the bull market is alive and well. And the Dow Theory holds that the last primary signal remains in force until reversed, and that last signal was a bullish buy signal several years ago."

Still, many market participants have turned cautious. "You have a lot of continued momentum in this downward trend we've seen dating back a couple weeks," Joe Bell, senior equity analyst at Schaeffer's Investment Research, tells Bloomberg. "It doesn't always resolve itself in one day."

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