Dow Theory

Equities 4 minutes to read

Junvum Kim

Sales Trader

Summary:  Since coronavirus, NASDAQ index has rapidly grown in both interest and market cap this year but these two out of favor indexes (Dow Jones Industrial Average and Dow Transportation Average) can still provide some useful insights on the market conditions by Dow Theory which has been around for more than a century.


Most of traders and investor would know Dow Jones Industrial Average (INDU) is a price weighted index of 30 US blue chip companies.  It is the second oldest US stock index behind 124-year old Dow Transportation Average (TRAN) which is also price weighted and represents 20 large US companies within transportation industry. 

There was a major change in the components of INDU on 31 Aug when Amgen (AMGN), Salesforce (CRM) and Honeywell (HON) replaced the well known companies – Exxon Mobil (XOM), Pfizer (PFE) and Raytheon (RTX) as Apple (AAPL)’s 4-1 stock split would reduce the weight on Information Technology sector that was already under-representing compared to other major market cap weighted indexes. 

 The update removed XOM, the longest serving member of the index that was once world’s biggest company back in 2011 however, the change is yet to have any significant impact on the YTD return as INDU’s negative performance still clearly lags behind both S&P 500 (+6%) and NASDAQ (+27%).  Interestingly TRAN so far has outperformed INDU in terms of year to date performance, 7% vs -1%.  The top two outperforming stocks within TRAN have been FedEx Corp (FDX) and United Parcel Service (UPS) which both gained 77% and 49% YTD respectively.  The worst stocks are unsurprisingly the airline stocks including United Airlines (UAL) and American Airlines (AAL) with -59% and -54%.  Fortunately, TRAN has a lot less weightings on these lagging airlines so there has been insignificant drag on the return of the index.

Since coronavirus, NASDAQ index has rapidly grown in both interest and market cap this year but these two out of favor indexes (INDU and TRAN) can still provide some useful insights on the market conditions by Dow Theory which has been around for more than a century.  It is essentially a belief that studying the two can indicate a basic market trends when both averages break previous swing high or low levels.  It may sound like a technical analysis, however the logical idea behind this signal could be more than just another indicator in current conditions as business activities and earnings are more sensitive to shipping and logistics triggered by lockdowns and change in the way people live post coronavirus.

Today TRAN gained 80% from March 2020 sell off low and hit all time high 11,737 surpassing the previous peak 11,623 that was printed back in Sep 2018.  In the meantime, the record high of INDU was 29,568 on Feb 2020 but the index has not yet either retest or break that level yet.  The obvious reasons behind this underperformance may be explained by the lack of tech components despite the inclusion of Salesforce and also Apple now having only less than 3% weight rather than pre index change weight of 12%.

Unless we see INDU to push itself higher above 29,568, it may be premature to validate or confirm a bullish outlook and relatively it is not expected to be an easy task as its components are largely less growth stocks with the index PE ration of 24 compared to NASDAQ’s 66.  This is even despite the fact that IT sector has the largest weight of nearly quarter of the index as only Apple is the sole stock out of the FAANG stocks hence it is missing out on the other trillion market cap tech stock’s momentum that has shown strong growth anticipation over the last six month.  Since Road/rail and freight/logistics sectors take up to nearly 90% of the TRAN, the recent outperformance over INDU may continue to exist even though we still see uncertainties surrounding impacts of the coronavirus.

It is easy to just follow and trade FAANG stocks or growth driven tech sectors related to cloud, chips, data and battery or even iron ore and soybean futures that are enjoying and maintaining strength with backwardation in their term structure, however the Dow Theory between INDU and TRAN may still provide relevant analysis to convince either speculators or investors who questions the magnitude of the recent recovery of stock market and those asking how long this current bull run can sustain its valuations heading into US presidential election in less than 4 weeks.

Dow Industrial Average can be traded by number of instruments: US30 (CFD), YMZ0 (futures), YM (futures options), DJX (index options), DIA (ETF)

Dow Transportation Average can be traded on IYT which is iShares ETF that has risk rating of 2.

 

 

 

Disclaimer

Saxo Capital Markets (Australia) Pty Ltd prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Pty Ltd ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide and Product Disclosure Statement to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as CFDs and Margin FX products may result in your losses surpassing your initial deposits. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.
Please click here to view our full disclaimer.