V.9:12 (508-511): The Essence Of Dow Theory: Confirmation And Divergence by Richard L. Evans

The Essence Of Dow Theory: Confirmation And Divergence by Richard L. Evans

The Dow theory tenet that the Dow Jones Industrials and Dow Jones Transports must "confirm" one another is listed perfunctorily in most Dow theory discussions, but confirmations and divergences are the gist of Dow theory. In an article in the July 1991 STOCKS & COMMODITIES, I discussed some nuances of Dow theory divergence and nonconfirmation. Briefly, Dow theory says that both the industrial and the transportation averages must confirm to have forecasting implications. Any signal on the part of one index without confirmation by the other is apt to be deceptive, if not outright negative.

However, I also pointed out that the Dow theory divergence and nonconfirmation tenet is one of the most misinterpreted facets of the theory. Some popular interpretations of Dow theory tend to be strictly statistical trend classification versus directional trend classification.

The statistical classification, which places heavy reliance on the averages jointly moving past a predetermined critical point, is by definition all hindsight, as it classifies what has happened. But nothing in Dow theory prevents us from drawing inferences about market trends, although some previous critical point may not have been penetrated. Instead, volume and the position of prices relative to the duration and extent of the primary and secondary trends can and should be used to make bullish or bearish inferences. The statistical classification of the trends should serve more to confirm or not confirm earlier implications in the averages.