Dow Theory Generates a Buy Signal … Again

by Tyler Craig | May 7, 2013 1:06 pm

Dow Theory Generates a Buy Signal … Again

Proponents of the century old Dow Theory are once again beating the bull drum. With yesterday’s breakout to new all-time highs in the Dow Jones Transportation Index, a new buy signal was generated — the second one this year.

For those who have been keeping score, the first buy signal triggered in early March when the Dow Jones Industrial Average broke above its 2007 highs (see chart below).

1stDowTheorySignal Dow Theory Generates a Buy Signal ... Again[1]

Dow Theorists look for a new high or low in either the DJIA or Dow Jones Transportation Average to be confirmed by a new high or low in the other index. Earlier this year, the transports were the first to break out to a new all-time high on Jan. 15. It took until May 5 for the industrials to follow suit and finally climb above their prior peak created in 2007. Since the May 5 confirmation signal, the DJIA has climbed more than 5%.

This go-around, the confirmation occurred much quicker, and it was the industrials that led the transports. As shown in the chart below, the DJIA broke out last Friday, followed by the transportation average yesterday.

2ndDowTheorySignal Dow Theory Generates a Buy Signal ... Again[2]

Time will tell how powerful the latest buy signal turns out, but with the Dow Jones Transportation Index up over 1% in trading Tuesday, it appears we’re off to a great start.

Although many transports are already up four days in a row and arguably too extended to consider buying at this stage, some are still providing low-risk entry points.

KSUchart 300x227 Dow Theory Generates a Buy Signal ... Again
Click to Enlarge
During the past two months, Kansas City Southern (NYSE:KSU[3]) has been forming a clean base, which might act as a springboard for the next stage of its ongoing uptrend. A breakout above the resistance level at $111 might well kick off its next advance.

One simple way to exploit a continued rise in the railroad company is purchasing a June 110-115 call spread by simultaneously buying the June 110 call and selling the June 115 call for around $1.95.

The max loss is limited to the initial $1.95 debit and will be incurred if KSU sits below $110 at June expiration. The max gain is limited to the distance between strikes minus the net debit, or $3.05, and will be captured if KSU can rise above $115 by expiration.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

Endnotes:
  1. [Image]: http://investorplace.com/wp-content/uploads/2013/05/1stDowTheorySignal.png
  2. [Image]: http://investorplace.com/wp-content/uploads/2013/05/2ndDowTheorySignal.png
  3. KSU: http://markets.financialcontent.com/investplace./quote?Symbol=KSU

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