Dow Theorists, Rejoice! Another Buy Signal Has Been Spotted

by Tyler Craig | September 19, 2013 2:11 pm

Yesterday’s FOMC announcement — in which Bernanke & Co. defied expectations by electing to hold off on any tapering[1] for now — was one for the ages.

Markets reacted with glee as gasoline was poured on an already robust fire. All of the recent trends seemingly driven by “taper discounting” were reversed. Interest-rate-sensitive sectors like utilities and REITs launched into the stratosphere[2] as the 10-year bond yield fell dramatically to 2.7%. The recent downturn in anything related to gold experienced an epic reversal — the Market Vectors Gold Miners ETF (GDX[3]), for example, was up a ridiculous 9%. Even the depressed and downtrodden U.S. Treasuries caught a bid.

And Dow Theory subscribers received a reason to rejoice, as the recently hampered Dow Jones Industrial Average soared to yet another new all-time high alongside its twin, the Dow Jones Transportation Index.

This simultaneous surge qualifies as yet another buy signal for the century-old Dow Theory, which contends that new highs in one of these indices ought to be confirmed by new highs in the other. While this isn’t the first buy signal generated this year, and although most followers of Dow Theory already sit in the bull camp, yesterday’s rally does reconfirm the ongoing bull market.

What’s more, it shows victory for the bears proved elusive once again, as they were unable to capitalize on the August swoon in the Dow.

DowTheoryChart Dow Theorists, Rejoice! Another Buy Signal Has Been Spotted
Click to Enlarge

Within the transports space, railroad stocks have begun a renewed advance. Norfolk Southern (NSC[4]) in particular boasts a couple compelling developments. It recently broke out of a descending triangle consolidation pattern, kicking off a new up-leg. At the same time, the comparative relative strength indicator turned up, showing it has embraced a new regime of relative strength for a change.

NSCchart Dow Theorists, Rejoice! Another Buy Signal Has Been Spotted
Click to Enlarge

While it might be a touch overextended in the short run, dips are likely buyable. On NSC’s next pullback, consider snatching up an Oct 75-80 bull call spread by purchasing the Oct 75 call and selling the Oct 80 call for a net debit around $3. The strategy sets up nicely for an eventual test of Norfolk Southern’s all-time highs near $80.

The max risk is limited to the initial debit paid, or $3. The max reward is limited to the spread between strikes minus the net debit, or $2. If you wait for a dip before pulling the trigger, the spread should be cheaper when you enter.

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

Endnotes:
  1. electing to hold off on any tapering: http://slant.investorplace.com/2013/09/fed-fomc-bernanke-qe-taper/
  2. launched into the stratosphere: http://investorplace.com/2013/09/5-no-taper-breakout-stocks-to-buy/
  3. GDX: http://studio-5.financialcontent.com/investplace/quote?Symbol=GDX
  4. NSC: http://studio-5.financialcontent.com/investplace/quote?Symbol=NSC

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