The Unspoken Rule of Charles Dow: The Role of Indices in Confirming Market Direction

The Importance of Confirmation

Charles Dow's confirmation principle is one of the most important, yet often overlooked, aspects of his theory. The principle states that for a market trend to be considered valid, the averages must confirm each other. In Dow's time, this meant the Dow Jones Industrial Average and the Dow Jones Transportation Average. The logic was that if the industrial companies were producing more goods, then the transportation companies must be shipping more goods. If both averages were moving in the same direction, it was a sign of a healthy economy and a sustainable trend.

Modern-Day Confirmation

In today's market, the same principle of confirmation can be applied, but with different indices. For example, a trader might look for confirmation between the S&P 500 and the Nasdaq 100. The S&P 500 represents the broad market, while the Nasdaq 100 is heavily weighted towards technology stocks. If both indices are making new highs, it is a sign of a strong and healthy market. If one index is making a new high while the other is not, it is a sign of divergence and a potential warning that the trend may be losing momentum.

The Unspoken Rule

The unspoken rule of Charles Dow is that you should never trust a market move that is not confirmed by another related index. A breakout on a single stock is not as reliable as a breakout that is confirmed by the broader market. A new high in the S&P 500 is not as reliable as a new high that is also confirmed by a new high in the Nasdaq 100. By waiting for confirmation, you can filter out many false signals and increase your chances of success.