The Golden Cross with Transport Index Confirmation

A lot of chatter about the stock market’s upcoming golden cross has focused on whether the Dow Jones Transportation Index (DJT) is confirming a bullish trend.

Unfamiliar with the golden cross? Read our take on the cross, about its two flavors (SMA and EMA) and crosses in up vs downtrending markets.

As the theory goes, to qualify as bullish, the DJT (an index of U.S. companies that move stuff around like airlines, railroads, ocean freight, etc.) must also confirm the market’s golden cross. I’m not a Dow Theory proponent, but if I remember correctly, this concept originated there.

In this post, we’ll look at how off-the-shelf golden crossovers, versus those confirmed by the DJT, have performed historically.

[logarithmically-scaled]

The chart above shows the results of two strategies trading the Dow Jones Industrial Average (DJIA) from 1931 (blue) to present. The first (red) is the straight version, going long at today’s close if the 50-day SMA crossed above the 200-day today. The second (green) is looking for DJT confirmation – it will only go long if both the first condition is met AND the 50-day SMA of the DJT index is trading above its 200-day.

Geek notes: these results are frictionless (i.e. do not account for transaction costs or slippage), and I’ve included a return on cash when not invested of half the nearest 13-week Treasury bill.

And for the number lovers…

Requiring DJT confirmation, improved performance over the life of the test, but only slightly. The strategy has gone through long periods where it hasn’t really helped or hurt.

What is more impressive to me is that the confirmation strategy maintained performance, while drastically reducing exposure (time invested in the market).

I’ve written about this before: accomplishing the same end goal with less exposure to the market is an inherently good thing because it reduces the risk of getting caught looking the wrong way on a massive unpredictable black-swan’ish day (a’la Oct. 1987 or Sep. 11, 2001).

Do I think DJT confirmation, as I’ve defined it here, is a huge step up in the strategy? No. Do I think it’s a nice little tweak that should at least be in the back of the mind for trend-following types? Sure.

Last comment: I’m not a fan of trading the DJ Industrial Average. I used it here because it was a nice match for the DJT, but my personal opinion is that it’s too driven by too few names (in other words, it’s not sufficiently diluted) to be easily traded.

I personally would much rather trade something like the S&P 500, so in a follow up post, I’ll rerun this same golden crossover test on the S&P 500, but still using the DJT for confirmation. More to follow.

Happy Trading.

Comments

[fletcherchr...:]

According to Dow Theory proponent Richard Russell, the DJT did NOT confirm the DJIA and therefore the conclusion drawn is based on an incorrect premise.

RR June 11th "...the Industrials recorded a high on May 8 at 8574.65 while the Transports recorded their high of 3404.11 on May 6. A minor decline followed, and on the ensuing advance Industrials continued to rise to a new high above their May 8 high. But on the latest rally, the Transports have failed to confirm the Industrials by refusing to advance to a new high above their May 6 peak. Twenty-four trading days have now elapsed since May 6 and despite talk of "a better economy" and numerous "green shoots," the Transports still have not confirmed."

And subsequently the DJTs have dropped further, indicating that a confirmation is extremely unlikely without a significant downward correction in the DJIA.

Jun 24 06:00 AM

[CLH:]

The nonconfirming transports are easy to explain (rationalize?). The transports are almost entirely dependent on energy. We are coming off an oil bubble (forming a second peak). When the price of oil returns to normal (30-40 dollars) the transports will quickly confirm.

Jun 24 01:21 PM

[cyclingscholar:]

Lets let the averages tell the story, as Dow always suggested. But I might add, lower oil prices would not necessarily mean a Transport confirmation, if the oil prices were the result of weak economic performance. Sometimes oil prices are the TAIL, not the dog!

Jun 24 02:30 PM

[fletcherchr...:]

The nonconfirming transports are much easier to explain by the massive drop in volumes of goods transported by Rail, Courier Companies, Trucking Co.s all of whom have seen a significant decline in volumes.

The oil price is a red-herring.


On Jun 24 01:21 PM CLH wrote:

> The nonconfirming transports are easy to explain (rationalize?).
> The transports are almost entirely dependent on energy. We are coming
> off an oil bubble (forming a second peak). When the price of oil
> returns to normal (30-40 dollars) the transports will quickly confirm.

Jun 25 02:44 AM

[Mad Hedge F...:]

Don't count your checkens before the eggs are hatched. Now that we are solidly into a correction, I have been flooded with requests from readers to call the next bottom in the S&P 500. Well here it is. Brace yourself. Put it on a Post-it-Note on your computer. It is without a doubt and unquestionably going to be 880, 850, 830, 800, 750, 666, or 320. That last number works out to be 90% of the book value of the S&P 500, which was the low seen in the 1930s depression. Yes, that depression, not this one. You are really asking me to solve a one billion variable equation, because that is the number of direct and indirect participants in global stock markets. If the few green shoots out there start to die off, the meltdown in commercial real estate accelerates, the Fed missteps by draining liquidity too soon, or there is another unforeseen shock to the system, then you can go with the lower of these numbers. If we are distracted by the health care debate, emerging market economies continue to perk up, and this strength helps our technology stocks stay alive, then sleepy narrow trading ranges will dominate, and the higher support levels will hold. But no matter what happens, I will be able to come back to you in three months and claim that I was right.

Jun 25 09:02 AM