The theory was originally derived from the editorials of Charles H. Dow (1851-1902), first editor of the Wall Street Journal and co-founder of Dow Jones and Company.The Dow Theory asserts that bull markets are characterised by a primary trend that consists of three major upward thrusts interrupted by two pull-backs i.e. periods of weakness. It was later redefined, after his death, to state that a new high in the DJ Industrials had to be confirmed by a new high in the DJ Transports, and visa versa. Charles Dow, should therefore be credited with discovering the basic tenets of the EW in the late 1800's: a five wave sequence, with 3 waves up and 2 interceding waves down. In modern times, the U.S. has shifted from being an industrial nation to a service nation, and as a result, the redefined theory is even considered pretty much passe. I tend to disagree, somewhat. An expanding economy, whether a service one or not, still needs the transportation industry for raw materials, dry goods, produce, etc. And as such, it would make sense that the Transports would be the first indicator of economic expansion/contraction: goods tend to flow with the rise/fall of demand.

Historically, the Transports has also been a good leading indicator for the EW as well. I've posted a chart of the past 15 years of the TRAN verses the DOW, and highlighted two significant areas: 1989 - 1990, and 1999 - 2000. Both, as you recall, were important tops in the stock market. 

In reference to the 1989 - 1990 period. The importance here, resides in the fact, that the stock market had risen fives waves up from the 1982 lows, and could have ended the bull market. Of course it didn't, the DOW corrected about 20% and turned up with the euphoria of the total dominance of Iraq in our first invasion. I remember that night distinctly. That euphoria ignited the longest bull market leg in the history of the stock market 1987 - 2000. It still amazes me! 

Notice in Oct 1989 the TRANsports topped and turned down, and the DOW corrected too. Then as the DOW resumed it's advance in 1990 into a July top, the TRAN would not confirm this last leg up. A perfect divergence, and warning that the DOW was in its last advance. 

Move ahead now to 1999. In May of that year the TRANsports topped and turned down, the DOW corrected again. When the DOW resumed it's advance with the rest of the market into a Jan 2000 top, the TRANsports were nowhere to be found. Another perfect divergence, and warning that the DOW was assuredly in it's last advance. The NAZ/SPX topped in Mar of 2000, and we all know what happened thereafter.

I've posted a three year chart entitled TRANbullmkt. As you can see the Transports are in their own bull market, and the EW count is not even similar to any of the other four major indices NAZ/NDX/SPX/DOW, which is what we would like to see for it to remain a leading indicator. It just recently hit ALL TIME NEW HIGHS, exceeding even the top in 2000.

I have the TRANsports in wave iii of wave 5 of wave III. With waves iv of 5, and finally wave V to complete the bull market. Thus, this advance to complete and a subsequent two more advances, exactly the same as the general market. Notice the momentum, (MACD), at the bottom of the chart. It's the highest it has been in the entire bull market. Is this a leading indicator of things to come in the general market? They are all in third waves! Makes you wonder right? Best to your week.