Dow Theory declared officially dead

Here and here and at briefing.com are some interesting links to reporting on the recent reshuffle of the Dow Inustrials.

Dow Jones announced today the first changes to the Dow Jones Industrial Average in five years. While the DJIA is still the most well known market index, these changes render the index less important and it puts the final nail in the coffin of traditional Dow Theory. Inclusion in the index will still be, as it always has been, a kind of "honorary" emblem of significance, but the index as a whole becomes less important because of this change.

Here is a short paper on the history of the Dow indexes for those interested. The original Dow theory was not developed by Charles Dow but by a couple of books published in the 1920's and 30's

* The Stock Market Barometer William Hamilton, 1922
* The Dow Theory Robert Rhea, 1932

According to these books, the indexes provided an insight into the overall health of the economy:

Traditional Dow Theory was based on the idea that the three basic indexes: industrials, transportation, and utilities provided an accurate reading of the core elements of the US economy. Since stock prices presage actual economic growth in a company, analyzing movements in the three basic indexes could provide meaningful clues as the direction of the overall economy.

This theory provided a sound basis for making investment decisions, too:

What Dow Theory all boiled down to is:

* Look for rises in the transportation and utility indexes -- ahead of a rise in the industrial index.
* When it happens: Buy the industrials.

The theory could also be used to forecast coming economic declines.

By following trends in each of the three indexes and looking for the relative movements among them, a reading of the market direction could be developed.

The recent change in the Dow Jones Industrial Index was the final straw, some say, in breaking the link between that index and the industrial sector of the economy. The theory, whatever it's previous value, has no value now.

What is needed?

What we really need is an "information index" that more accurately reflects the direction of the US economy.

[But] Technical analysis of Dow average charts will likely continue .... old traditions take centuries to die.