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I've read that the Dow Theory is too old school, and that it runs at a lag. Why do you pay attention to it?

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Q: I've read that the Dow Theory is too old school, and that it runs at a lag. Why do you pay attention to it?

A: Dear Subscriber,

We like the old school. Over the last century, the Dow Theory has done a fine job of assessing the majority money opinion. Is it reliable enough to warrant switching from positions of 100% invested to 0% invested? Of course not. We’ve never found any indicator that reliable, and we don’t attempt such all-or-nothing market timing. However, we’ve had success using the Dow Theory to help determine our cash position.

In general, when the Dow Theory is bearish, we hold a larger percentage of recommended equity portfolios in cash or a short-term bond fund. During bullish periods, we’re more heavily invested. This asset-allocation strategy has boosted our returns over the long haul.

The Dow Theory does run at a slight lag because it reacts to new highs or lows in the averages. That is by design. The strategy’s lag allows it to reflect enough trading history to increase its accuracy. We don’t try to use the Dow Theory to peg market highs or lows. It doesn’t do that job well and, frankly, trying to pick exact highs and lows requires more luck than skill. However, the Dow Theory can help us increase market exposure starting in the early stage of an upswing and reduce exposure starting in the early stage of a downswing. There’s a lot of value in such information.

Thanks for your interest,

Bob Sweet, CFA
Managing Editor, Dow Theory Forecasts

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