Saturday, January 24, 2015

Dow Theory Special Issue: Digging deeper into the primary bull market signal for gold and silver

I promised you that this weekend I was going to give you my take on the brand new primary bull market signal for SLV and GLD.

I’d like to say I find a compelling risk/reward ratio for GLD. The primary bull market was signaled on 1/16/2015 and GLD closed at 122.52. The primary bear market lows (11/5/2014) which are our Dow Theory initial stop are at 109.79 (more about the Dow Theory stop here). This means that our likely exit point lays -10.39% below the hypothetical entry level. Given gold’s daily volatility, which on occasion almost doubles that of the SPY (as of this writing GLD’s 30 days average of the daily volatility is merely 20% higher than that of the SPY, which is unusual), I feel that a stop that lies nearly 10% below our entry point is a very narrow stop (which would be the equivalent for stocks of a stop lying 5-6% below the entry point, which is a narrow stop by Dow Theory standards). Given gold’s volatility and current technical picture, I find that a position in gold offers a good risk reward ratio. We risk ca. 10%, and a gain of 30% is not an outlandish target if we are too judge according to past bull markets in gold.

Similar considerations apply to SLV, although with an even better technical picture:

1)     SLV’s stop (primary bear market lows), lie slightly below percetangewise than those of gold (entry point at 16.95 –close of 1/16/2015, primary bear market lows at 14.66) at ca. -13.51%. However, given SLV higher volatility, it is a narrow stop.

2)     The upside target (though fuzzy targets are) looks even better than for GLD. Why? Because the latest decline (primary bear market swing) was so deep, that merely reaching the last completed secondary reaction highs of 8/27/2013 at 23.59 would imply a +39.17% from our entry point. Of course, if this is not a failed bull market signal (a ca. 30% probability), it is safe to assume that at least the last recorded secondary reaction highs against the now defunct primary bear market are to be touched. Furthermore, and back to Rhea, this is the alternative primary bull market signal (break up/down of the high/lows of last completed secondary reaction). So technically the closing highs of the last secondary reaction against the primary bear market is a very important level, which should act like a magnet (if the primary bull market is a real one). I cannot thing of a real bull market that cannot manage to break up such technical level.

All in all, in this very specific instance, I like the risk reward for both SLV and GLD and the specific chart structure (location of the highs of the last completed secondary reaction, which should be an easy target) confirms me that a 30% price appreciation from the entry point (especially for SLV) is within easy reach.

Here you have a chart displaying price action for SLV (top) and GLD (bottom) since April 2013. There you can see on the left side (blue rectangle) the last secondary reaction against the primary bear market. The blue horizontal lines display the closing highs of such a secondary reaction, which is a very modest target, if we are talking of a “good” (ca. 70% probability) signal. Of course, if the new bull market is for real, then the blue lines should be exceeded with ease.

Nice primary bull market signal: Stops (primary bear market lows) near entry point and "easy" upside target

So while I don’t have a crystal ball, my Dow Theory tools tell me that the looks of this trade are certainly good. A gain of 30% or more is probable, while losses are well contained (primary bear market lows) as explained above.

Have a nice weekend.

The Dow Theorist.

Friday, January 23, 2015

Dow Theory Update for January 23: Stocks set up yesterday for primary bear market signal.

More on gold and silver this weekend


If you want to know how did we fare in 2014 by following the Dow Theory, you may read our yesterday's post, which you can find here
The SPY, Industrials and Transports closed down.

Yesterday, the SPY and the Transports managed to rally more than three percent from the secondary reaction lows (January 15th), and, hence set up US stocks for a primary bear market signal. The Industrials rallied a mere 2.85%. In any instance, as per Schannep’s Dow Theory, if suffices just one index to rally more than 3% from the secondary reaction lows in order to set up stocks for a primary bear market.

If you think I am doing away with the Dow Theory principle of confirmation by merely demanding one index to rally more than 3%, I quote what I wrote in my post of November 10th, 2012:

“Inquisitive minds should ask: What about the principle of confirmation for the rally that follows the pullback? Isn’t it necessary to have at least in two indices such +3% rally? Since only the Transports underwent such a +3% rally no valid setup exists since confirmation is lacking?

My answer is: You are not misguided, and I wouldn’t brand you as inaccurate if you demanded confirmation (at least two rallies exceeding 3%). Furthermore, when using three indices most of the times one sees two rallies exceeding 3%.

However, Rhea wrote that the principle of confirmation becomes more important the longer the time frame. In other words, a primary bull market signal is meaningless without confirmation. The same basically applies to secondary reactions. However, when it comes to rallies (or small pullbacks in bear markets) which I would label “tertiary movement," some Dow Theorists are lukewarm with the principle of confirmation.
Here are two quotes from Hamilton (contained in Rhea’s master book “The Dow Theory”) which are illustrative:

“…Dow’s theory….stipulates for a confirmation of one average by the other. This constantly occurs at the inceptions of a primary movement, but is anything but consistently present when the market turns for a secondary swing
“This illustration serves to emphasize the fact that while the two averages may vary in strength they will not materially vary in direction, especially in a major movement. Throughout all the years in which both averages have been kept this rule has proved entirely dependable. It is not only true of the major swings of the market but it is approximately true of the secondary reactions and rallies. It would not be true of the daily fluctuation (…)”

So from the two quotes we can deduct that a rally may be considered in itself without requiring confirmation. While this is not carved in stone and confirmation is always welcome, when we talk of a tertiary movement, we can be a little less demanding with the principle of confirmation. Please mind that one of the quotes even questions the inflexible application of the principle of confirmation to secondary reactions. As far as I know contemporary Dow Theorists like Russell, and Schannep have not gone that far and require confirmation for secondary reactions. So do I.

However, Schannep has done away with the requirement of confirmation when it comes to the rally that follows the secondary reaction in a bull market (same reversed in a bear market). Bearing in mind the preceding quotes, I don’t find anything irregular in it. However, those followers of the Dow Theory that also demand confirmation even for such rallies are not wrong either. Both interpretations may be fully reconciled with the Dow Theory.

Personally, I tend to follow Schannep quite closely and hence, I feel satisfied with just one rally after a secondary reaction has been established (which requires at least two indices going down by more than 3%). “

End of quote.

All in all, now we can say:

1)     The lows of the secondary reaction have been firmly established.

2)     Their joint violation would entail a primary bear market signal. 

3)     If stocks broke above the last recorded closing highs (12/26/2014 for the Industrials, and 12/29/2014 for the SPY and Transports), the primary bull market would be reconfirmed. 

Here you have an updated chart (the orange rectangle on the right side displays the secondary reaction and the ellipses display the current rally from the lows):

Ellipses show rally exceeding 3%. Set up for primary bear market signal completed on 1/23/2015

So now we have to wait and see…

The primary trend remains bullish, as explained here and here.

The secondary trend is bearish as explained here.

Gold and Silver

SLV and GLD closed down. The primary trend is bullish as explained here. The secondary trend is bullish too (no secondary reaction in sight).

This weekend I will post some thoughts concerning the primary bull market signal for SLV and GLD. As you will read, I particularily like this specific signal in terms of risk reward and chart structure (which makes it easy to attain handsome rewards).

Gold and Silver miners ETFs (GDX and SIL)

As to the gold and silver miners ETFs, SIL closed and GDX closed down.

On January 12, 2015, a primary bull market was signaled. More information as to the details of such a signal here.

The primary and secondary trend is bullish.

Some days ago I wrote that I’d feel more confident about the brand new primary bull market in gold and silver stocks, if the precious metals themselves were soon in a primary bull market. Well, now the entire precious metal universe is under a primary bull market. The principle of confirmation also applies on this basis: Bullishness in the stocks confirmed by the metals themselves (and vice versa) lends more credence to each respective bull market.

The Dow Theorist

Thursday, January 22, 2015

Dow Theory Special Issue: Putting 2014 in perspective

US Stocks

Let’s briefly recap how our Dow Theory analysis fared in 2014. Did we do a good job at determining the primary trend of the markets? 2013, as explained here was a good year for those applying the Dow Theory to stocks, gold, silver and their miners. 2014 has been a good year too (by avoiding losses with losers, and by winning with the winners).

Today I focus on US stocks. In the coming days, I will review how gold, silver and their ETF miners fared when traded in pursuance with the Dow Theory.

The year began on January 2 with an ongoing primary bull market, which had been reconfirmed on November 13th,2013, as you can read here.

This primary bull market signal lasted until October 10th, when a primary bear market was signaled, as explained here.

The long position was closed with profits, as explained here.

For the sake of completeness, I must say that Schannep, of “” interpreted the Dow Theory in a different fashion which resulted in his not signaling a primary bear market on October 10, 2014. Thus, Schannep remained fully invested. Our friendly discrepancy gave rise to a “saga” wherein I analyzed the reasons advocated by Schannep and I. Actually, this saga is not finished yet, as I have to write yet the closing chapter (which in many aspects will acknowledge Schannep’s acumen). You can find the hitherto four chapters of the saga here:



and here:

The primary bear market was short-lived and on October 31, a new primary bull market was signaled, as explained here.

This primary bull market remains in force as of this writing.

Here you have a chart displaying 2014, from January 2nd (first trading day) to December 31st. The orange rectangle displays the period we were sitting on the sidelines due to the primary bear market signal.

The trend is your friend. Don't fight it!

Now let's have a look at profits, as shown in the spreadsheet:






Jan 2

Jan 2
Dec 31

Oct 10 Primary bear mkt


Profit 1 (realized)

Oct 31 Primar bull mkt

Dec 31
 end of 2014

Profit 2 (unrealized)

Nominal profit (1+2)

Capitalised profit

Dow Theory outpeformance

Please mind that the real profits made by the investors are those that I label "capitalised". This is the money you'd have made starting with 100 units, cashing out 104.2 units at the Oct 10 exit and reinvesting the 104.2 units at the second buy signal on Oct 31. As you can see the Dow Theory made 6.2%. Nonetheless, buy and hold managed to make 12.36%. 

However we should put this numbers in perspective (don’t get too carried away by “buy and hold”)

If we adjust total returns by taking into account the maximum drawdown suffered during 2014, then buy and hold begins to shine a little bit less. A proper measure of performance (that takes into account risk, losses), is to obtain the ratio of total returns versus maximum drawdown. As you will see on the spreadsheets below, when we adjust for risk, buy and hold has a more modest outperformance.

MAX Drawdown 2014 SPY buy and hold

MAX Drawdown 2014 SPY  Dow Theory


Closing High

Closing High
Closing low


Max Drawdown

Max Drawdown

So we see that buy and hold had to endure a deeper drawdown than that of the Dow Theory (and a -7.62% drawdown is certainly a very mild drawdown according to historical standards).

Now, if we divide total performance by the largest drawdown, we obtain the risk adjusted measure of performance:

Ratio total return/Max DD for year 2014

Ratio total return/Max DD for year 2014

buy and hold

Dow Theory

total return

total return

max DD

max DD



So, even in a very lenient year (as far maximum drawdown is concerned) when we adjust for risk, we see that buy and hold, outperformed the Dow Theory but by a smaller degree than raw performance.

And please bear in mind that the deeper the drawdown, the more degraded the risk-adjusted performance of buy and hold. I give you an example that, alas, happens every now and then in the stock market. Let’s imagine that the October 2014 drawdown had been much deeper, let’s say 15% (which is not a rare occurrence). In such case, the Dow Theory, on a risk-adjusted basis would have outperformed buy and hold.

The bottom line is: focus on avoiding risk (losses). Don’t get blinded by performance. Performance will come, once you learn to contain losses.

Thus, for those thinking that buy and hold was better than trying to time the market, please heed this: Don't get blinded with 2014 (or 2013, for that matter). Please bear in mind that in “good” years buy and hold outperforms any timing device which tries to follow the primary trend. Furthermore, as I explained in my post "How often does the Dow Theory outperform Buy and Hold", we have to bear in mind that 41.2% of any given year the Dow Theory underperforms buy and hold. The global outperformance of the Dow Theory (be it "classical" or Schannep's) is made in relatively few years (normally, when markets are weak).

You can see what I have stated many times: it is close to impossible to beat buy and hold when there is a strong trend, since by definition timing devices (such as the Dow Theory) will always get aboard too late or exit prematurely (when there is a failed signal). However, as I have said ad nauseam in past posts, the Dow Theory manages to outperform buy and hold (both in terms of performance and in terms of reduced volatility) thanks to the “bad” times. In other words, the outperformance comes from cutting losses short. Thanks to the Dow Theory we manage to win slightly less than buy and hold when the sun shines, but we lose much, much less during bad times. The overall result is slight outperformance and, more importantly, dramatically reduced drawdowns. You are referred to the “Face off” saga for more information.

Conclusion: the Dow Theory did a good job keeping us most of the year on the right side of the market. While many fundamentalists and macro analysts were predicting a stock market decline (as they did in 2013 during this most hated bull market), the Dow Theory, impervious to ego or fundamentally-based ideas, told us that the trend was up. Out of 12 months, the Dow Theory had us invested in the market 11 months and some days. I pay with pleasure the price of being some weeks out of the market (and foregoing the corresponding performance) as an insurance against a real primary bear market.

To be continued with an analyisis of gold, silver and their miners ETFs during 2014.


The Dow Theorist