Friday, August 31, 2012

Fundamental versus Technical analysis and Dow Theory. Who is right?

The sad truth is that whatever method you apply it is very difficult to make money in the markets.

As the saying goes: It is easier to talk (or write) about money than making it.

Thus, it is difficult to discern (a) the encrypted messages of technical analysis, and (b) the validity of the “fundamental” information.

Personally, I tend to believe that you have to go with the flow. Ego is a very bad counselor in the markets. Thus, if I were placed between a rock and a hard place, I’d choose the investment method that relies less on you own ego. So I’d choose technical analysis by default.

Of course, by choosing “technical” you have not fully solved the ego problem. The ego can bias our application and interpretation of technical analysis. Furthermore, most of the technical analysis tools are too fuzzy and do not let themselves well to hard and fast rules that minimize “ego” interference.

My only concession to “fundamental analysis” would be when trying to ascertain very long term investment themes. If we, for instance, believe in peak oil, which I don’t, then we should adjust our very long term investments to this belief. If we believe, as I do, that major currencies and their associated debt will undergo major upheaval during the next decade, then a very long term position in gold might be advisable. However, my concession to “fundamental analysis” is strongly nuanced. How do I know that I am not wrong in my long term investment theme? How do I know what I don’t know? The more I know about economics and investments, the more I realize that knowledge plays a minor part in achieving investment success.

Famed investor Soros is a good example of humility at work and his track record attests to his wisdom. Ego is appealing to us but it can be very costly in the markets.

So I am clearly in the “technical” camp by default. Merely because I don’t trust earnings reports, macro economic analysis, etc. I don’t trust the data (in most instances) and I trust even less my interpretation or others interpretation thereof.

I repeat there is no magic formula (well there is one here ) in investing. This is why somebody said that trading (and investing) “is the hardest way to make easy money”.

For me most “technical analysis” techniques are dubious at best (try to test them in a computer and you will see it by yourself) but they are less harmful than a bloated ego which is the result of too much fundamental analysis.

After all is said and done, only one tool of technical analysis has stood the test of time and has a proven track record: The Dow Theory.

And this is why I hone it every day and I kindly encourage you to do so.

The Dow Theorist

Thursday, August 30, 2012

The Dow Theory gives us order. It provides us with a framework to analyze the market.

We fail at making money in the markets not because of a lack of tools but because we (1) lack consistency in using our tools, (2) have an undefined time-frame and (3) lack of well defined exits (stops)

Dow Theory addresses these three issues: It allows us to be consistent. Of course, to be consistent you have to believe in it. And such faith in Dow Theory will come from focused study. Dow Theory is based on a definite set of rules which make sense aprioristically and empirically. And we also know that it works, since the Dow Theory has a proven track record spanning more than 110 years. Few technical systems can boast such outstanding “back testing results”. The rules are sufficiently defined and psychologically bearable so that we consistently use them and not jump from one method to the next while our losses mount. When the Dow Theory is properly digested (and hopefully this blog helps you at that) it is easy to buy when it says to buy and to sell when it says “sell” (which usually translates into “get out of danger and run for the exits”).

It has clearly defined time-frames. We know the time it takes for a movement to be qualified as a correction, we roughly know what to expect (at a minimum) of a primary movement both in time and extent. We know that to qualify as a rally price action must have a magnitude of at least 3%. Dow Theory gives us a yardstick with which we can assess market conditions. Personally, without the Dow Theory yardstick I am at a loss when trying to make sense of the markets. It is like being unable to read. Without Dow Theory I feel market illiterate.

And last but not least, the Dow Theory tells us when to run for the exits. As Buffet said the first rule of investing is not to lose money, the second one not to forget the first one. Most fortunes are lost (not only in trading/investing but mainly by entrepreneurs but this is the subject for another post) by not knowing when to get out. In other words, capital is usually lost by poor timing. Dow Theory, while not having hard defined stops (and this is good to avoid stop running), adapts to the vicissitudes of the market and tells us when to get out. Studies show that rarely the Dow Theory gives away more than 10% of the unrealized gains from the top. Hence it helps us keep our power dry and while sitting on the sidelines in cash, expect the next bull wave (primary movement).

Dow Theory gives order to the universe or, at least, a powerful tool to analyze it. When one learns to identify a primary swing, a correction, a rally, etc. one is able to see the market as if through a kaleidoscope. Suddenly all the crystals fall in place.

The Dow Theorist

August 22, 2012. Dow Theory signals a new primary bull movement in gold and silver? II

Yesterday we discussed that a new primary bull market in gold and silver was born as per my interpretation of the Dow Theory.

Today, we are going to look into the details of the Dow Theory signal.

For the purposes of this post I will use GLD and SLV (the most popular gold and silver ETFs) as proxies for the prices of gold and silver.

In 5/16/12 we had the last leg down (primary movement) in both indices that established new lows for the move. These are the prices to note:

149.46 GLD
26.37 SLV

Thereafter, there was a rally, namely:

11 days rally in gold. End of rally: 06/01/2012 at 157.5. This amounts to a rally exceeding 5.3% from the lows (at 149.46).

14 days rally in silver. End of rally: 6/6/2012 at 28.51. This amounts to a rally exceeding 8% from the lows (at 26.37).

Thus, both rallies qualify as a correction of the previous primary down move, since both movements exceeded 3% and lasted more than 10 trading days. Three percent (3%) is the minimum magnitude under Dow Theory of a movement to be considered as significant. Under Dow Theory a rally (or decline) must last at least 10 trading days to be considered as a correction of the primary move.

From that point on, both markets staged a new leg down. However, gold refused to make a lower low (that is that the lows of June at 149.46 were not violated).

However, silver made new lower lows on 6/21, 6/22 and 6/28/2012. Such new lows were not confirmed by GLD. Under Dow Theory this lack of confirmation by GLD hinted that the primary bear market movement was likely getting exhausted.

Little by little both markets staged a new rally and:

On 8/21/2012 the previous HIGH at 157.5 was bettered by GLD
On 8/22/2012 the previous HIGH at 28.51 bettered by SLV.

So with one day delay (also bullish sign, the shorter the delay for the confirmation, the better) both GLD and SLV have bettered their previous secondary correction highs.

Under Dow Theory we got a primary bull market movement signal.

Furthermore, it is noteworthy that we are seeing higher highs and lows. In each rally gold and silver are establishing higher highs and lows. Under Dow Theory higher highs and lows hint at a bull movement of secondary nature at least.

In other words, the primary tide of the market has turned bullish for both metals and the secondary tide of the market seems, for the time being, also bullishly aligned with it.

The only negative note, however, is the mining indices. Hitherto they have refused to better their previous highs. 

The Dow Theorist

Wednesday, August 29, 2012

August 22, 2012. Dow Theory signals a new primary bull movement in gold and silver

First of all, we have to know our time frame. As I tend to say to market practitioners: “Show me your time frame”. It is easy to forecast the market without defining the time frame where the prediction is supposed to play out. Even a couple of up days could be labelled as a bull market, hence proving the market forecaster right.
What do I mean by a “new primary bull movement”? Do I mean that I think the market will go up for a month, a quarter, a year or a secular bull lasting many years?

Well, in Dow Theory the expression “primary movement” defines a bull or bear market over periods that span from less than a year to several years. Thus, the movement that under Dow Theory started last August 22, 2012 is supposed to be significant both in extent and duration. Maybe 6 months or maybe 2 years.

A primary bull movement doesn’t mean that gold and silver will not undergo corrections. However, such corrections should not exceed the lows made in May (Gold) and June (Silver).

In any instance, the signal we have just got is powerful under Dow Theory.

While Dow Theory was originally devised for stocks, it lends itself well to being applied to correlated markets like gold and silver. After all, Dow Theory is just a subset, albeit a very powerful one, of technical analysis. So the inferences drawn from Dow Theory may safely be applied to gold and silver like any other tool of technical analysis.

The Gold/Silver ratio (GSR) is moving in favor of silver which in the short-medium term is bullish for both metals. Thus, the GSR seems to be aligned with the Dow Theory signal. 

Tomorrow I will give you the details of my interpretation of Dow Theory when applied to the gold and silver markets. 

The Dow Theorist

How to learn Dow Theory?

While we will discuss and deepen all the tenets of the Dow Theory and apply them "life" to the markets, this blog is neither a primer nor a book on Dow Theory. Any reader interested in becoming conversant with Dow Theory is highly encouraged to passionately read the following books:

I would begin with this one. It is brief and clear. It is a great primer to Dow Theory written by Richard Russell the most famous Dow Theorist still alive to this day:

Dow Theory Today (Fraser Publishing Library) (The Contrary Opinion Library) [Paperback] Richard Russell (Author)

After having digested Russell’s book, I’d go on with the classical work on Dow Theory written in 1932.
The Dow Theory (Fraser Publishing Library) [Paperback] Robert Rhea (Author) 

After Rhea’s book, and last, but definitely not least by any means, I’d continue with this one:

Dow Theory for the 21st Century: Technical Indicators for Improving Your Investment Results [Hardcover]  Jack Schannep (Author) 


Schannep’s book is definitely a great one and makes a wonderful job in presenting an updated version of the Dow Theory while respecting its essentials. It is written from a real investor to the real investor. It is a no-nonsense book

Anyone really interested in fully understanding Dow Theory should read at least three times each of the three books I have just mentioned.

Wikipedia does a pretty good job in giving us a cursory glimpse into Dow Theory.

While not enough to make you an outstanding Dow Theorist, Wikipedia may be helpful to give you a foretaste of the Dow Theory.

In another future post, for those with the time, passion and inclination for a deeper understanding of the Dow Theory, I will recommend some other books.

The Dow Theorist

Tuesday, August 28, 2012

The Dow Theory Investment Blog is born!

We are up and running!

The Dow Theory Investment blog is born. 

We will be following the markets according to the Dow Theory.

And in the process, we will learn a lot about the Dow Theory, the importance of technical analysis and how to protect our savings.

See you soon.
The Dow Theorist