Tuesday, September 11, 2012

What should I do if I missed the Dow Theory bull signals for the SPY and GLD? Dow Theory’s second chance: The first secondary reaction.

In my yesterday’s post which you can find here I have made clear that under Dow Theory both the SPY and GLD are in a primary bull market. Furthermore, I explained that both markets offered the best risk reward ratio (RRR). In other words, the stop losses are sufficiently close to the entry points (June 29 for the SPY and August 22 for GLD).

All this is fine and dandy for those that recognized the “buy” signal in “real time”. However, those that failed to recognize the signal may get the feeling of having been left high and dry. Nothing is more irksome than to recognize a primary bull market and being left out in the cold.

Should the investor “chase” the SPY and GLD? Or should he write off this trade as a lost opportunity?

No. The investor shouldn’t jump aboard right now, because as you can see from the latest figures posted here the potential loss has almost doubled from the original entry point. In this post I spoke of a RRR of roughly 6 which is excellent (this means a potential gain of 40% divided by a maximum loss between 6-7%). However, after the solid advance we have witnessed since the Dow Theory signaled the bull market for the SPY and GLD, the markets have gone up 5.74 and 4.58 respectively. In other words, an entry point at this juncture would offer a much diminished RRR; barely above 3.

However, it is likely (albeit not a sure thing) that sooner or later a secondary reaction will correct part of the gains hitherto made by SPY and GLD. We know that secondary reactions are likely to retrace from 1/3 to 2/3 of the previous advance. We know that, until now, both markets have gained more than 12% since the inception of their respective bull markets. So a secondary reaction bringing down the gains to, i.e. 6% wouldn’t be uncommon (this would be a 50% reaction). But, what happens if prices go down by 6%? Then, provided the primary bull market doesn’t end up in a fizzle, you have just found your second sweet entry spot. You would have at your disposal the same entry prices that were available on June 29 (SPY) and August 22 (GLD).

Of course, if the primary bull market continues, this would mean your last chance. “The postman always rings twice”, but not three times. By definition, the next secondary reaction should make higher lows and, hence, offer you a lower RRR.

Until now we have just had what I’d term the “first leg” of the primary bull market. For me a “leg” is a full uncorrected move. This is precisely what we experienced. However, such “legs” (primary uncorrected movement) tend to last on average ca. 3 months. Thus, statistically, this “leg” is starting to get old and a secondary reaction might be due. However, under Dow Theory I don’t see any signs of an impending secondary reaction yet. 

By the way, for those with a greater risk appetite maybe silver is worth a second look. The higher risk (larger Dow Theory stop loss) may be compensated by a larger reward given silver's higher volatility. You can find the most recent figures about silver (SLV) here

Bottom line: When the market undergoes the first secondary reaction in a primary bull market, you should be happy for two reasons:

1)     If offers you the last chance to jump aboard under the same “conditions” (price) as those that recognized the bull market earlier.

2)   It moves the Dow Theory trailing stop higher (when the secondary reaction is over) so that you keep your losses short and let your profits run. More on this here  

So keep following these posts in order to see whether the “Postman will ring twice”.

If you want to know more, you should maybe read my post "Why Dow Theory matters: Outstanding Risk Reward Ratio thanks to the Dow Theory’s trailing stop" which you can find here

Have a nice evening while the markets are closed.

The Dow Theorist

No comments:

Post a Comment