Friday, October 19, 2012

Special Dow Theory issue: Revisiting the 1987 crash

The Dow Theory saved its followers.

As I promised earlier today, here are my two cents on the October 19, 1987 crash.

So, how fared those that followed the Dow Theory? Were they spared?

The answer if a clear: YES. They were spared.

In this study, I will use “classical” Dow Theory with just the Industrials and Transports. I do this because in “real time” Schannep’s improvement by including the S&P was not known yet (or at least was not known to the majority of the public since his seminal book was not published yet). More on Schannep’s book here:

However, even “classical” Dow Theory was responsive enough to keep us on the safe side of the market during the market crash.

Look at the chart below which displays the period surrounding the crash.

October 1987 Crash: The Dow Theory kept investors protected
 We can see that the highest high of the Industrials was sported on 08/25/1987 at 2722.42. The highest high of the Transports was made on 08/14/1987 at 1101.16.

From such highs a secondary reaction developed. The lows of the secondary reaction were jointly made on 09/21/1987. The Industrials’ low was 2492.82 and the Transports’ low was 1005.80. Hence, percentagewise the Industrials declined 9.21% and the Transports 9.48%. The secondary reaction lasted 18 trading days (from 08/25 to 09/21) thus fulfilling the time requirement for a secondary reaction (even for those Dow Theorists who require at least 3 weeks).

A rally ensued that exceeded 3% in both indices. Thereafter, the markets headed south. On 10/09/2012 the Industrials violated the preceding secondary reaction lows of 09/21/1987. However, the Transports didn’t confirm. So no primary bear market signal was displayed.

On 10/15/1987 the Transports violated its secondary reaction lows giving a Dow Theory primary bear signal. At the close of that day, the Transports stood at 980.24 and the Industrials at 2355.09.

Those nifty investors could have exited at the close. Those less reactive investors should have exited next 10/16/2012 (Friday) at the open. Under Dow Theory, there is no excuse for getting out later than that.

So, how much “lost” Dow Theory investors from the highest high of the Industrials to the exit point at 2355.09? Let’s do the math: (2355.09/2722.42)-1 =

-13.49% Loss for followers of the Dow Theory.

How much was to lose the market from the 2722.42 high to the 1738.74 low? Let’s do the math again: (1738.74 / 2722.42)-1 =

-36.13 % Potential loss for ordinary investors.

No need to use more letters or words. The facts speak for themselves.

And what would have been the numbers if we had used the Schannep version of the Dow Theory? The answer: Even better. According to his book, the loss would have been further reduced by 2.4% (page 114).

This is my Dow Theory way to celebrate the 25th anniversary of the Black Monday.


The Dow Theorist.

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