Monday, October 8, 2012

What should I do if I missed the Dow Theory bull signals for the SPY? Dow Theory’s second chance: The Transports

Latecomers' new opportunity to be long stocks

 In my post “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” which you can read here I explained how latecomers could join in the bull crowd. However, the ideas advanced in the post required the development of a secondary reaction in the SPY and the Industrials. Hitherto such secondary reaction has failed to materialize. The market is not supposed to accommodate our wishes and it is us that should react according to market action. This is what I am doing right now by writing this post in this Dow Theory blog. 


For more details as to why I don’t recommend getting in the SPY “at any price," please read the above mentioned post in this Dow Theory blog. There you will find an extremely useful discussion on risk reward ratios. 


However, I feel that the market is delivering another golden opportunity for those willing to get in but not being able to do so at current SPY market levels.

This second opportunity is just materializing in front of our noses, and it is the Transports. As you have read in previous posts in this blog (here and here), since October 4 I have been saying that the Transports are coming back to life.


The Transports until very recently were near the June 4 lows. Such lows defined the end of the primary bear market, the start of the ongoing bull market and established our stop-losses as per Dow Theory, since the joint violations of such lows (by the SPY and Industrials) would imply the demise of the current primary bull market.


Unlike the Transports and the SPY which have had a sizable run up off the lows (you can check the figures in my daily “Dow Theory market update”), the Transports have been hovering around the lows. This is good news for latecomers, provided the Transports weakness is over. Why do I believe that the worst is over? Because, as I wrote before, in the last seven days the transports are clearly displaying more relative strength than the Industrials and the SPY. Given that all primary bull markets should be given the benefit of doubt, the most likely outcome is that the Transports will finally join the bullish parade. We shouldn’t forget that overwhelmingly (more of this in a future post) primary bull market signals tend to be right, and hence it is to be expected that the stocks will continue advancing at least for some eight months (which would render a 12-month  bull market, given that four months have already elapsed). 

If the odds favor a continuation of the bull market and historically, the Transports tend to join in belatedly the bull market, I feel we have now in front of us a sweet entry point.

The skeptical mind will be asking: “He is suggesting that we buy weakness, and this is always dangerous because 7 days of slightly better relative strength is not enough to turn the moribund Transports bullish."

Well, of course, if we want to be really sure about the Transport being stronger, we should wait until the Transports highs of 09/14/2012 are exceeded. This would confirm the primary bull market also in the Transports.

However, I insist, under Dow Theory, we are already in a primary bull market. So either the laggard turns stronger, or the strongest (SPY and Industrials turn weaker).

But I will tell you my little secret that makes me so confident about buying now and not waiting until the Transports break the last significant highs of 09/14/2012.

The lowest relevant low of the Transports under Dow Theory was made on 09/28/2012 at 4892.62. Currently, the Transports stand at: 5057.05. So an entry at this point would imply a risk of 3.3% versus an average likely reward of ca. 40%. This is an astounding risk reward ratio of more than 12. Really unbelievable and unbeatable! We could be wrong 11 times and only right once and still get even.

Dow Theorists like Sparta Fritz Jr and A.M. Shumate (authors of “Making the Dow Theory Work”) which you can buy here, advocated for buying near the lows when the odds clearly favor an upward movement.

If we are strict with the Dow Theory, then we should wait until the 09/14/2012 highs at 5215.97 are broken. Under such scenario, we would have a risk of ca. 6.6% versus a reward of ca. 40% (this is the average gain made in bull markets) which results in a very respectable RRR of ca. 6. The advantages of not jumping the gun right now are as follows:

·        The bullish trend in the Transports will be more consolidated. Now we are speculating that the Transports will turn bullish. However, we need the highs of 09/14/2012 to be broken to be sure under Dow Theory that the Transports have turned finally bullish.

·        You will have an ampler stop-loss (since it would remain at the lows of 09/28/2012 at 4892.62), and you will be less likely to be stopped out.

Every investor should make its own decisions. I just want to open your mind as to possible scenarios.

Maybe a solution would be to start a commitment with 50% at current levels and add 50% when the highs of 09/14/2012 are broken. It’s up to the investor to decide.

I can only tell you that latecomers may get their second change to join in. Now it is up to them to read this post and this one many times over and make up their mind.


The Dow Theorist.

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