A secondary reaction within a primary bear market
As I promised in my yesterday’s post in this Dow
Theory blog, I will provide you with additional information as to the ongoing
secondary reaction.
As a recap, we know that the Dow Theory signaled a
primary bear market on Nov 16. You have the details concerning such Dow Theory
signal here and here.
The primary bear market lows were made on 11/15/2012
by the SPY and Industrials at 12542.38 and 135.70 respectively. The Transports
bottomed next day, 11/16/2012 at 4891.27.
From that point until 11/30/2012 the SPY and the
Industrials rallied to 142.15 and 13025.58. This amounts to a 4.75 % rally for
the SPY and a 3.85% rally for Industrials. The Transports made their rally
highs on 11/29/2012 at 5145.35 for a gain of 5.19%.
As I wrote in a previous
post:
"There are three requirements that always must be met in order to
qualify a movement contrary to the prevailing primary trend as a secondary
correction:
1)
Firstly, it must last at least 10 trading days. This requirement has been met
by the three indices I monitor (DJI, DJT and SPY).
2)
Secondly, it must at least be 3% movement. As per Dow Theory a rally or
a decline to be meaningful must result in a net reversal of direction exceeding
3%.
3)
Two indices must confirm. The movement of one index unconfirmed by the other
leads to deceptive conclusions.
There is a fourth requirement that comes in handy when appraising secondary
reactions. A secondary reaction tends to retrace 1/3 to 2/3 of the previous
primary up movement. However, this rule is to be interpreted with flexibility.
If a reaction retraces just 20% of the previous primary movement, but it lasted
three months, then I’d tend to label such a movement as a full secondary
correction in spite of not having retraced 1/3 of the prior movement".
Therefore, if we
apply the preceding rules to current market action, we can see:
1)
10
trading days elapsed between the lows of 11/15/2012 and the highs of 11/30/2012
for the SPY and the Industrials.
2)
Both
indices exceeded the minimum threshold of 3%.
Accordingly, the rally that started on 11/15/2012 must
be labeled as a bullish secondary reaction against the primary bear market
trend.
Here you have a chart that helps you visualize the
ongoing secondary reaction (highlighted with blue rectangles).
![]() |
The rally contained in the blue rectangles qualifies as a secondary reaction under Dow Theory |
What about the Transports? As we can see, the
Transports only rallied for 8 days.
However, as you know if you are a follower of this blog, given that the
Industrials and the SPY have rallied for a minimum of 10 days, we may safely
declare the market as undergoing a secondary reaction. Confirmation merely
means two indices confirming, not three.
Let’s have a look at the retracements from the latest highs.
The retracements are measured taking into account the percentage “lost” from
the latest highs (09/14/2012 for the SPY and 10/05/2012 for the Industrials) to
the latest lows (primary bear market lows 11/15/2012) and the percentage
“retraced” or gained since such lows until the rally highs of 11/30/2012.
SPY: ca. 55% retracement of the prior bear market
swing.
Industrials: ca. 46% retracement of the prior bear
market swing.
So roughly ½ of the previous primary bear market
decline has been recovered. This is fully in line with the typical retracement
of a secondary reaction.
So, we can safely conclude that the stock market is
undergoing a secondary reaction. If this secondary reaction is followed by a
new decline (in at least one index) exceeding 3% (which seems likely according
to today’s market action), and such decline is followed by a new upward thrust
jointly breaking the 11/30/2012 highs, then we would have a new primary bull
market signal.
If, conversely, the markets fail to break the
11/30/2012 secondary reaction highs and violate the 11/15/2012 primary bear
market lows, then the primary bear market will be reconfirmed.
I’d like to finish this post by stressing that the
issue of appraising secondary reactions is a tricky one. For those of you
willing to learn more about them, I suggest you read my post in this Dow Theory
blog “A primer on secondary reactions under Dow Theory” which you can read here.
Sincerely,
The Dow Theorist
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