In this post,
I explained that a primary bull market had been signaled in Chinese stocks. Let’s look
a bit deeper into it.
Let's start by showing an updated chart:
Anatomy of a primary bull market signal |
I will focus
on the FXI as it represents 25 big companies. It is the equivalent of focusing
on the Industrials (DIA). So, even though, I also use the HAO (small cap ETF),
the following considerations are based on the HAO.
The primary
bear market lows were made on June 25th, 2013 at 31.7.
The primary
bull market was signaled on September 10, 2013; the FXI closed at 38.79.
Thus, our
initial Dow Theory trailing stop (more about such a stop here), is set at the primary bear market lows at 31.7, which
amounts to 22.37% below 38.79.
A stop of 22.37%
is a remarkably wide stop, which exposes the investor to a significant amount
of risk should the market reverse its course and, with no intervening secondary
reaction, violate the primary bear market lows at 31.7. Readers of this blog
know that when dealing with the US stock market, the original Dow Theory stop
tends to be narrower (between 5 and 10%), as explained here.
Why, then,
such a larger Dow Theory stop? There are two reasons:
1)
FXI’s volatility more than doubles
that of the SPY. Given FXI’s larger volatility it is normal that the original
Dow Theory stop is larger. The same happens when trading GDX or SIL. Such
precious metals ETFs have a very high volatility and, accordingly, all price
movements and patterns (including initial Dow Theory stops) reflect such higher
volatility.
2)
The setup leading to the primary bull
market signal was of the variety which does not include a pullback, and which results in a lower entry price
level. The only pullback that occurred (orange circle on the chart) didn’t
reach the minimum volatility threshold to be meaningful under the Dow Theory.
Thus, we had an unusual, but fully orthodox, as explained here, primary bull market signal, which consists on the breaking up
of the last recorded secondary reaction closing high against the primary bearish trend. This
results in a somewhat delayed primary bull market signal and a concomitant larger
original Dow Theory stop.
Of course, if
I were to invest in the FXI, I wouldn’t be willing to risk losing -22.37% if
things go sour. My rule of thumb is that the initial risk should never exceed
more than 10% in long term trades (being long term for me anything that on
average may last 1 year). Thus, my “solution” would be to invest a lower amount
of equity, so that the real amount of capital lost doesn’t exceed 10%. In this
specific case, this would imply investing ca. 44% of one’s capital and letting
the remainder in cash (or better yet, invested in some other trading
opportunity with a maximum risk not exceeding 10%).
Issues of
portfolio composition (that is how much money to allocate to each specific
trade) are almost as important as proper timing the market.
Here you have a recap:
DOW THEORY PRIMARY TREND MONITOR FXI | |||
SPY | |||
Bull market started | 06/25/2013 | 31.7 | |
Bull market signaled | 09/10/2013 | 38.79 | |
Last close | 09/13/2013 | 38.21 | |
Current stop level: Bear mkt low | 31.7 | ||
Unrlzd gain % | Tot advance since start bull mkt | Max Pot Loss % | |
-1.50% | 20.54% | 22.37% |
Have a nice
weekend.
Sincerely,
The Dow
Theorist
No comments:
Post a Comment