Friday, September 6, 2013

Face off: Schannep versus “classical” Dow Theory

Part IV. Performance comparison under secular bull markets.

Until now this series “Face off: Schannep versus “classical” Dow Theory has focused on comparing Schannep’s and “Rhea/classical” Dow Theory irrespective of the secular condition of the market. In part I we set out the premises of our study (so that we conduct an apple to apples comparison). In parts II and III we provided a wealth of data concerning both Dow Theory “flavors”. However, until now, the results of our analysis did not differentiate between secular bull and bear markets.

The secular condition of the market does matter, though. Positions taken under secular bull markets tend to last longer and be more profitable than trades taken under secular bear markets. By secular market, I mean a market condition that spans many years, which goes beyond the 1-3-year  duration of cyclical bull and bear markets. Dow Theorist Schaeffer wrote that secular markets could last up to 14 years. While I am reluctant to put a limit to the duration of secular bull and bear markets, one thing is certain: they last more than cyclical bull and bear markets and clearly influence the outcomes of the trades taken along cyclical bull and bear markets. However, determining secular bull/bear market conditions is not an easy feat on real time. It looks simple when looking at charts ex post facto (after the fact). Unlike spotting cyclical bull and bear markets, which, under Dow Theory, is done with the exclusive aid of price patterns, determining the secular condition of the market is not an easy feat on real time, since it entails determining value. And “value” determination is far from easy.

As I have written here:

“While classifying secular bull and bear markets is always subjective, there are some guidelines like “q” “PER” or dividend yield, which may come in handy. In a nutshell, secular bull markets start when stocks are very good values. While determining value is always elusive (and this accounts for my being interested in cyclical bull and bear markets with an average duration of less than 2 years), we need a frame of reference. Personally, I am skeptical as to PER and dividend yield for reasons to be explained in a future post on this Dow Theory blog. However, having read, and, more importantly, digested, Smithers and Wright book “Valuing Wall Street” (which you can buy here), I personally feel that the “q” ratio a quite dependable measure of the cheapness or dearness of a market on a secular basis.
Financial writer Doug Short, whom I respect, has recently updated the “q” ratio as you can read here. According to him “q” is currently overvalued, which implies that it is likely that we are still mired in the secular bear market that began in year 2000.”

The longer the life-span of a trade, the more important fundamental and value considerations are. If you are day-trading, earnings, business prospects, etc, play no role in forecasting the stock’s price in the next five minutes. Technical considerations (and significant randomness) are the overriding factors. However, if you lengthen your time horizon to, let’s say, 10 years, fundamental and value-based consideration will prevail and technical analysis will pale by comparison.

Dow Theorist Schaeffer, and to some more nuanced extend, Richard Russell, of the "Dow Theory Letters" advocate in favor of investing along the secular trend. Rhea, Schannep, of "" and this blogger truly yours feel more comfortable investing along the cyclical bull and bear markets that occur within the secular trend for reasons to be given in a future post on this Dow Theory blog. Since, by definition, cyclical bull and bear markets have a shorter duration than secular trends (let’s put it at 1-3 years), the technical condition of the market plays a greater role in determining the outcome of any given trade. Accordingly, the Dow Theory rules are a valuable tool (in my opinion, the best one) to determine the trend on a cyclical (1-3 years basis). Nonetheless, the secular condition of the market, as a distant but powerful tide, affects the profitability of the cyclical bull markets. A secular bull market puts the very long term tide in your favor. This is why it is important to try to ascertain the secular condition of the market, even though one is not interested in investing along with it.

All in all, both Schannep’s and the “Rhea/classical” Dow Theory generate trades which exploit cyclical bull markets. Neither “flavor” attempts at investing along the secular trend. However, the secular trend affects the outcome of the trades taken along cyclical bull markets, and, hence, it makes sense to, albeit tentatively, be able to determine the secular condition of the market. The secular condition of the market will be “head” or “tail” wind, and, thus, it is not to be neglected.

While defining “secular” bull and bear markets is subjective, I have tabulated the following periods:

From 1954 to 1967: SECULAR BULL
From 1968 to 1981: SECULAR BEAR
From 1982 to 2000: SECULAR BULL
From Mid 2000 to now: SECULAR BEAR.

Well, after this lengthy, but necessary introduction, let’s start with our analysis of the transactions taken under secular bull markets.

Schannep versus Traditional Dow Theory vital statistics (secular bull markets)

Total number of transactions (trades) taken:



When secular market conditions are propitious, Schannep’s Dow Theory flashes almost the same number of signals than the “Rhea/classical” Dow Theory. So much for the accusation of Schannep’s Dow Theory being too restive. From this figure, we can deduct that the slightly higher activity of Schannep’s Dow Theory (more trades) takes place when most needed: When a secular bear market results in many aborted cyclical bull markets. When there is headwind, more transactions are the antidote against being caught in a monstrous drawdown. More about this when we analyze Schannep’s performance under secular bear markets. However, when there is tailwind (secular bull market), Schannep’s Dow Theory is as calm as the “classical” Dow Theory.

Average duration of each transaction:

Schannep: 864 days.
Traditional: 856 days.


This is astounding. If you have been following this “face-off” series, you know than when the secular condition of the market is not taken into account, the average trade duration for Schannep’s Dow Theory was ca. 24% shorter than the average trade duration for the “classical” Dow Theory.

Now we see that when we zero in on secular bull markets, the average duration of each transaction is actually longer (albeit marginally) for Schannep’s Dow Theory than for the classical. From this finding, we derive three conclusions:

a)     The myth of Schannep’s Dow Theory being too restive is just that: myth. When there is tailwind (secular bull market), Schannep’s Dow Theory excels at sticking with the prevailing trend, and accordingly, its trades manage to outlast those taken in pursuance of the “classical” Dow Theory.

b)     Schannep’s Dow Theory is better in sync with cyclical bull markets. Longer trade duration implies that more “meat” from each cyclical bull market is extracted by Schannep’s Dow Theory.

c)     Longer trade duration also tells us that Schannep’s Dow Theory is better at timing the entry and exit points, as it stays more time invested in the market.

Average gain in each transaction

Schannep: 53.37%
Traditional: 51.27%


Once again, Schannep’s Dow Theory beats the classical one on this score. However, to be fully sure of the superiority of Schannep’s Dow Theory, it is necessary that we annualize performance so that we account for Schannep’s longer average trade duration. If we normalize, we obtain the following figures:

Schannep: 22.55%
Traditional: 21.85%


Please mind that this figure merely divides the average gain in each transaction by the average time in each transaction. We can see given an equal amount of time (i.e. 1 year) Schannep’s Dow Theory manages to extract more profit from the market than the DowTheory.

While ca. 0.7% annual outperformance doesn’t seem much, we have to bear in mind that, once we capitalize, we see that Schannep’s competitive edge builds up significant profits over time:

If we take base=100 in 1954 for both Dow Theory “flavors”, such 100 would have grown into:

Growth of 100 USD since 1954

Traditional: 3301

Please bear in mind that this capitalization merely refers to the 10 transactions for the classical Dow Theory and 11 for Schannep’s one, taken during secular bull markets. Thus, this is not the total performance of either Schannep’s or the “classic” Dow Theory (as the gains made during secular bear markets are not included). It is merely an indication of what to expect during secular bull markets. However, the figures above clearly show that Schannep’s does a much better job at cumulating profits when conditions are favorable.

Total time in the market (total days invested during secular bull markets)

Schannep:9502 days
Traditional: 8563 days


This statistic shows that Schannep’s Dow Theory manages to “stick” to the cyclical bullish trend longer than the traditional Dow Theory. Since, as we have seen, profits are larger for Schannep’s Dow Theory we conclude that Schannep’s Dow Theory is more efficient at selecting the right trends. More time on the market also suggests that Schannep’s Dow Theory tends to get’s us early aboard (and earlier than the “classical” one). Furthermore, since I know that Schannep’s Dow Theory tends to exit a trade earlier than the classical Dow Theory, we have to conclude that the time spent on the market is well spent.

This assertion is proved if we divide the total percentage points gained by the total time spent in the market.

Total percentage points gained (non capitalized summation):

Traditional: 512.74

Total time in the market:

Schannep:9502 days
Traditional: 8563 days

                            Percentage points gained per day:

        Traditional: 0.0598%

Thus, we can see that given an equal amount of time, Schannep’s Dow Theory was ca. 3.17% more efficient than the “classical Dow Theory." This leads me to conclude that Schannep’s Dow Theory is a better market timing device than the classical Dow Theory.

Winning transactions (trades) versus losing trades

Schannep: 11 winners/0 losers (100% winners)
Traditional: 9 winners/1 losers (90% winners)


While “past performance is no guarantee for future performance," it seems that under secular bull market conditions, Schannep’s Dow Theory is better tuned with the “pulse” of the market.

Since we are analyzing transactions under secular bull markets, the only loser incurred by the “classical” Dow Theory is of minor importance (-5.60% in 1990). However, it is noteworthy that the equivalent trade taken in pursuance of Schannep’s rules, resulted in a modest gain of +2.25% proving, once again, that under challenging market conditions, Schannep’s flavor does a much better job at protecting one’s equity. It is not the same to lose -5,60% than to win +2.25%.

Profit factor

Profit factor is the quotient of total points gained divided by total points lost. More about the importance of a healthy profit factor here.

From 1954 to 2013, we get the following profit factors:

Schannep: Infinite (no hype)
Classical: 92.55

 Of course, we should take such astronomic profit factors with a grain of salt. For sure the future, is going to produce some losing trades (even within secular bull markets), which will lower our actual profit factors. However, one thing is clear, both Dow Theory flavors do a great job at letting profits run and cutting losses short, as expressed by high profit factors.


Well, we this comparative study of both Dow Theory flavors under secular bull markets is drawing to an end.

Schannep’s Dow Theory outperformance is kind of an accomplishment, since during secular bull markets it is very difficult to beat buy and hold or anything closely resembling it (as the “classical” Dow Theory, which theoretically is less prone to trading and hence is more similar to buy and hold). This is a testament to the net superiority of Schannep’s Dow Theory.

Even though, Schannep’s outperformance under secular bull markets, is certainly good news, I must confess that I am more interested in comparing both Dow Theory flavors when the going gets tough, namely, under secular bear markets. Rule number one of investing is not to lose money; and money is lost, and in spades, during secular bear markets. Thus, instead of getting greedy and rejoice at Schannep’s outperformance during secular bull markets (when even buy and holders can make a nice buck without the threat of a killing drawdown), I am more interested in seeing how both Dow Theory flavors fare under adverse market conditions (i.e. secular bear market). It is under market stress when I expect to see Schannep’s Dow Theory to really shine; being the outperformance under secular bull markets just an appetizer.

Thus, readers of this blog stay tuned for the next issue of this “Face-off” saga.

To be continued

The Dow Theorist

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