Thursday, October 16, 2014

Dow Theory Special Issue: After the dust hast settled: Commentary to the Dow Theory primary bear market signal

Trends in gold and silver have not changed

Let’s make a brief recap.

Yesterday I announced that stocks are under a primary bear market. You can find the details here.

The primary bull market started on June 24th, 2013 (on that they were made the final primary bear market lows). The primary bull market was signaled on July 18th, 2013, as explained here and here.

The primary bull market underwent and survived four secondary reactions and was re-confirmed as bullish on October 17th, 2013, and November 13th, 2013, March 7th, 2014, and more recently, September 2nd, 2014, for the reasons given here, here, here and here.

However, the US stock market was not able to survive the last secondary reaction which started on September 18th (for the SPY and Transports) and September 19th (for the Industrials). The last and ongoing secondary reaction by violating the last completed secondary reaction lows (those made on August 7th, 2014) has signaled a new primary bear market. Now such a last secondary reaction has been requalified as the first leg or swing of the new primary bear market.

How did followers of the Dow Theory fare?

The entry point (taking the SPY as a proxy of the S&P) was 168.87 on July 18TH, 2013.

The exit point was October 10th, 2014’s close at 190.54

Now I will make some observations concerning the profit made and putting it into context. It will help you in your understanding if, while reading the following lines, in another tap you open this article:

All the figures I will refer to are based on Schannep’s Dow Theory flavor, which as you should know by now, is the exclusive “flavor” I use (seasoned with my own personal touch, about which I will write in a future post, if I find the time)

The SPY has made 12.83% since the primary bull market was announced (dividends, slippage and commissions not included) on July 18th, 2013. Not such a bad result, bearing in the carnage seen in the last few days. As you can see the combined play of the four alternatives “stops” I alluded to yesterday seems to do a good job in protecting unrealized gains. Please mind that three out of the four “stops” I referred to are mentioned by Dow Theorist Rhea, so they are not an invention of mine. The -16% stop (please read my yesterday’s post) is a valuable addition made by Schannep, who fully documented it in his masterpiece book “The DowTheory for the 21st Century."

So the last primary bull market signal clearly belongs to the ca. 70% of successful signals (those signals that end up in profits). No time to brag, since it could have been a loser.

The position taken in pursuance of the Dow Theory signal lasted 450 days, which is very close to the average trade duration under Schannep’s Dow Theory flavor (479 days) and lower than the average trade duration for only winning trades (as ours) which is 621 days. This shorter duration (although in the antipodes of a short term trade), tends to confirm me that, more likely than not, we are still in a secular bear market. Please bear in mind that the average trade duration during secular bear markets is lower (283 days), whereas the average trade duration during secular bull markets amounts to 864 days.

By the way, when analyzing the primary bull market signal out of which a profit of 12.83% has been realized, I wrote that I wasn’t expecting a monster primary bull market. Why? Because I insisted we are under a secular bear market. I quote:

“How long is supposed this new bull market to last?

Rhea wrote in 1932 that:

“there is no known method of forecasting the extent or duration of a primary movement”

Thus, anything can happen. It may be stillborn (if the market stages a powerful decline that violates the 06/24/2013 lows), or it may last one or even two years. Nobody knows.

Since I consider the secular trend of the market as bearish (more about the bearishness of the secular trend here), which is kind of “secular” headwind, I’d be tempted to say that the odds favor a shorter life-span. My research shows that primary bull markets tend to be shorter lived (but still profitable) when they occur in the midst of a secular bear market. However, determining whether the market is in a secular bear or bull market is not an easy feat, as it requires “fundamental” thinking (i.e. gauging values), and one can be proven wrong. Ex post facto is very easy to spot secular bull and bear markets on the chart; in real time, it is quite another thing.

After such caveats, if we believe that we are under the spell of a secular bear market, my research of Schannep’s Dow Theory signals shows an average duration of 283 days (ca. 0.77 years). Therefore, secular bear markets matter. “

Here I also wrote about the significance of secular bear markets in shortening the average trade duration:

“Trades last significantly less when there is a secular bear market. 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.

If we are under the spell of a secular bear market, we should look at the average trade during bear markets. According to my calculations, transactions taken in pursuance of Schannep’s Dow Theory during secular bear markets lasted on average 283 days, which is significantly less than the average duration figure regardless of the secular condition of the market.”

Another reason that advocates for a secular bear market (peppered with its cyclical primary bull markets which are fully investable, as you have just seen in the present trade) is the amount won. The average gain during secular bull markets amounts to a whopping 53.37%, whereas the average winning trade during secular bear markets amounts to just 5.46%. The gain made in our last trade, namely, 12.83% seems to be closer to what is normal under secular bear market conditions.

Let’s move on to another aspect:

How much has lost the SPY since its market highs of 09/18/2014 at 201.82?

Here is the answer: from the closing highs to October 10th closing low:  -5.59%.

I feel few timing systems can beat the Dow Theory when it comes at being responsive. A loss from the top of just -5.59% implies excellent timing for a system designed to trade cyclical bull and bear markets. Please bear in mind that official lore says that a bear market is signaled when stocks have gone down by 20%, and a correction is called when stocks decline by 10%.

So I think that, once again, the Dow Theory has done a remarkable good job at “letting profits run", and, more importantly, "cutting losses short."

How long is supposed this new primary bear market to last?

Rhea wrote in 1932 that:

“there is no known method of forecasting the extent or duration of a primary movement”

Thus, anything can happen. It may be stillborn (if the market stages a powerful rally off these lows as happened on mid November 2012 or the end of June of 2013) or it may last one or even two years. Nobody knows.

What we do know, however, is that being invested in stocks when a primary bear market has been signaled will more likely result in losses than in gains. The empirical record of all signals since +116 years attests to this. Whatever the Dow Theory “flavor” of your fancy, it is not advisable to be long when a primary bear market sets in.

We do know something, though. While we do not know how long this bear market is going to last, we know from past experience that primary bear markets last on average 6.2 months after the primary bear market signal has been flashed. We, investors, are indebted to Schannep for his research on this matter, which is freely available under on his website “”.

If you go to the link I gave you, you will see that a bear market may last as little as a few days or more than 20 months. In any instance, don’t argue with the bear and get out of the way.

How deep is supposed a bear market to go?

Again we have no way of knowing beforehand. But if history is to serve us as a guide, Schannep states that the average decline after the primary bear market signal averages 14.8%. But don’t get fooled by averages, a bear market can entail losses exceeding 30, 40 and even 50%. So again, my piece of advice is: Don’t argue with the bear!

Should I short the market?

No. A future post (if time allows) on this Dow Theory blog will show you with hard figures why it is not advisable, once you factor in shorting fees and dividends that you have to pay when being short.

Only skillful short term traders who know their trade (pun intended), could attempt well timed shorts. The rest of mortals are advised to leave this market alone.

What should an investor do?

As it is written in the disclaimer at the footer of this blog, I am not a financial advisor, and I am not engaged in advising people. This blog merely serves an intellectual pursuit and hopes to get people thinking about the market.

Personally, my line of thought is as follows (which is the same the one I had two years ago and has been hitherto been proven right):

·        For medium and long term positions (i.e. anything lasting more than a few days) I would be out of stocks completely. No questions asked. 

·     The position to be is cash or very short term debt. However, I would be mindful of the balance sheet of the bank in order not to be cyprused. 

·       I would have very short term US and German debt, and would be mindful of the legal fine print to be sure that I am the real owner and not a mere creditor of a financial institution.

·        As to paper gold and silver and their miners, followers of this blog now that we are in a primary bear market. So don’t touch them until the primary trend turns bullish.

·        I’d have, though, a healthy measure of physical gold, as explained here. Physical gold has optionality in case there is a reset. 

·        And I would be very patient, under the current circumstances with bonds also falling out of bed. Cash and very short term debt shouldn’t burn a hole in our pockets. 
  - Those that are able to extract profits off the market with short term trading may continue trading stocks (being long) provided: (a) they know what they do, (b) have predefined stops and exits and (c) if possible adjust their strategy settings to a primary bear market condition (i.e. by demanding less powerful rallies when selling into strength).


·     In spite of today’s primary bear market signal, those invested under Dow Theory have managed to make a healthy profit nearing 13 % in ca. 15 months.

·     The Dow Theory, again, has been able to keep losses short.

·     A bear market has been signaled at less than 6% off the market top. This is certainly excellent timing.

·     All medium and long term investors should at the very least sell down or get out completely of stocks.


The Dow Theorist.

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