Wednesday, October 15, 2014

Dow Theory Update for October 15: Stocks in primary bear market


Primary bear market for stocks was signaled on October 10

I am writing before the close. But the final close won't affect my veredict. 

My apologies for neglecting this Dow Theory blog during the last few days. My time is in extremely short supply and, after all, this is a free service without a subscription fee, so no obligation on my side to be “online” permanently, since I prioritize the businesses that feed me.

My charts tell me that on October 10th, the SPY and the Transports violated the last recorded secondary reaction lows of August 7, 2014 (red rectangles on the left side of the charts).  Such confirmed violation of the last secondary reaction lows, signaled a primary bear market. On October 13th, the Industrials did also confirm, although their confirmation was not necessary for the primary bear market signal to exist.

It is true that the current secondary reaction (now requalified as the ongoing first leg of the new primary bear market) is still “ongoing” and hence the 3% rally off the lows which would setup stocks for a primary bear market signal has not occurred yet.

However, a primary bear market signal can also be signaled by a violation of the preceding secondary reaction closing lows when, after making higher highs, stocks start to fall and no intervening +3% rally occurs in any one index. This is exactly what has happened this time. We have an ongoing secondary reaction that goes lower and lower, and no index has hitherto managed to rally by +3%. As per the “stardard” primary bear market signal, we cannot declare the existence of a primary bear market yet, because the current secondary reaction hasn’t manage to put a +3% rally. Of course, adhering strictly to just this set up means that stocks could go down by 16% and we still would be declaring the primary bull market alive and well  (why the decline of 16% as an alternative signal to declare the existence of a primary bear market? The answer here)

Now is when the wisdom of Rhea comes in handy.   I quote from his book “The Dow Theory” (Fraser Edition, page 77):

“When declines in a primary bull market result in violating the lowest points encountered during the last major secondary reaction of that market, it may generally be assumed that the primary trend has changed from bullish to bearish” (emphasis added).

In other words, we have to always keep an eye on the lows of the last completed secondary reaction. If they get violated (by at least to indices) a primary bear market has been signaled. As you can see a primary bear market can be signaled in four alternative ways:

a) The “classical”.

b) The -16% decline.

c) The lows of the last completed secondary reaction.

d) The primary bear market lows (when a new primary bull market has been born, and no secondary reaction has developed yet).

Cogitate these 4 primary bear market signals, and you’ll greatly increase your odds of being on the right side of the market. Please mind the words of Rhea: He doesn't talk certainties but probabilities. Take your time in studying the four signals, as it took me deep reading of Rhea and Schannep to be able to systematize, digest and understand the deep meaning of these 4 signals.

Here you have the chart that says it all:

The lows of the last completed secondary reaction (left) have been violated: Primar bear market signaled

I don’t attempt to forecast how deep or how long will this primary bear market last. This is not our business. It is better, to run for the exits. Maybe stocks bill bounce, I don’t know. But if they do, then soon a primary bull market will be signaled. So, instead of theorizing; we strictly comply with the instructions given by the Dow Theory and remain on the sidelines.

In a future post, I will provide you will calculations as to the realized profit of the last primary bull market signal (which I can see has been clearly profitable)

The Dow Theorist


  1. As always very interesting.

    Didn't know the rule: c) The lows of the last completed secondary reaction.

    when you have the time would you be so kind as to explain :

    d) The primary bear market lows (when a new primary bull market has been born, and no secondary reaction has developed yet).

    Also are there any other rules?


    1. Rule c: Read carefully Rhea's book , page 77 (and for that matter, read the book at least 10 times to fully aprehend Rhea's wisdom).

      Rule d: Same book, same page, same paragraph. I quote:

      "When a series of rallies and declines break trough the lowest prices of a primary bear trend, the probability of much lower prices is generally a reasonable inference".

      end of quote//

      Thus, when a new primary bull market has been born, the last recorded primar bear market lows are our exit point. All these posts have dealt with this:

      Thx for following

  2. do you have any idea of Schannep, Russell or Moroney regarding this situation and if they also say it's now a bear market?

    1. Russell: he follows a different Dow Theory "flavor" which is much less reactive (it is pure Rhea with no changes). However, as I have written on this blog, he's lost it long ago and now the only Dow Theory I see in his letter is the title "Dow Theory". The rest has nothing to do with the Dow Theory. It saddens me to say that as he was not like this in the past, and I learnt a lot from his letters of yesteryear.

      Moroney: As far as I know, not yet, because he follows the less reactive "flavor"; not Schannep's.

      Schannep: He fathered the more reactive Dow Theory "flavor" (and best performing). However, he seems to ignore rule "c" (which is well hidden in Rhea's book). But the more you think about it, the more sense it makes rule "c",as basic rule of trading is to trail stops. Without rule "c" we would be now without stop as under rule "a" we are far from completing the primary bear market signal setup.

      While I am an ardent admirer of Schannep (he was even more important to me than Rhea because he provided a practical framework from which to operate), I deviate from Schannep on three minor issues. Rule "c" seems to be one of them. But please mind that Schannep is one of the best.