Dow Theory Update for January 23: Stocks set up yesterday for primary bear market signal.

More on gold and silver this weekend

US STOCKS

If you want to know how did we fare in 2014 by following the Dow Theory, you may read our yesterday's post, which you can find here. 

The SPY, Industrials and Transports closed down.

Yesterday, the SPY and the Transports managed to rally more than three percent from the secondary reaction lows (January 15^th), and, hence set up US stocks for a primary bear market signal. The Industrials rallied a mere 2.85%. In any instance, as per Schannep’s Dow Theory, if suffices just one index to rally more than 3% from the secondary reaction lows in order to set up stocks for a primary bear market.

If you think I am doing away with the Dow Theory principle of confirmation by merely demanding one index to rally more than 3%, I quote what I wrote in my post of November 10^th, 2012:

“Inquisitive minds should ask: What about the principle of confirmation for the rally that follows the pullback? Isn’t it necessary to have at least in two indices such +3% rally? Since only the Transports underwent such a +3% rally no valid setup exists since confirmation is lacking?

My answer is: You are not misguided, and I wouldn’t brand you as inaccurate if you demanded confirmation (at least two rallies exceeding 3%). Furthermore, when using three indices most of the times one sees two rallies exceeding 3%.

However, Rhea wrote that the principle of confirmation becomes more important the longer the time frame. In other words, a primary bull market signal is meaningless without confirmation. The same basically applies to secondary reactions. However, when it comes to rallies (or small pullbacks in bear markets) which I would label “tertiary movement," some Dow Theorists are lukewarm with the principle of confirmation.

Here are two quotes from Hamilton (contained in Rhea’s master book “The Dow Theory”) which are illustrative:

“…Dow’s theory….stipulates for a confirmation of one average by the other. This constantly occurs at the inceptions of a primary movement, but is anything but consistently present when the market turns for a secondary swing”

“This illustration serves to emphasize the fact that while the two averages may vary in strength they will not materially vary in direction, especially in a major movement. Throughout all the years in which both averages have been kept this rule has proved entirely dependable. It is not only true of the major swings of the market but it is approximately true of the secondary reactions and rallies. It would not be true of the daily fluctuation (…)”

So from the two quotes we can deduct that a rally may be considered in itself without requiring confirmation. While this is not carved in stone and confirmation is always welcome, when we talk of a tertiary movement, we can be a little less demanding with the principle of confirmation. Please mind that one of the quotes even questions the inflexible application of the principle of confirmation to secondary reactions. As far as I know contemporary Dow Theorists like Russell, and Schannep have not gone that far and require confirmation for secondary reactions. So do I.

However, Schannep has done away with the requirement of confirmation when it comes to the rally that follows the secondary reaction in a bull market (same reversed in a bear market). Bearing in mind the preceding quotes, I don’t find anything irregular in it. However, those followers of the Dow Theory that also demand confirmation even for such rallies are not wrong either. Both interpretations may be fully reconciled with the Dow Theory.

Personally, I tend to follow Schannep quite closely and hence, I feel satisfied with just one rally after a secondary reaction has been established (which requires at least two indices going down by more than 3%). “

End of quote.

All in all, now we can say:

1)     The lows of the secondary reaction have been firmly established.

2)     Their joint violation would entail a primary bear market signal. 

3)     If stocks broke above the last recorded closing highs (12/26/2014 for the Industrials, and 12/29/2014 for the SPY and Transports), the primary bull market would be reconfirmed. 

Here you have an updated chart (the orange rectangle on the right side displays the secondary reaction and the ellipses display the current rally from the lows):

 

Ellipses show rally exceeding 3%. Set up for primary bear market signal completed on 1/23/2015

So now we have to wait and see…

The primary trend remains bullish, as explained here and here.

The secondary trend is bearish as explained here.

Gold and Silver

SLV and GLD closed down. The primary trend is bullish as explained here. The secondary trend is bullish too (no secondary reaction in sight).

This weekend I will post some thoughts concerning the primary bull market signal for SLV and GLD. As you will read, I particularily like this specific signal in terms of risk reward and chart structure (which makes it easy to attain handsome rewards).

 

Gold and Silver miners ETFs (GDX and SIL)

As to the gold and silver miners ETFs, SIL closed and GDX closed down.

On January 12, 2015, a primary bull market was signaled. More information as to the details of such a signal here.

The primary and secondary trend is bullish.

Some days ago I wrote that I’d feel more confident about the brand new primary bull market in gold and silver stocks, if the precious metals themselves were soon in a primary bull market. Well, now the entire precious metal universe is under a primary bull market. The principle of confirmation also applies on this basis: Bullishness in the stocks confirmed by the metals themselves (and vice versa) lends more credence to each respective bull market.

Sincerely,

The Dow Theorist