Saturday, May 30, 2015

Dow Theory Special Issue: Dual Momentum versus Dow Theory

Trends remain unchanged

I have compared in the past the Dow Theory versus moving averages. Let's compare now the Dow Theory and Dual Momentum.

This post is the edited correspondence with one follower of this Dow Theory blog.

He, like I, has read the book "Dual Momentum Investing", by Gary Antonacci. 

By the way, I wrote a laudatory review of his book here.

 I was asked whether dual momentum, as expounded by Antonacci was even better than the Dow Theory, since Dual Momentum boasts an annual return of 17.43%.

What follows is my answer with some more "meat" I have added during the writing of this post.

Antonacci’s dual momentum seems to have a máximum drawdown of -22.72% (page 102) (with a lookback period from 1974).

Schannep’s Dow Theory has had a lower drawdown (I don’t have here the exact figure) (with a lookback period from 1956). I suggest you go back to this page, in order to fully understand why Schannep’s drawdowns are well contained and likely not to get out of hand in the future.

The longer the lookback period, the more realistic the maximum drawdown. However, always bearing in mind that the worst drawdown in our career lies ahead. Thus, I find more credible Schannep's drawdowns (due to a longer lookback period) than those of Dual Momentum. I am not implying that dual momentum is a bad strategy, since I have written in the past that if I forgot all I know about the Dow Theory, I would immediatly make dual momentum my investing strategy of choice.

The average “loss from entry point” (be it actual –losing trade- or potential) with Schannep tends to be around 4-8%, which is quite narrow. If we had 3-4 losing trades in a row we could match Antonnaci’s drawdown. This has not happened yet, but it can certainly happen when looking forward. But such a bad luck (string of losing trades, or death by a thousand cuts), could also afflict Antonnaci, as it affects all who don't stick to "buy and hold". However, Schannep’s Dow Theory has a quirk (to be explained in the future, if I find time and focus) which makes such scenario a very unlikely event.

There is another thing that makes me more comfortable with just the Dow Theory. It has nothing to do with technical analysis. In my blog I have writtten several times that, even though, I am a technical guy, I have eyes to see and a brain to thing. Personally, and I can be “fundamentally” wrong, I distrust bonds, t-bills (yes, what if one day the USD goes under or there is a reset; look what happened to the EUR/CHF some days ago). So, on the eve of a big reset, stocks could show less momentum than bonds (first deflation, then, suddenly, high inflation), and following Antonacci, one should be in bonds. All in all, I don’t like debt, I like equity, and, as an insurance with optionality, physical gold. While all this is “fundamental”, I feel more comfortable “trading technically” with a system (Dow Theory) focused on equities and avoid debt instruments.

During Weimar (Germany) hyperinflation, debt was destroyed. Equities hold some ground (even though they lost real value), and gold and USD made real purchasing power gains.

So, under the current economic environment I distrust all kinds of debt (be it USD, EUR o JPY denominated).  If I don’t want to touch debt, then Antonacci’s system becomes somewhat maimed.

As to physical gold, this is a very personal decision.

As to equities, I feel comfortable with the Dow Theory. Having said this, if I didn't know the Dow Theory, I'd find Antonacci's Dual Momentum the best technical strategy to follow (for trades with a time horizon of ca. 1 year). So, I find Antonacci's strategy very sound. 

Furthermore, there are some ways to increase the basic performance of the Dow Theory and aim for dual momentum returns. Instead of buying the indices, if you just buy high relative strength stocks when a primary bull market is signaled and sell them when a primary bear market is signaled, you tend to make much more than by merely buying the SPY. However, you get more of a roller coaster. Of couse, this strategy can be improved (and has been improved) but even the basic version works well. 

Another way to try to add an additional 3-4% annual performance to the Dow Theory would be buying stocks with positive insider buying ratings. I am in the early stages of this research but preliminary I think that coupling stocks with good insider buying when a primary bull market signal is flashed and selling them when a primary bear market is signaled is a sensible way to aim for greater returns with a very limited risk (as such stocks tend to have lower draw downs unlike high relative strength stocks). The best book I have read, which contains in-depth research, concerning insider buying is "Investment Strategy for Insider Trading". Read the book and start exploring coupling such stocks with a Dow Theory filter, and relax.


The Dow  Theorist

Wednesday, May 20, 2015

Dow Theory Special Issue: A closer look at the Chinese primary bull market in stocks

Some days ago, I made a cursory reference to an ongoing primary bull market in Chinese stocks.

One reader of this Dow Theory blog kindly asked me to further analyze the bull market in Chinese stocks.

As I explained here, the Dow Theory can also be applied to foreign stocks indices and even assets other than stocks (as I do with gold and silver).

 Let’s begin with an updated chart showing you the development of the primary bull market since its inception to today.

On the top of the chart I have plotted FXI (IShs China Large Cap ETF). At the bottom of the chart I have plotted HAO (Guggenheim China Small Cap). So we have two indices that are quite related. They are similar enough and, at the same time, different enough, to be a good “dancing pair” in order to apply the Dow Theory. 

As with US debt ( ), the bull market started hesitatingly to be followed by an explosive move

The primary bull market signal was flashed on 7/3/2014 (vertical line on the left of the chart, blue arrows), when FXI confirmed the higher closing high made by HAO on 7/2/2014. The blue rectangle on the left side of the chart partially displays a secondary bullish reaction against the then existing primary bear market.  The blue rectangle on the middle of the chart displays a secondary bearish reaction against the primary bull market. HAO made a higher high (penetration of the red horizontal line, whereas FXI did not confirm. Lack of confirmation implied that we could not declare the secondary reaction as extinguished and, hence, the primary bull market had not been reconfirmed.

Next, HAO violated its secondary reaction lows several times whereas FXI did not deign to confirm. Lack of confirmation by FXI implied that no primary bear market had been signaled. So the Chinese stocks market was caught with a double non confirmation. On the one hand, there was not enough bullish thrust to re-confirm the primary bull market; on the other hand, there was not enough bearishness for a primary bear market signal to be signaled. As always, the benefit of doubt is to be given to the existing primary trend, and hence, the primary trend remained bullish during these weeks of non-confirmations. The price action of FXI and HAO reminds me the words of Market Wizard trader Minervini, who wrote in his book "Trade Like a Stock Market Wizard" that quite often explosive moves are preceded by a shake out. Lower unconfirmed lows fit quite well within the definition of a "shake out". By the way, while not strictly Dow Theory, Minervini's book contains many pearls of market wisdom. In spite of my being "Dow Theorist", technical knowledge is always welcome, especially when it comes from investors with a proven track record. While this could well deserve a future post on this Dow Theory blog, I feel many of Minervini's insights can be successfully merged with Dow Theory tenets.

Finally, on 01/21/2015 FXI broke above its last recorded primary bull market highs (red horizontal line), and hence the primary bull market was re-confirmed.

As of this writing, the primary bull market remains unchallenged. The secondary trend remains bullish too, as the decline that followed the last recorded highs has not even met the time requirement. I see that on 5/4/2015 HAO made a higher closing high which was unconfirmed (highlighted by ellipse on the right side of the chart). This might be hinting at the development of a secondary reaction. But it is too soon to tell.

So what I see on the charts is:

·        New primary bull market for the Euro (which implies weaker USD).
·        US debt on the verge of a primary bear market signal (but not there yet).
·        US Stocks have reconfirmed the primary bull market.
·        Chinese stocks under their own primary bull market as well.

More about the Euro, the USD, and USD denominated debt, here.

And, concerning, the re-confirmation of the primary bull market in US Stocks, here.

Precious metals and their miners EFTs, in spite of their being in a primary bull market, remain firmly caught in a secondary bearish reaction.

So let’s see what happens….

The Dow Theorist

Monday, May 18, 2015

Dow Theory Update for May 18: Primary bull market for US Stocks reconfirmed

 Trends unchanged in all markets.


On 5/14/2015 the SPY bettered its last recorded primary bull market closing high of 3/2/2015. Today the Industrials has confirmed by exceeding its 3/2/2015 closing high.

As per my reading of the Dow Theory, stocks did not even enter into a secondary reaction, since the lowest confirmed closing lows of the downward movement were made 03/11/2015, and the time requirement (at least 8 days of declining prices as the average of the three indices) was not met on that date. From that point, the SPY and the Industrials refused to make lower lows, and hence the lower lows of the Transports were not confirmed. All in all, we didn’t even get a proper secondary reaction, and this is why I was labeling during all these weeks the secondary trend as bullish.

Here you have the chart depicting the most recent action:

Blue horizontal lines (primary bull market highs) jointly bettered by the Industrials and SPY

So, both the primary and secondary trend remains bullish.

I know that I am slightly departing from Schannep. According to Schannep, “in the clear” signals require confirmation by the three indices. Furthermore,  the Transports are not merely non confirming but diverging (that is going down, whereas the SPY and Industrials go up). Thus, according to Schannep’s Dow Theory, the primary bull market has not been reconfirmed, and we have to wait until:

a) Either the SPY violates the last recorded secondary reaction lows.

b) Or the Transports joins the bullish parade and breaks up above the last primary bull market highs.

For practical purposes, the difference between Schannep’s interpretation and mine is that I will begin to monitor the development of a new secondary reaction from the newer higher highs. The counting of days for gauging a new secondary reaction is set to zero. Thus, a practical implication of my way of applying the Dow Theory, is that it tends to produce “narrower” Dow Theory stops, as secondary reactions are appraised in some instances earlier than under Schannep’s Dow Theory. This is neither good nor bad. It just depends on the risk tolerance and global psychological and financial make up of the investor.

More about this issue here:

Gold and Silver

The primary trend is bullish as explained here.

The secondary trend turned bearish on February 6th, 2015 (secondary reaction against the primary trend) as explained here.

The setup for a primary bear market signal was completed on March 24, 2015 as explained here.

Thus, now:

a) Either the primary bull market closing highs 01/22/2015 are bettered in which case the primary bull market will be reconfirmed.

b) Or the  secondary reaction lows are violated in which case a primary bear market will be signaled.

We have to wait and see.

Gold and Silver miners ETFs.

As to the gold and silver miners ETFs,on 3/10/15 SIL violated its 12/16/2014 primary bear market closing low. However, GDX did not confirm. As per the Dow Theory lower lows unconfirmed have no validity, and hence we cannot declare a primary bear market. Since we cannot declare a primary bear market, the primary trend remains bullish. Furthermore, the GDX and SIL staged a rally that set them up for a primary bear market signal on March 24, 2015 as explained here.

Thus, now:

a) Either the primary bull market closing highs 01/20/2015 are bettered in which case the primary bull market will be reconfirmed.

b) Or the secondary reaction lows (or the primary bear market lows of SIL, and secondary reaction lows of GDX) are violated in which case a primary bear market will be signaled.

Once again, we have to wait and see.

The Dow Theorist